-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PsLe0t+q3SDx81EVmeWKIlLrsqwJKOU1zDKAj5uNjrhCL1Jnq9UPIVf0L0V3oGLM 6JpUrH2gLzoAqF0L2IjZzg== 0000935069-09-000992.txt : 20090409 0000935069-09-000992.hdr.sgml : 20090409 20090409140945 ACCESSION NUMBER: 0000935069-09-000992 CONFORMED SUBMISSION TYPE: N-CSR PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20090131 FILED AS OF DATE: 20090409 DATE AS OF CHANGE: 20090409 EFFECTIVENESS DATE: 20090409 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST TRUST STRATEGIC HIGH INCOME FUND III CENTRAL INDEX KEY: 0001380534 IRS NUMBER: 743195115 FILING VALUES: FORM TYPE: N-CSR SEC ACT: 1940 Act SEC FILE NUMBER: 811-21994 FILM NUMBER: 09742206 BUSINESS ADDRESS: STREET 1: 120 EAST LIBERTY DRIVE, SUITE 400 CITY: WHEATON STATE: IL ZIP: 60187 BUSINESS PHONE: 630-765-8000 MAIL ADDRESS: STREET 1: 120 EAST LIBERTY DRIVE, SUITE 400 CITY: WHEATON STATE: IL ZIP: 60187 N-CSR 1 fho_ncsr13109.txt WRAPPER, ANNUAL REPORT, AND VOTING POLICIES UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number 811-21994 First Trust Strategic High Income Fund III (Exact name of registrant as specified in charter) 120 East Liberty Drive, Suite 400 Wheaton, IL 60187 (Address of principal executive offices) (Zip code) W. Scott Jardine, Esq. First Trust Portfolios L.P. 120 East Liberty Drive, Suite 400 Wheaton, IL 60187 (Name and address of agent for service) registrant's telephone number, including area code: (630) 765-8000 Date of fiscal year end: January 31 Date of reporting period: January 31, 2009 Form N-CSR is to be used by management investment companies to file reports with the Commission not later than 10 days after the transmission to stockholders of any report that is required to be transmitted to stockholders under Rule 30e-1 under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may use the information provided on Form N-CSR in its regulatory, disclosure review, inspection, and policymaking roles. A registrant is required to disclose the information specified by Form N-CSR, and the Commission will make this information public. A registrant is not required to respond to the collection of information contained in Form N-CSR unless the Form displays a currently valid Office of Management and Budget ("OMB") control number. Please direct comments concerning the accuracy of the information collection burden estimate and any suggestions for reducing the burden to Secretary, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. Section 3507. ITEM 1. REPORTS TO STOCKHOLDERS. The Report to Shareholders is attached herewith. (GRAPHIC) FIRST TRUST STRATEGIC HIGH INCOME FUND III ANNUAL REPORT FOR THE YEAR ENDED JANUARY 31, 2009 (FIRST TRUST LOGO) (VALHALLA CAPITAL PARTNERS LOGO) TABLE OF CONTENTS FIRST TRUST STRATEGIC HIGH INCOME FUND III (FHO) ANNUAL REPORT JANUARY 31, 2009 Shareholder Letter ........................................................ 1 At a Glance ............................................................... 2 Portfolio Commentary ...................................................... 3 Policy Change ............................................................. 6 Portfolio of Investments .................................................. 7 Statement of Assets and Liabilities ....................................... 11 Statement of Operations ................................................... 12 Statements of Changes in Net Assets ....................................... 13 Statement of Cash Flows ................................................... 14 Financial Highlights ...................................................... 15 Notes to Financial Statements ............................................. 16 Report of Independent Registered Public Accounting Firm ................... 23 Additional Information .................................................... 24 Board of Trustees and Officers ............................................ 28 Privacy Policy ............................................................ 32
CAUTION REGARDING FORWARD-LOOKING STATEMENTS This report contains certain forward-looking statements within the meaning of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements regarding the goals, beliefs, plans or current expectations of First Trust Advisors L.P. ("First Trust" or the "Advisor") and/or Valhalla Capital Partners, LLC ("Valhalla" or the "Sub-Advisor") and their respective representatives, taking into account the information currently available to them. Forward-looking statements include all statements that do not relate solely to current or historical fact. For example, forward-looking statements include the use of words such as "anticipate," "estimate," "intend," "expect," "believe," "plan," "may," "should," "would" or other words that convey uncertainty of future events or outcomes. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of First Trust Strategic High Income Fund III (the "Fund") to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. When evaluating the information included in this report, you are cautioned not to place undue reliance on these forward-looking statements, which reflect the judgment of the Advisor and/or Sub-Advisor and their respective representatives only as of the date hereof. We undertake no obligation to publicly revise or update these forward-looking statements to reflect events and circumstances that arise after the date hereof. PERFORMANCE AND RISK DISCLOSURE There is no assurance that the Fund will achieve its investment objectives. The Fund is subject to market risk, which is the possibility that the market values of securities owned by the Fund will decline and that the value of the Fund shares may therefore be less than what you paid for them. Accordingly, you can lose money investing in the Fund. See "Risk Considerations" in the Notes to Financial Statements for a discussion of other risks of investing in the Fund. Performance data quoted represents past performance, which is no guarantee of future results, and current performance may be lower or higher than the figures shown. For the most recent month-end performance figures, please visit http://www.ftportfolios.com or speak with your financial advisor. Investment returns, net asset value and common share price will fluctuate and Fund shares, when sold, may be worth more or less than their original cost. HOW TO READ THIS REPORT This report contains information that may help you evaluate your investment. It includes details about the Fund and presents data and analysis that provide insight into the Fund's performance and investment approach. By reading the portfolio commentary by the portfolio management team of the Fund, you may obtain an understanding of how the market environment affected the Fund's performance. The statistical information that follows may help you understand the Fund's performance compared to that of relevant market benchmarks. It is important to keep in mind that the opinions expressed by personnel of Valhalla are just that: informed opinions. They should not be considered to be promises or advice. The opinions, like the statistics, cover the period through the date on the cover of this report. The risks of investing in the Fund are spelled out in the prospectus, the statement of additional information, this report and other regulatory filings. SHAREHOLDER LETTER FIRST TRUST STRATEGIC HIGH INCOME FUND III (FHO) ANNUAL REPORT JANUARY 31, 2009 Dear Shareholders: 2008 brought all sorts of challenges to investors. Throughout the year, the financial sector was plagued with failures in banking, insurance and by brokerage firms. By year's end, after a meltdown in the credit markets, historically high levels of volatility in the stock market, and the resulting turmoil to the overall economy, the Dow Jones Industrial Average's ("Dow's") total return was -31.92% (as of 12/31/08). In fact, 2008 was the Dow's third worst calendar year since its inception in 1896. For the year, the negative total return performance of the Dow was surpassed only by 1931 and 1907, two years in which the U.S. was also enduring a major banking crisis. Of the thirty stocks in the Dow, only two were up in 2008. Yet, regardless of the market, First Trust Advisors L.P. ("First Trust") has always believed that in order to be successful in reaching your financial goals, you should be invested for the long term. A long-term investor understands that the market, from a historical perspective, has always experienced ups and downs. But history has shown that the patient investor is typically rewarded over the long term. While no one has the ability to predict when the markets will recover, we believe that staying invested in quality products and having a long-term perspective can help investors reach their financial goals. The report you hold contains detailed information about your investment in First Trust Strategic High Income Fund III (the "Fund"). It contains a portfolio commentary from the Fund's portfolio management team that provides a market recap for the period, a performance analysis and a market and Fund outlook. Additionally, the report provides the Fund's financial statements for the period covered by the report. I encourage you to read this document and discuss it with your financial advisor. First Trust has been through many types of markets and remains committed to bringing you quality investment solutions regardless of the inevitable ups and downs experienced in the market. We offer a variety of products that may fit many financial plans to help those investors seeking long-term investment success. As well, we are committed to making available up-to-date reports about your investments so you and your financial advisor have current information on your portfolio. We continue to value our relationship with you, and we thank you for the opportunity to assist you in achieving your financial goals. Sincerely, /s/ James A. Bowen James A. Bowen President of First Trust Strategic High Income Fund III Page 1 FIRST TRUST STRATEGIC HIGH INCOME FUND III "AT A GLANCE" (UNAUDITED) AS OF JANUARY 31, 2009 FUND STATISTICS Symbol on New York Stock Exchange FHO Common Share Price $ 6.12 Common Share Net Asset Value ("NAV") $ 4.53 Premium (Discount) to NAV 35.10% Net Assets Applicable to Common Shares $41,162,359 Current Monthly Distribution per Common Share (1) $ 0.1200 Current Annualized Distribution per Common Share $ 1.44 Current Distribution Rate on Closing Common Share Price (2) 23.53% Current Distribution Rate on NAV (2) 31.79%
COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE) (PERFORMANCE GRAPH) First Trust Strategic High Income 3 chart plot points
Mkt NAV ----- ----- 2/1/08 12.03 10.09 2/8/08 11.68 10.08 2/15/08 12.12 10.08 2/22/08 11.88 10.09 2/29/08 11.33 10.03 3/7/08 9.79 9.45 3/14/08 10.4 9.45 3/20/08 10.28 9.49 3/28/08 11.15 9.52 4/4/08 11.39 9.07 4/11/08 11.1 8.91 4/18/08 11.15 8.93 4/25/08 11.35 8.98 5/2/08 11.97 8.83 5/9/08 11.7 8.71 5/16/08 11.94 8.72 5/23/08 12.05 8.58 5/30/08 11.91 8.53 6/6/08 11.87 8.32 6/13/08 10.41 8.29 6/20/08 9.95 8.36 6/27/08 10.2 8.38 7/3/08 9 7.99 7/11/08 8.57 7.92 7/18/08 8.95 7.82 7/25/08 8.01 7.84 8/1/08 7.99 7.65 8/8/08 7.6 7.4 8/15/08 7.05 7.45 8/22/08 7.41 7.46 8/29/08 8.29 7.48 9/5/08 8.19 7.31 9/12/08 7.69 7.21 9/19/08 5.84 7.01 9/26/08 6.05 7.01 10/3/08 5.54 6.67 10/10/08 4.6 6.58 10/17/08 5.15 6.4 10/24/08 5.17 6.2 10/31/08 5.24 6.1 11/7/08 5.32 5.97 11/14/08 4.1 5.86 11/21/08 3.81 5.78 11/28/08 4.23 5.75 12/5/08 4.1 5.44 12/12/08 3.69 5.37 12/19/08 4.43 5.27 12/26/08 4.7 5.29 1/2/09 5.17 5.19 1/9/09 5 5.04 1/16/09 5.01 5.02 1/23/09 5.83 5.05 1/31/09 6.12 4.53
PERFORMANCE
Average Annual Total Return Inception 1 Year Ended (3/27/2007) 1/31/2009 to 1/31/2009 ------------ -------------- Fund Performance NAV (3) -43.80% -44.90% Market Price (4) -35.96% -36.76% Index Performance Barclays Capital Ba U.S. High Yield Index (formerly known as Lehman Brothers Ba U.S. High Yield Index) -11.37% -11.44%
% OF TOTAL ASSET CLASSIFICATION (6) INVESTMENTS - ------------------------ ----------- Corporate Bonds 47.0% Collateralized Debt Obligations 27.2 Residential Mortgage-Backed Securities 24.4 Equity 1.4 ----- Total 100.0% =====
% OF TOTAL CREDIT QUALITY (5) INVESTMENTS - ------------------ ----------- BB 9.6% B 33.9 CCC 35.0 CC 17.5 C 3.5 NR 0.5 ----- Total 100.0% =====
(1) Most recent distribution paid or declared through 1/31/2009. This distribution was decreased subsequent to 1/31/2009. See Note 9-Subsequent Events in the Notes to Financial Statements. Subject to change in the future. (2) Distribution rates are calculated by annualizing the most recent distribution paid or declared through the report date and then dividing by Common Share price or NAV, as applicable, as of 1/31/2009. Subject to change in the future. (3) Total return based on NAV is the combination of reinvested distributions and reinvested capital gain distributions, if any, at prices obtained by the Dividend Reinvestment Plan and changes in NAV per share and does not reflect sales load. Past performance is not indicative of future results. (4) Total return based on market value is the combination of reinvested dividend distributions and reinvested capital gain distributions, if any, at prices obtained by the Dividend Reinvestment Plan and changes in Common Share price. Past performance is not indicative of future results. (5) The credit quality information represented reflects the ratings assigned by one or more nationally recognized statistical rating organizations (NRSROs). For situations in which a security is rated by more than one NRSRO and ratings are not equivalent, the ratings are averaged. (6) 58.33% of the Fund's assets are cash. Page 2 PORTFOLIO COMMENTARY SUB-ADVISOR Valhalla Capital Partners, LLC ("Valhalla"), the Sub-Advisor to First Trust Strategic High Income Fund III, is a boutique asset management firm focused on managing high-yield portfolios with an emphasis on structured finance securities. Valhalla was founded in 2005 and is currently managed by its Managing Partners, Ken L. Mathis, Raymond P. Mecherle, CFA and Justin L. Ventura. Valhalla is a Kentucky limited liability company located in Prospect, Kentucky. As of December 31, 2008, Valhalla had approximately $161 million in assets under management. PORTFOLIO MANAGEMENT TEAM RAYMOND P. MECHERLE, CFA, PORTFOLIO MANAGER Raymond P. Mecherle, CFA, is a founding Managing Partner of Valhalla. He has over ten years of experience in the financial industry. Mr. Mecherle currently serves as Co-Manager of First Trust Strategic High Income Fund (NYSE: FHI), First Trust Strategic High Income Fund II (NYSE: FHY) and First Trust Strategic High Income Fund III (NYSE: FHO). Mr. Mecherle was a dual employee of Hilliard Lyons Asset Management and Valhalla from Valhalla's inception in 2005 through April 2006. From October 2004 to April 2006, Mr. Mecherle was employed by Hilliard Lyons Asset Management as Director of Fixed Income and Co-Manager of FHI. Prior to that, Mr. Mecherle was employed by Morgan Keegan Asset Management for seven years. There, Mr. Mecherle was an Analyst and Assistant Portfolio Manager for three high-yield funds, two investment-grade bond funds, and various separate accounts. Mr. Mecherle received a B.A. from the University of Virginia and an M.B.A. from the Johnson Graduate School of Management, Cornell University. JUSTIN L. VENTURA, PORTFOLIO MANAGER Justin L. Ventura is a founding Managing Partner of Valhalla. He has over sixteen years of experience in the financial industry. Mr. Ventura currently serves as Co-Manager of First Trust Strategic High Income Fund (NYSE: FHI), First Trust Strategic High Income Fund II (NYSE: FHY) and First Trust Strategic High Income Fund III (NYSE: FHO). Mr. Ventura was a dual employee of Hilliard Lyons Asset Management and Valhalla from Valhalla's inception in 2005 through April 2006. From June 2005 to April 2006, Mr. Ventura was employed by Hilliard Lyons Asset Management as Co-Manager of FHI. Prior to that, Mr. Ventura was employed by State Street Bank for six years as Vice President, Capital Markets Portfolio/ABS-MBS-CDO Sectors. Mr. Ventura began his career with Fitch IBCA, Inc. where he worked for five years and was a Director of Structured Finance/Mortgage and Asset-Backed Securities. Mr. Ventura received a B.A. from the University of Massachusetts and a J.D. from George Mason School of Law. COMMENTARY FIRST TRUST STRATEGIC HIGH INCOME FUND III The primary investment objective of First Trust Strategic High Income Fund III ("FHO" or the "Fund") is to seek a high level of current income. The Fund seeks capital growth as a secondary objective and pursues its investment objectives through a diversified portfolio of below-investment grade and investment grade debt securities and equity securities that Valhalla believes offer attractive yield and/or capital appreciation potential. There can be no assurance that the Fund's investment objectives will be achieved. The Fund may not be appropriate for all investors. MARKET RECAP The six months ended January 31, 2009 were among the most challenging investors have faced in the better part of a century. The credit crisis, already a year old at the start of the period, intensified in the latter half of 2008 and added more names to the casualty list that began with Bear Stearns in March 2008. After a quiet August, the crisis exploded over roughly a 30-day period, starting in early September. During that time, the Federal Government seized Fannie Mae and Freddie Mac; Lehman Brothers filed the largest bankruptcy in U.S. history; Bank of America bought a faltering Merrill Lynch; AIG was bailed out by the government; Washington Mutual was taken over by the FDIC; and finally, Wachovia was purchased by Wells Fargo, as it struggled to stay afloat. Then, in the first few days of October, European regulators were forced to wrestle some large crises to the ground. In Germany, the government kept Hypo Real Estate Holding AG alive with a $68 billion infusion, and in Belgium, officials dismantled and sold off parts of Fortis, after rumors of an impending failure helped strangle this once top-20 global bank. To cap off the month, Iceland, a country that enjoyed one of the highest living standards in the world, suffered bank losses that came in at almost 87% of the country's GDP and virtually destroyed its financial system. Page 3 PORTFOLIO COMMENTARY Much of the macroeconomic data that accompanied this tumult was equally unsettling to the markets. October 2008 revealed that housing starts had reached a 26-year low the previous month, and building permits declined to a level not seen since 1981. On the commercial side, November 2008 data showed manufacturing dropped at the fastest rate in twenty-six years, which in turn, put pressure on the employment numbers, which showed the largest payroll decline since 1974. Finally, at year-end, housing data through October indicated that prices had dropped roughly 18% for the previous 12 months - bad news for public and private players alike, looking for any sign of a floor. Accordingly, the equity markets fell sharply. Over the twelve months ended January 31, 2009, the Standard & Poor's (S&P) 500 Index lost -40.09%, with the last six months of that period losing -34.83%. The financial sector, as measured by the New York Stock Exchange Financial Index, produced an abysmal -60.09% for the Fund's fiscal year period. This is hardly surprising given the number of financial institutions that needed additional capital over the last year and, in a number of cases, emergency assistance over the last few months. Throughout the period covered by this report, the Federal Reserve (the "Fed") remained highly engaged with the markets. On October 8th, the Fed cut the Federal Funds Rate by 50 basis points at an unscheduled meeting. Roughly two weeks later, it invoked emergency authority to acquire assets from money-market mutual funds which could not keep pace with redemptions. At the end of October, at its regularly scheduled meeting, it cut rates again by 50 basis points. Then, in December, it chopped rates to a range of 0% to 0.25%, citing ongoing risks to the economy, which is where the rates remain today. PERFORMANCE ANALYSIS The strained financial system pressured all of the Fund's asset classes, both in price and credit fundamentals. For the fiscal year ended January 31, 2009, the Fund delivered a -43.80% net asset value ("NAV") total return(1). The total return for the Fund's benchmark, the Barclays Capital Ba U.S. High Yield Index, was -11.37% over the same period. One of the differences between the Fund and its index arises from the fact that the latter contains predominantly corporate high-yield debt; a majority of FHO's holdings, in contrast, were structured finance securities. Of all the Fund's sectors, residential mortgage-backed securities ("RMBS") and collateralized debt obligations ("CDO's") declined the most in average price. These two categories suffered from a potent mix of continued negative credit trends and an acute lack of liquidity. As a result, investors and Wall Street continued to apply the most stringent bids and severe outlook to these asset classes. Until the housing market stabilizes and the general health of the commercial sector improves, it is likely these assets will continue to suffer from worsening credit performance and illiquidity. Like its RMBS and CDOs, FHO's corporate bond holdings also experienced a significant drop in average price and a weakening of credit metrics over the period covered by this report. With the overall business environment in decline and the ability to re-finance debt severely limited, most investors believe this market sits on the edge of a sharp climb in default rates, and pricing reflected this. In the Barclays High-Yield Index, for example, higher-rated bonds performed significantly better than their lower-rated peers. Over the twelve months covered by this report, the Ba-rated component of the index fell -18.38% in value but the Caa-rated component dropped by -46.88%. In the end, the market's willingness and ability to maintain exposure to this space shrank markedly over the period. FHO's market price total return(2) was -35.96% for the 12 months ended January 31, 2009, while its benchmark ended at -11.37%. For much of the first half of the year, the Fund traded at a premium to its NAV. From January 31st to July 31st of 2008, the average premium was 21.62%. The more volatile market conditions of the second half of the period, however, left FHO trading at a discount for much of that time. From July 31, 2008 to to January 31, 2009, the average price divergence from the NAV was -10.60%. For the year, the average price was at a 5.45% premium to the NAV. Given the uncertainty hovering over the market at fiscal year-end, market-price volatility around the NAV will likely remain elevated. - ---------- (1) Total return based on NAV is the combination of reinvested dividend distributions and reinvested capital gain distributions, if any, at prices obtained by the Dividend Reinvestment Plan and changes in NAV per share and does not reflect sales load. (2) Total return based on market value is the combination of reinvested dividend distributions and reinvested capital gains distributions, if any, at prices obtained by the Dividend Reinvestment Plan and changes in Common Share price. Page 4 PORTFOLIO COMMENTARY MARKET AND FUND OUTLOOK The challenges ahead are clearly outlined by the period's negative economic data, as well as market declines in both stocks and bonds. While it is still reasonable to assume the duration of the credit squeeze will greatly affect bond performance, another equally important variable now is the recession that has emerged from this crisis. Further large-scale Federal efforts are currently underway to loosen lending to businesses and consumers, remove toxic assets from the system, and stem the freefall of home prices and escalating foreclosures. These government actions may be able to supply incremental liquidity and stability to the credit markets, and if so, the Fund is positioned to invest opportunistically, given its current cash position of 58.33%. The question remains, however, as to whether the financial crisis and the recession will combine to inflict a level of damage commensurate with current prices, and if so, in what sectors. Until conditions can be stabilized, it is likely prices and credit fundamentals will remain strained. Page 5 POLICY CHANGE CHANGE IN TEMPORARY DEFENSIVE POLICY On September 15, 2008, the Fund's Board of Trustees approved a change in the Fund's temporary defensive policy. Previously, the temporary defensive policy of the Fund permitted it to deviate from its investment strategy and invest all or any portion of its managed assets in cash or cash equivalents. Cash equivalents, in general terms, include: U.S. Government securities, certificates of deposit, repurchase agreements, commercial paper, bankers' acceptances, bank time deposits and money market funds. Under the revised temporary defensive policy, the Fund may deviate from its investment strategy and invest all or any portion of its total assets in cash, cash equivalents and certain other defensive instruments, including manufactured home loan-backed securities; certain securities guaranteed by the U.S. Government or its agencies or instrumentalities; asset-backed securities representing direct or indirect participations in, or secured by and payable from, pools of leases of aircrafts and/or loans to purchase aircrafts; asset-backed securities representing direct or indirect participations in, or secured by and payable from, loans or other obligations of franchises; corporate bonds; and any other securities rated in the AA category or better by at least one nationally recognized statistical rating organization. The revised temporary defensive policy is included in the Additional Information section of this report. A summary of Fund risk disclosures is included in Note 8 - Risk Considerations in the Notes to the Financial Statements. Page 6 FIRST TRUST STRATEGIC HIGH INCOME FUND III PORTFOLIO OF INVESTMENTS (a) JANUARY 31, 2009
PRINCIPAL STATED VALUE DESCRIPTION COUPON MATURITY VALUE - ------------ ------------------------------------------------- ------ -------- ------------ ASSET-BACKED SECURITIES - 10.4% ABCLO, Ltd. $ 3,500,000 Series 2007-1A, Class D (c) (d) .............. 4.99% 04/15/21 $ 346,185 ACE Securities Corp. 447,291 Series 2007-ASP2, Class M9 (c) ............... 2.89% 06/25/37 2,809 Bear Stearns Asset Backed Securities Trust 4,000,000 Series 2007-HE3, Class M9 (c) ................ 2.64% 04/25/37 51,160 5,057,000 Series 2007-SD3, Class M8 (c) ................ 1.64% 05/25/37 36,714 BNC Mortgage Loan Trust 5,792,000 Series 2007-2, Class B1 (b) (c) .............. 2.89% 05/25/37 189,572 1,400,000 Series 2007-2, Class B2 (b) (c) .............. 2.89% 05/25/37 27,748 4,000,000 Series 2007-3, Class B2 (b) (c) .............. 2.89% 07/25/37 97,160 Eaton Vance CDO Ltd. 2,500,000 Series 2006-8A, Class D (b) (c) .............. 5.57% 08/15/22 204,750 Exum Ridge CBO 2,844,679 Series 2007-1A, Class D (b) (c) (g) .......... 5.28% 03/22/14 995,638 GSamp Trust 991,846 Series 2006-S3, Class A2 ..................... 5.77% 05/25/36 103,652 1,301,950 Series 2006-S5, Class A1 (c) ................. 0.48% 09/25/36 48,966 Home Equity Asset Trust 3,850,000 Series 2007-3, Class M9 (c) .................. 2.89% 08/25/37 94,133 Indymac Residential Asset Backed Trust 5,000,000 Series 2007-B, Class M10 (c) ................. 2.89% 07/25/37 173,350 Long Beach Mortgage Loan Trust 1,955,472 Series 2006-A, Class A2 ...................... 5.55% 05/25/36 156,438 Loomis Sayles Ltd. 5,000,000 Series 2006-1A, Class E (b) (c) .............. 5.01% 10/26/20 474,300 Park Place Securities, Inc. 4,954,263 Series 2005-WCW3, Class M11 (c) (d) .......... 2.89% 08/25/35 109,142 Renaissance Home Equity Trust 2,750,000 Series 2007-2, Class M9 ...................... 7.50% 06/25/37 144,815 Rosedale CLO Ltd. 2,500,000 Series 1-A, Class II (b) ..................... 0.00% 07/24/21 75,000 Signature 5 Ltd. 4,000,000 Series 5A, Class C (b) ....................... 2.56% 10/27/12 195,680 Soundview Home Equity Loan Trust 4,000,000 Series 2007-OPT1, Class M10 (c) (d) .......... 2.89% 06/25/37 78,560 3,400,000 Series 2007-OPT2, Class M10 (c) (d) .......... 2.89% 07/25/37 99,178 Structured Asset Securities Corp. 5,000,000 Series 2007-BC3, Class B1 (b) (c) ............ 2.89% 05/25/47 125,700 5,000,000 Series 2007-OSI, Class M10 (c) ............... 2.89% 06/25/37 37,850 Telos CLO Ltd. 3,000,000 Series 2007-2A, Class E (b) (c) .............. 6.09% 04/15/22 345,360 WaMu 2,000,000 Series 2007-HE3, Class M9 (c) ................ 2.89% 05/25/47 21,154
See Notes to Financial Statements Page 7 FIRST TRUST STRATEGIC HIGH INCOME FUND III PORTFOLIO OF INVESTMENTS (a) - (CONTINUED) JANUARY 31, 2009
PRINCIPAL STATED VALUE DESCRIPTION COUPON MATURITY VALUE - ------------ ------------------------------------------------- ------ -------- ------------ ASSET-BACKED SECURITIES - (CONTINUED) Wells Fargo Home Equity Trust $ 3,482,000 Series 2007-2, Class B1 (b) (c) .............. 2.89% 04/25/37 $ 59,264 ------------ TOTAL ASSET-BACKED SECURITIES (Cost $67,945,607) ........................... 4,294,278 ------------ COLLATERALIZED MORTGAGE OBLIGATIONS - 5.4% Bear Stearns Alt-A Trust 2,264,488 Series 2006-8, Class 2A2 ..................... 5.43% 08/25/46 681,350 Countrywide Alternative Loan Trust 3,331,936 Series 2005-56, Class M4 (c) ................. 1.31% 11/25/35 199,616 2,845,000 Series 2007-OA6, Class M9 (c) ................ 1.89% 06/25/37 67,711 Deutsche Alt-A Securities, Inc. Mortgage Loan Trust 4,119,000 Series 2007-AR3, Class 1M5 (c) ............... 1.74% 06/25/37 90,165 3,505,258 Series 2007-OA3, Class M10 (c) (d) ........... 2.89% 07/25/47 135,548 4,001,349 Series 2007-OA4, Class M10 (c) ............... 3.39% 08/25/47 187,463 Greenpoint Mortgage Funding Trust 4,944,154 Series 2007-AR2, Class 2M9 (c) ............... 2.14% 05/25/37 184,812 Indymac Index Mortgage Loan Trust 2,029,313 Series 2007-FLX3, Class M5 (c) ............... 2.64% 06/25/37 210,338 1,425,051 Series 2007-FLX3, Class M6 (c) ............... 2.64% 06/25/37 109,102 Lehman XS Trust 5,004,730 Series 2007-4N, Class M9 (c) ................. 2.14% 03/25/47 189,379 TBW Mortgage Backed Pass-Through Certificates 2,270,000 Series 2007-2, Class M4 (c) .................. 1.89% 07/25/37 56,546 3,240,000 Series 2007-2, Class M5 (c) .................. 2.39% 07/25/37 101,671 ------------ TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (Cost $30,933,636) ........................... 2,213,701 ------------ CORPORATE BONDS AND NOTES - 19.0% 3,500,000 AmeriCast Technologies, Inc. (b) ................ 11.00% 12/01/14 2,310,000 2,000,000 Dayton Superior Corp. ........................... 13.00% 06/15/09 1,145,000 2,500,000 Dune Energy Inc. ................................ 10.50% 06/01/12 875,000 1,000,000 International Coal Group, Inc. .................. 10.25% 07/15/14 750,000 3,000,000 MSX International UK/MXS International Business Service FR/MXS International GmBH (b) ........ 12.50% 04/01/12 1,215,000 3,500,000 Rafealla Apparel Group, Inc., Series B .......... 11.25% 06/15/11 1,067,500 1,500,000 Rare Restaurant Group LLC (b) ................... 9.25% 05/15/14 457,500 ------------ TOTAL CORPORATE BONDS AND NOTES (Cost $17,024,528) ........................... 7,820,000 ------------ STRUCTURED NOTES - 5.1% Bacchus Ltd. 3,000,000 Series 2006-1I, Subordinated Note (b) ........ (e) 01/20/19 1,440,000 InCaps Funding II Ltd./InCaps Funding II Corp. 4,800,000 Subordinated Note (b) ........................ (e) 01/15/34 576,000 Preferred Term Securities XXVI, Ltd. 2,500,000 Subordinated Note (b) ........................ (e) 09/22/37 250
See Notes to Financial Statements Page 8 FIRST TRUST STRATEGIC HIGH INCOME FUND III PORTFOLIO OF INVESTMENTS (a) - (CONTINUED) JANUARY 31, 2009
PRINCIPAL STATED VALUE DESCRIPTION COUPON MATURITY VALUE - ------------ ------------------------------------------------- ------ -------- ------------ STRUCTURED NOTES - (CONTINUED) Primus CLO Ltd. $ 2,625,000 Series 2007-2I, Subordinated Bond (b) ........ (e) 07/15/21 $ 78,750 ------------ TOTAL STRUCTURED NOTES (Cost $7,291,645) ............................ 2,095,000 ------------
SHARES DESCRIPTION VALUE - ------------ ------------------------------------------------- ------------ PREFERRED SECURITIES - 0.5% 1,000 Stanfield Vantage CLO Ltd. (b) (e) .............. 210,000 3,000 White Marlin CDO Ltd., Series AI (b)(e)(g) ...... 15,000 ------------ TOTAL PREFERRED SECURITIES (Cost $1,078,720) ............................ 225,000 ------------ TOTAL INVESTMENTS - 40.4% (Cost $124,274,136) (f) ...................... 16,647,979 NET OTHER ASSETS AND LIABILITIES - 59.6% ........ 24,514,380 ------------ NET ASSETS - 100.0% ............................. $ 41,162,359 ============
- ---------- (a) All percentages shown in the Portfolio of Investments are based on net assets. (b) This security, sold within the terms of a private placement memorandum, is exempt from registration under Rule 144A of the Securities Act of 1933, as amended (the "1933 Act"), and may be resold in transactions exempt from registration normally to qualified institutional buyers. Pursuant to procedures adopted by the Fund's Board of Trustees, this security has been determined to be liquid by Valhalla Capital Partners, LLC, the Fund's investment sub-advisor. Although recent instability in the markets has resulted in periods of increased overall market illiquidity, liquidity for each security is determined based on security specific factors and assumptions, which require subjective judgement. At January 31, 2009, securities noted as such amounted to $9,092,672 or 22.1% of net assets. (c) Floating rate security. The interest rate shown reflects the rate in effect at January 31, 2009. (d) This security, sold within terms of a private placement memorandum, is exempt from registration under Rule 144A of the 1933 Act, and may be resold in transactions exempt from registration, normally to qualified institutional buyers. (See Note 2C - Restricted Securities in the Notes to Financial Statements). (e) Zero coupon (f) Aggregate cost for federal income purposes is $127,987,610. As of January 31, 2009, the aggregate gross unrealized appreciation for all securities in which there as an excess of value over tax cost was $0 and the aggregate gross unrealized depreciation for all securities in which there was an excess of tax cost over value was $111,339,631. (g) The issuer is in default, income is not being accrued. CBO Collateralized Bond Obligation CDO Collateralized Debt Obligation CLO Collateralized Loan Obligation See Notes to Financial Statements Page 9 FIRST TRUST STRATEGIC HIGH INCOME FUND III PORTFOLIO OF INVESTMENTS (a) - (CONTINUED) JANUARY 31, 2009 SECURITY VALUATION INPUTS A summary of the inputs used to value the Fund's investments as of January 31, 2009 is as follows (See Note 2A - Portfolio Valuation in the Notes to Financial Statements):
VALUATION INPUTS INVESTMENTS - ---------------- ----------- Level 1 - Quoted Prices ........................ $ -- Level 2 - Other Significant Observable Inputs .. 13,101,153 Level 3 - Significant Unobservable Inputs ...... 3,546,826 ----------- TOTAL .......................................... $16,647,979 ===========
The following table presents the activity of the Fund's investments measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at the period presented.
INVESTMENTS AT FAIR VALUE USING SIGNIFICANT UNOBSERVABLE INPUTS (LEVEL 3) INVESTMENTS - ------------------------------------------- ----------- Balance as of January 31, 2008 ............ $ -- Transfers in (out) of Level 3 ............. 3,546,826 ---------- Balance as of January 31, 2009 ............ $3,546,826 ==========
Net unrealized depreciation from Level 3 investments held as of January 31, 2009 was $8,779,971 and is included in "Net change in unrealized appreciation (depreciation) on investments" on the Statement of Operations. See Notes to Financial Statements Page 10 FIRST TRUST STRATEGIC HIGH INCOME FUND III STATEMENT OF ASSETS AND LIABILITIES JANUARY 31, 2009 ASSETS: Investments, at value (Cost $ 124,274,136) ...................................................................... $ 16,647,979 Cash ......................................................................................... 24,010,268 Interest receivable .......................................................................... 634,830 ------------- Total Assets ........................................................................... 41,293,077 ------------- LIABILITIES: Payables: Audit and tax fees ........................................................................ 51,078 Investment advisory fees .................................................................. 34,936 Printing fees ............................................................................. 18,384 Administrative fees ....................................................................... 8,330 Legal fees ................................................................................ 5,555 Transfer agent fees ....................................................................... 3,021 Trustees' fees and expenses ............................................................... 2,803 Custodian fees ............................................................................ 2,150 Accrued expenses and other liabilities ....................................................... 4,461 ------------- Total Liabilities ...................................................................... 130,718 ------------- NET ASSETS ................................................................................... $ 41,162,359 ============= NET ASSETS CONSIST OF: Paid-in capital .............................................................................. $ 155,705,381 Par value .................................................................................... 90,867 Accumulated net investment income (loss) ..................................................... 4,816,529 Accumulated net realized gain (loss) on investments .......................................... (11,824,261) Net unrealized appreciation (depreciation) on investments .................................... (107,626,157) ------------- NET ASSETS ................................................................................... $ 41,162,359 ============= NET ASSET VALUE, per Common Share (par value $0.01 per Common Share) ......................... $ 4.53 ============= Number of Common Shares outstanding (unlimited number of Common Shares has been authorized) .. 9,086,745 =============
See Notes to Financial Statements Page 11 FIRST TRUST STRATEGIC HIGH INCOME FUND III STATEMENT OF OPERATIONS FOR THE YEAR ENDED JANUARY 31, 2009 INVESTMENT INCOME: Interest ................................................................ $ 15,714,663 ------------ Total investment income ........................................... 15,714,663 ------------ EXPENSES: Investment advisory fees ................................................ 617,060 Facility commitment fees ................................................ 107,440 Administrative fees ..................................................... 99,997 Printing fees ........................................................... 54,731 Audit and tax fees ...................................................... 54,486 Legal fees .............................................................. 41,895 Trustees' fees and expenses ............................................. 41,372 Transfer agent fees ..................................................... 34,795 Custodian fees .......................................................... 8,977 Other ................................................................... 72,808 ------------ Total expenses .................................................... 1,133,561 ------------ NET INVESTMENT INCOME ................................................... 14,581,102 ------------ NET REALIZED AND UNREALIZED GAIN (LOSS): Net realized gain (loss) on investments .............................. (22,600,153) Net change in unrealized appreciation (depreciation) on investments .. (28,496,338) ------------ NET REALIZED AND UNREALIZED GAIN (LOSS) ................................. (51,096,491) ------------ NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS ......... $(36,515,389) ============
See Notes to Financial Statements Page 12 FIRST TRUST STRATEGIC HIGH INCOME FUND III STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED PERIOD ENDED 1/31/2009 1/31/2008 (a) ---------- ------------- OPERATIONS: Net investment income (loss) ................................ $ 14,581,102 $ 12,432,687 Net realized gain (loss) .................................... (22,600,153) (418,901) Net change in unrealized appreciation (depreciation) ........ (28,496,338) (79,129,819) ------------ ------------ Net increase (decrease) in net assets resulting from operations ............................................... (36,515,389) (67,116,033) ------------ ------------ DISTRIBUTIONS TO SHAREHOLDERS FROM: Net investment income ....................................... (1,364,120) (11,330,871) Return of capital ........................................... (14,434,308) -- ------------ ------------ Total distributions to shareholders ......................... (15,798,428) (11,330,871) ------------ ------------ CAPITAL TRANSACTIONS: Net proceeds from the sale of Common Shares ................. -- 170,328,758 Proceeds from Common Shares reinvested ...................... 1,296,039 654,992 Offering costs .............................................. -- (356,709) ------------ ------------ Net increase (decrease) in net assets resulting from capital transactions ............................................. 1,296,039 170,627,041 ------------ ------------ Total increase (decrease) in net assets ..................... (51,017,778) 92,180,137 NET ASSETS: Beginning of period ......................................... 92,180,137 -- ------------ ------------ End of period ............................................... $ 41,162,359 $ 92,180,137 ============ ============ Accumulated net investment income (loss) at end of period ... $ 4,816,529 $ 1,086,058 ============ ============ CAPITAL TRANSACTIONS WERE AS FOLLOWS: Common Shares at beginning of period ........................ 8,957,976 -- Common Shares sold .......................................... -- 8,917,736 Common Shares issued as reinvestment under the Dividend Reinvestment Plan ........................................ 128,769 40,240 ------------ ------------ Common Shares at end of period .............................. 9,086,745 8,957,976 ============ ============
- ---------- (a) Initial seed date of February 20, 2007. The Fund commenced operations on March 27, 2007. See Notes to Financial Statements Page 13 FIRST TRUST STRATEGIC HIGH INCOME FUND III STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JANUARY 31, 2009 CASH FLOWS FROM OPERATING ACTIVITIES: Net increase (decrease) in net assets resulting from operations ............................................... $(36,515,389) Adjustments to reconcile net increase (decrease) in net assets resulting from operations to net cash provided by operating activities: Purchases of investments ................................. (2,448,557) Sales, maturities and paydowns of investments ............ 15,907,637 Net amortization/accretion of premium/discount on investments ........................................... (6,428,045) Net realized gain/loss on investments .................... 22,600,153 Net change in unrealized appreciation/depreciation on investments ........................................... 28,496,338 CHANGES IN ASSETS AND LIABILITIES: Decrease in dividends receivable ......................... 45,252 Decrease in interest receivable .......................... 489,557 Decrease in prepaid expenses ............................. 6,543 Decrease in payable for investment securities purchased .. (622,774) Decrease in investment advisory fees payable ............. (40,315) Increase in audit and tax fees payable ................... 24,328 Increase in legal fees payable ........................... 2,732 Decrease in printing fees payable ........................ (9,905) Increase in transfer agent fees payable .................. 402 Decrease in facility commitment fees payable ............. (21,080) Decrease in administrative fees payable .................. (53) Decrease in custodian fees payable ....................... (110) Increase in Trustees' fees and expenses payable .......... 2,273 Increase in accrued expenses and other liabilities ....... 2,491 ------------ CASH PROVIDED BY OPERATING ACTIVITIES ....................... $ 21,491,478 CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from Common Shares reinvested ................... 1,296,039 Distributions to Common Shareholders from net investment income ................................................ (1,364,120) Return of capital distributions .......................... (14,434,308) ------------ CASH USED BY FINANCING ACTIVITIES ........................... (14,502,389) Increase in cash ............................................ 6,989,089 ------------ Cash at beginning of period ................................. 17,021,179 ------------ CASH AT END OF PERIOD ....................................... $(24,010,268) ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for facility commitment fees .... $ (128,520) ============
See Notes to Financial Statements Page 14 FIRST TRUST STRATEGIC HIGH INCOME FUND III FINANCIAL HIGHLIGHTS FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD
YEAR PERIOD ENDED ENDED 1/31/2009 1/31/2008(a) --------- ------------ Net asset value, beginning of period ........................ $ 10.29 $ 19.10(b) ------- ------- INCOME FROM INVESTMENT OPERATIONS: Net investment income (loss) ................................ 1.60 1.39 Net realized and unrealized gain (loss) ..................... (5.61) (8.89) ------- ------- Total from investment operations ............................ (4.01) (7.50) ------- ------- DISTRIBUTIONS PAID TO SHAREHOLDERS FROM: Net investment income ....................................... (0.15) (1.27) Return of capital ........................................... (1.60) -- ------- ------- Total distributions ......................................... (1.75) (1.27) ------- ------- Common Shares offering costs charged to paid-in capital ..... -- (0.04) ------- ------- Net asset value, end of period .............................. $ 4.53 $ 10.29 ======= ======= Market value, end of period ................................. $ 6.12 $ 12.20 ======= ======= Total return based on net asset value (c) (d) ............... (43.80)% (40.91)% ======= ======= Total return based on market value (d) (e) .................. (35.96)% (33.09)% ======= ======= RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA: Net assets, end of period (in 000's) ........................ $41,162 $92,180 Ratio of total expenses to average net assets ............... 1.66% 1.40%(f) Ratio of net investment income to average net assets ........ 21.26% 10.57%(f) Portfolio turnover rate ..................................... 5% 4%
- ---------- (a) Initial seed date of February 20, 2007. The Fund commenced operations on March 27, 2007. (b) Net of sales load of $0.90 per share on initial offering. (c) Total return based on net asset value is the combination of reinvested dividend distributions and reinvested capital gains distributions, if any, at prices obtained by the Dividend Reinvestment Plan and changes in net asset value per share and does not reflect sales load. (d) Total return is not annualized for periods less than one year. (e) Total return based on market value is the combination of reinvested dividend distributions and reinvested capital gains distributions, if any, at prices obtained by the Dividend Reinvestment Plan and changes in Common Share price. (f) Annualized. See Notes to Financial Statements Page 15 NOTES TO FINANCIAL STATEMENTS FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 1. FUND DESCRIPTION First Trust Strategic High Income Fund III (the "Fund") is a diversified, closed-end management investment company organized as a Massachusetts business trust on November 14, 2006 and is registered with the Securities and Exchange Commission ("SEC") under the Investment Company Act of 1940, as amended (the "1940 Act"). The Fund trades under the ticker symbol FHO on the New York Stock Exchange ("NYSE"). The Fund's primary investment objective is to seek a high level of current income. The Fund seeks capital growth as a secondary objective. The Fund seeks to achieve its investment objectives by investing in a diversified portfolio of below-investment grade and investment grade debt securities and equity securities that Valhalla Capital Partners, LLC ("Valhalla" or the "Sub-Advisor") believes offer attractive yield and/or capital appreciation potential. There can be no assurance that the Fund will achieve its investment objectives. The Fund may not be appropriate for all investors. 2. SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements. The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts and disclosures in the financial statements. Actual results could differ from those estimates. A. PORTFOLIO VALUATION: The net asset value ("NAV") of the Common Shares of the Fund is determined daily as of the close of regular trading on the NYSE, normally 4:00 p.m. Eastern time, on each day the NYSE is open for trading. Domestic debt securities and foreign securities are priced using data reflecting the earlier closing of the principal markets for those securities. The NAV per Common Share is calculated by dividing the value of all assets of the Fund (including accrued dividends and interest), less all liabilities (including accrued expenses, dividends declared but unpaid and any borrowings of the Fund) by the total number of Common Shares outstanding. The Fund's investments are valued daily at market value or, in the absence of market value with respect to any portfolio securities, at fair value according to procedures adopted by the Fund's Board of Trustees. Securities for which market quotations are readily available are valued at market value, which is currently determined using the last reported sale price on the business day as of which such value is being determined or, if no sales are reported on such day (as in the case of some securities traded over-the-counter), the last reported bid price, except that certain U.S. Government securities are valued at the mean between the last reported bid and ask prices. The Fund values mortgage-backed securities and other debt securities not traded in an organized market on the basis of valuations provided by dealers who make markets in such securities or by an independent pricing service approved by the Board of Trustees which uses information with respect to transactions in such securities, quotations from dealers, market transactions for comparable securities, various relationships between securities and yield to maturity in determining value. In the Fund's financial statements, the Statement of Assets and Liabilities includes investments with a value of $3,546,826 (21.3% of total investments) as of January 31, 2009, whose values have been determined based on prices supplied by dealers and investments with a value of $13,101,153 (78.7% of total investments) whose values have been determined based on prices supplied by independent pricing services. These values may differ from the values that would have been used had a ready market for these investments existed, and the differences could be material. Debt securities having a remaining maturity of less than sixty days when purchased are valued at cost adjusted for amortization of premiums and accretion of discounts. In the event that market quotations are not readily available, the pricing service or dealer does not provide a valuation for a particular security, or the valuations are deemed unreliable, the Fund's Board of Trustees has designated First Trust Advisors L.P. ("First Trust") to use a fair value method to value the Fund's securities. Additionally, if events occur after the close of the principal market for particular securities (e.g. domestic debt and foreign securities) but before the Fund values its assets, that could materially affect NAV, First Trust may use a fair value method to value the Fund's securities and other investments. As a general principle, the fair value of a security is the amount which the Fund might reasonably expect to receive for the security upon its current sale. A variety of factors may be considered in determining the fair value of such securities including 1) the fundamental business data relating to the issuer; 2) an evaluation of the forces which influence the market in which these securities are purchased and sold; 3) type of holding; 4) financial statements of the issuer; 5) cost at date of purchase; 6) credit quality and cash flow of issuer based on external analysis; 7) information as to any transactions in or offers for the holding; 8) price and extent of public trading in similar securities of the issuer/borrower, or comparable companies; and 9) other relevant factors. The use of fair value pricing by the Fund is governed by valuation procedures adopted by the Fund's Board of Trustees, and in accordance with the provisions of the 1940 Act. When fair value pricing of securities is employed, the prices of securities Page 16 NOTES TO FINANCIAL STATEMENTS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 used by the Fund to calculate its NAV may differ from market quotations or official closing prices. In light of the judgment involved in fair valuations, there can be no assurance that a fair value assigned to a particular security will be the amount which the Fund might be able to receive upon its current sale. The Fund invests a significant portion of its assets in below-investment grade debt securities, including mortgage-backed securities, asset-backed securities, corporate bonds and collateralized debt obligations. The value and related income of these securities is sensitive to changes in economic conditions, including delinquencies and/or defaults. Recent instability in the markets for fixed-income securities, particularly mortgage-backed and asset-backed securities, has resulted in increased volatility and periods of illiquidity that have adversely impacted the valuation of certain securities held by the Fund. In September 2006, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements ("FAS 157"), effective for fiscal years beginning after November 15, 2007. This standard clarifies the definition of fair value for financial reporting, establishes a framework for measuring fair value and requires additional disclosures about the use of fair value measurements. FAS 157 became effective for the Fund as of February 1, 2008, the beginning of its current fiscal year. The three levels of the fair value hierarchy under FAS 157 are described below: - Level 1 - quoted prices in active markets for identical securities - Level 2 - other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.) - Level 3 - significant unobservable inputs (including the Fund's own assumptions in determining the fair value of investments) The inputs or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities. A summary of the inputs used to value the Fund's investments as of January 31, 2009 is included in the Fund's Portfolio of Investments. B. SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are recorded as of the trade date. Realized gains and losses from securities transactions are recorded on the identified cost basis. Dividend income is recorded on the ex-dividend date. Interest income is recorded on the accrual basis. Amortization of premiums and accretion of discounts are recorded using the effective interest method. The Fund invests in certain lower credit quality securitized assets that have contractual cash flows (for example, asset-backed securities, collateralized mortgage obligations and commercial mortgage-backed securities). For these securities, if there is a change in the estimated cash flows, based on an evaluation of current information, then the estimated yield is adjusted on a prospective basis over the remaining life of the security. Investment income is recorded net of foreign taxes withheld where recovery of such taxes is uncertain. Debt obligations may be placed on non-accrual status and related interest income may be reduced by ceasing current accruals and amortization/accretion and writing off interest receivables when the collection of all or a portion of interest has become doubtful based on consistently applied procedures. A debt obligation is removed from non-accrual status when the issuer resumes interest payments or when collectibility of interest is reasonably assured. Securities purchased or sold on a when-issued or delayed-delivery basis may be settled a month or more after the trade date; interest income on such securities is not accrued until settlement date. The Fund maintains liquid assets with a current value at least equal to the amount of its when-issued or delayed-delivery purchase commitments. At January 31, 2009, the Fund had no when-issued or delayed-delivery purchase commitments. C. RESTRICTED SECURITIES: The Fund invests in restricted securities, which are securities that may not be offered for public sale without first being registered under the 1933 Act. Prior to registration, restricted securities may only be resold in transactions exempt from registration under Rule 144A of the 1933 Act, normally to qualified institutional buyers. As of January 31, 2009, the Fund held restricted securities as shown in the table on the following page that the Sub-Advisor has deemed illiquid pursuant to procedures adopted by the Fund's Board of Trustees. Although recent instability in the markets has resulted in periods of increased overall market illiquidity, liquidity for each security is determined based on security specific factors and assumptions, which require subjective judgement. The Fund does not have the right to demand that such securities be registered. These securities are valued according to the valuation procedures as stated in the Portfolio Valuation footnote (Note 2A) and are not expressed as a discount to the carrying value of a comparable unrestricted security. There are no unrestricted securities with the same maturity dates and yields for these issuers. Page 17 NOTES TO FINANCIAL STATEMENTS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009
CARRYING % OF ACQUISITION PRINCIPAL VALUE CARRYING NET SECURITY DATE VALUE PER SHARE COST VALUE ASSETS - -------- ----------- ----------- --------- ----------- -------- ------ ABCLO, Ltd. Series 2007-1A, Class D, 4.99%, 04/15/21 04/25/07 $ 3,500,000 $9.89 $ 3,452,564 $346,185 0.84% Deutsche Alt-A Securities, Inc. Mortgage Loan Trust Series 2007-OA3, Class M10, 2.89%, 07/25/47 05/22/07 3,505,258 3.87 2,654,889 135,548 0.05 Park Place Securities, Inc. Series 2005-WCW3, Class M11, 2.89%, 08/25/35 12/26/07 4,954,263 2.20 374,756 109,142 0.33 Soundview Home Equity Loan Trust Series 2007-OPT1, Class M10, 2.89%, 06/25/37 05/04/07 4,000,000 1.96 3,270,698 78,560 0.19 Series 2007-OPT2, Class M10, 2.89%, 07/25/37 06/18/07 3,400,000 2.92 2,996,006 99,178 0.24 ----------- ----------- -------- ---- $19,359,521 $12,748,913 $768,613 1.65% =========== =========== ======== ====
D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: The Fund will distribute to holders of its Common Shares monthly dividends of all or a portion of its net income after the payment of interest and dividends in connection with leverage, if any. Distributions will automatically be reinvested into additional Common Shares pursuant to the Fund's Dividend Reinvestment Plan unless cash distributions are elected by the shareholder. Distributions from income and capital gains are determined in accordance with income tax regulations, which may differ from accounting principles generally accepted in the United States of America. These differences are primarily due to differing treatments of income and gains on various investment securities held by the Fund, timing differences and differing characterization of distributions made by the Fund. Permanent differences incurred during the fiscal year ended January 31, 2009, resulting in book and tax accounting differences, have been reclassified at year end to reflect a decrease in accumulated net investment income (loss) of $9,486,511, an increase in accumulated net realized gain (loss) on investments of $11,179,035 and a decrease to paid-in capital of $1,692,524. Net assets were not affected by this reclassification. The tax character of distributions paid during the fiscal periods ended January 31, 2009 and January 31, 2008 was as follows: Distributions paid from:
2009 2008 ----------- ----------- Ordinary Income .............................. $ 1,364,120 $11,330,871 Return of Capital ............................ 14,434,308 --
As of January 31, 2009, the components of distributable earnings on a tax basis were as follows: Undistributed Net Investment Income .......... $ -- Net Unrealized Appreciation (Depreciation) ... (111,339,631) Accumulated Capital and Other Losses ......... (3,294,258)
E. INCOME TAXES: The Fund intends to continue to qualify as a regulated investment company by complying with the requirements under Subchapter M of the Internal Revenue Code of 1986, as amended, which includes distributing substantially all of its net investment income and net realized gains to shareholders. Accordingly, no provision has been made for federal or state income taxes. The Fund intends to utilize provisions of the federal income tax laws, which allow it to carry a realized capital loss forward for eight years following the year of loss and offset such loss against any future realized capital gains. At January 31, 2009, the Fund had available realized capital losses of $43,053 and $3,250,843 to offset future net capital gains through the fiscal years 2016 and 2017, respectively. POST-OCTOBER LOSSES. Under current laws, certain losses realized after October 31 may be deferred and treated as occurring on the first day of the following fiscal year. For the fiscal year ended January 31, 2009, the Fund intends to elect to defer net realized losses incurred from November 1, 2008 through January 31, 2009 of $362. In June 2006, the FASB issued Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes". FIN 48 establishes the minimum threshold for recognizing, and a system for measuring, the benefits of a tax position taken or expected to be taken on a tax-return, and is effective for the Fund's current fiscal year. As of January 31, 2009, management has evaluated the application of FIN 48 to the Fund, and has determined that no provision for income tax is required in the Fund's financial statements for uncertain tax positions. Page 18 NOTES TO FINANCIAL STATEMENTS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 F. EXPENSES: The Fund pays all expenses directly related to its operations. G. ORGANIZATION AND OFFERING COSTS: Organization costs consisted of costs incurred to establish the Fund and enable it to legally do business. These costs included filing fees, listing fees, legal services pertaining to the organization of the business and audit fees relating to the initial registration and auditing the initial statement of assets and liabilities, among other fees. Offering costs consisted of legal fees pertaining to the Fund's Common Shares offered for sale, registration fees, underwriting fees, and printing of the initial prospectus, among other fees. First Trust and Valhalla have paid all organization expenses and all offering costs of the Fund (other than sales load) that exceeded $0.04 per Common Share. The Fund's share of Common Share offering costs of $356,709 was recorded as a reduction of the proceeds from the sale of Common Shares during the fiscal period ended January 31, 2008. H. ACCOUNTING PRONOUNCEMENT: In March 2008, FASB released Statement of Financial Accounting Standards No. 161, "Disclosures about Derivative Instruments and Hedging Activities" ("FAS 161"). FAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit risk-related contingent features in derivative agreements. The application of FAS 161 is required for fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. Management is currently evaluating the impact the adoption of FAS 161 will have on the Fund's financial statement disclosures, if any. 3. INVESTMENT ADVISORY FEE AND OTHER AFFILIATED TRANSACTIONS First Trust is a limited partnership with one limited partner, Grace Partners of DuPage L.P., and one general partner, The Charger Corporation. First Trust serves as investment advisor to the Fund pursuant to an Investment Management Agreement. First Trust is responsible for the ongoing monitoring of the Fund's investment portfolio, managing the Fund's business affairs and providing certain administrative services necessary for the management of the Fund. For these investment management services, First Trust is entitled to a monthly fee calculated at an annual rate of 0.90% of the Fund's Managed Assets (the value of the securities and other investments the Fund holds plus cash or other assets, including interest accrued but not yet received minus liabilities other than the principal amount of any borrowings). Valhalla, a boutique asset management firm focused on managing high-yield portfolios with an emphasis on structured finance securities, serves as the Fund's sub-advisor and manages the Fund's portfolio subject to First Trust's supervision. The Sub-Advisor receives a portfolio management fee at an annual rate of 0.40% of Managed Assets that is paid by First Trust from its investment advisory fee. First Trust Portfolios L.P., an affiliate of First Trust, owns a minority interest in Valhalla. PNC Global Investment Servicing (U.S.) Inc., formerly known as PFPC Inc., an indirect, majority-owned subsidiary of The PNC Financial Services Group, Inc., serves as the Fund's Administrator, Fund Accountant, Transfer Agent and Board Administrator in accordance with certain fee arrangements. PFPC Trust Company, also an indirect, majority-owned subsidiary of The PNC Financial Services Group, Inc., serves as the Fund's Custodian in accordance with certain fee arrangements. Each Trustee who is not an officer or employee of First Trust, any sub-advisor or any of their affiliates ("Independent Trustees") is paid an annual retainer of $10,000 per trust for the first 14 trusts of the First Trust Fund Complex and an annual retainer of $7,500 per trust for each subsequent trust in the First Trust Fund Complex. The annual retainer is allocated equally among each of the trusts. No additional meeting fees are paid in connection with board or committee meetings. Additionally, the Lead Independent Trustee is paid $10,000 annually, the Chairman of the Audit Committee is paid $5,000 annually, and each of the chairmen of the Nominating and Governance Committee and the Valuation Committee is paid $2,500 annually to serve in such capacities, with such compensation paid by the trusts in the First Trust Fund Complex and divided among those trusts. Trustees are also reimbursed by the trusts in the First Trust Fund Complex for travel and out-of-pocket expenses in connection with all meetings. The Lead Independent Trustee and each Committee chairman will serve two-year terms. The officers and "Interested" Trustee receive no compensation for serving in such capacities. 4. PURCHASES AND SALES OF SECURITIES Cost of purchases and proceeds from sales, maturities and paydowns of investment securities, excluding U.S. government and short-term investments, for the year ended January 31, 2009, were $2,448,557 and $15,907,637, respectively. Page 19 NOTES TO FINANCIAL STATEMENTS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 5. REVOLVING LOAN AGREEMENT On July 10, 2007, the Fund entered into a Revolving Credit and Security Agreement with Liberty Street Funding Corp., as conduit lender, and The Bank of Nova Scotia, as secondary lender, which provided for a revolving credit facility to be used as leverage for the Fund. The credit facility provided for a secured line of credit for the Fund, where Fund assets would be pledged against advances made to the Fund. Under the requirements of the 1940 Act, the Fund, immediately after any such borrowings, must have an "asset coverage" of at least 300% (33 1/3% of the Fund's total assets after borrowings). In addition, the Fund agreed to pay facility commitment fees on the unutilized line of credit, which are included in "Facility commitment fees" on the Statement of Operations. The total commitment under the Revolving Credit and Security Agreement was $80,000,000. The Revolving Credit and Security Agreement was terminated on July 8, 2008. For the year ended January 31, 2009, the Fund had no borrowings against the agreement. 6. INDEMNIFICATION The Fund has a variety of indemnification obligations under contracts with its service providers. The Fund's maximum exposure under these arrangements is unknown. However, the Fund has not had prior claims or losses pursuant to these contracts and expects the risk of loss to be remote. 7. LITIGATION Two class action lawsuits were filed in the United States District Court for the Northern District of Illinois on behalf of purchasers of shares of First Trust Strategic High Income Fund, First Trust Strategic High Income Fund II and First Trust Strategic High Income Fund III. The complaints in these lawsuits, Gosselin v. First Trust Advisors L.P., et. al. (filed September 12, 2008) and Evans vs. First Trust Advisors L.P. et. al. (filed September 19, 2008) each name the following entities as defendants: First Trust Advisors L.P., Hilliard Lyons Asset Management, Valhalla Capital Partners LLC, First Trust Portfolios, L.P., and the three closed-end funds (the "Funds") named above. The complaints also name the Trustees and certain officers of the Funds as defendants. The plaintiffs in both lawsuits purport to bring the actions on behalf of a putative class consisting of all persons or entities who acquired shares of the Funds between July 26, 2005 and July 7, 2008 inclusive. The plaintiffs in each action assert, among other things, that the registration statements and prospectuses for the Funds failed to disclose that (a) the Funds lacked effective controls and hedges to minimize the risk of loss from mortgage delinquencies, (b) the Funds lacked effective internal controls, (c) the extent of the Funds liquidity risk was omitted, (d) the extent of the Funds' risk exposure to mortgage-backed assets was misstated. The defendants believe the lawsuits are without merit and intend to contest them vigorously. 8. RISK CONSIDERATIONS Risks are inherent in all investing. The following summarizes some of the risks that should be considered for the Fund. For additional information about the risks associated with investing in the Fund, please see the Fund's prospectus and statement of additional information, as well as other Fund regulatory filings. INVESTMENT AND MARKET RISK: An investment in the Fund's Common Shares is subject to investment risk, including the possible loss of the entire principal invested. An investment in Common Shares represents an indirect investment in the securities owned by the Fund. The value of these securities, like other market investments, may move up or down, sometimes rapidly and unpredictably. Common Shares at any point in time may be worth less than the original investment, even after taking into account the reinvestment of Fund dividends and distributions. Security prices can fluctuate for several reasons including the general condition of the securities markets, or when political or economic events affecting the issuers occur. When the Advisor or Sub-Advisor determines that it is temporarily unable to follow the Fund's investment strategy or that it is impractical to do so (such as when a market disruption event has occurred and trading in the securities is extremely limited or absent), the Fund may take temporary defensive positions. In 2008, and continuing into 2009, securities markets have been significantly negatively affected by the financial crisis that initially resulted from the downturn in the subprime mortgage market in the United States. The potential impact of the financial crisis on securities markets may prove to be significant and long-lasting and may have a substantial impact on the value of the Fund. RESIDENTIAL MORTGAGE-BACKED SECURITIES CONCENTRATION RISK: The Fund will invest at least 25% of its total Managed Assets in residential mortgage-backed securities under normal market conditions. The Fund may deviate from its investment strategies, including its concentration policy, when engaging in temporary defensive positions. A fund concentrated in a single industry is likely to present more risks than a fund that is broadly diversified over several industries. Mortgage-backed securities may have less potential for capital appreciation than comparable fixed-income securities, due to the likelihood of increased prepayments of mortgages as interest rates decline. If the Fund buys mortgage-backed securities at a premium, mortgage foreclosures and prepayments of principal by mortgagors (which usually may be made at any time without penalty) may result in some loss of the Fund's principal investment to the extent of the Page 20 NOTES TO FINANCIAL STATEMENTS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 premium paid. Alternatively, in a rising interest rate environment, the value of mortgage-backed securities may be adversely affected when payments on underlying mortgages do not occur as anticipated, resulting in the extension of the security's effective maturity and the related increase in interest rate sensitivity of a longer-term instrument. The value of mortgage-backed securities may also change due to shifts in the market's perception of issuers and regulatory or tax changes adversely affecting the markets as a whole. In addition, mortgage-backed securities are subject to the credit risk associated with the performance of the underlying mortgage properties. In certain instances, third-party guarantees or other forms of credit support can reduce the credit risk. The Fund may also invest in mortgage-backed securities which are interest-only ("IO") securities and principal-only ("PO") securities. Generally speaking, when interest rates are falling and prepayment rates are increasing, the value of a PO security will rise and the value of an IO security will fall. Conversely, when interest rates are rising and prepayment rates are decreasing, generally the value of a PO security will fall and the value of an IO security will rise. In addition to the foregoing, residential mortgage-backed securities are subject to additional risks, including: (i) the United States residential mortgage market has recently encountered various difficulties and changed economic conditions. In addition, recently, residential property values in various states have declined or remained stable, after extended periods of appreciation. A continued decline or an extended flattening in those values may result in additional increases in delinquencies and losses on residential mortgage loans generally; (ii) if a residential mortgage obligation is secured by a junior lien it will be subordinate to the rights of the mortgagees or beneficiaries under the related senior mortgages or deeds of trust; and (iii) depending on the length of a residential mortgage obligation underlying a residential mortgage-backed security, unscheduled or early payments of principal and interest may shorten the security's effective maturity and the prevailing interest rates may be higher or lower than the current yield of the Fund's portfolio at the time the Fund receives the payments for reinvestment. VALUE INVESTING RISK: The Fund focuses its investments on securities that the Sub-Advisor believes are undervalued or inexpensive relative to other investments. Such securities are subject to the risk of misestimating certain fundamental factors. Disciplined adherence to a "value" investment mandate during periods in which that style is "out of favor" can result in significant underperformance relative to overall market indices and other managed investment vehicles that pursue growth style investments and/or flexible style mandates. BELOW-INVESTMENT GRADE SECURITIES RISK: The Fund invests in below-investment grade securities. The market values for high-yield securities tend to be very volatile, and these securities are less liquid than investment grade debt securities. For these reasons, your investment in the Fund is subject to the following specific risks: (a) increased price sensitivity to changing interest rates and to a deteriorating economic environment; (b) greater risk of loss due to default or declining credit quality; (c) adverse issuer specific events are more likely to render the issuer unable to make interest and/or principal payments; and (d) a negative perception of the high-yield market may depress the price and liquidity of high-yield securities. DISTRESSED SECURITIES RISK: The Fund may invest in securities issued by companies in a bankruptcy reorganization proceeding, subject to some other form of a public or private debt restructuring or otherwise in default or in significant risk of default in the payment of interest or repayment of principal or trading at prices substantially below other below-investment grade debt securities of companies in similar industries. Distressed securities frequently do not produce income while they are outstanding. A Fund may be required to incur certain extraordinary expenses in order to protect and recover its investment. Therefore, to the extent a Fund seeks capital appreciation through investment in distressed securities, its ability to achieve current income may be diminished. ECONOMIC CONDITIONS RISK: Adverse changes in economic conditions are more likely to lead to a weakened capacity of a high-yield issuer to make principal payments and interest payments than an investment grade issuer. An economic downturn could severely affect the ability of highly leveraged issuers to service their debt obligations or to repay their obligations upon maturity. Under adverse market or economic conditions, the secondary market for high-yield securities could contract further, independent of any specific adverse changes in the condition of a particular issuer and these securities may become illiquid. As a result, the Fund could find it more difficult to sell these securities or may be able to sell the securities only at prices lower than if such securities were widely traded. FIXED-INCOME SECURITIES RISK: Debt securities, including high yield securities, are subject to certain risks, including: (i) issuer risk, which is the risk that the value of fixed-income securities may decline for a number of reasons which directly relate to the issuer, such as management performance, financial leverage and reduced demand for the issuer's goods and services or, in the case of asset-backed issuers, a decline in the value and/or cash flows of the underlying assets; (ii) reinvestment risk, which is the risk that income from the Fund's portfolio will decline if the Fund invests the proceeds from matured, traded or called bonds at market interest rates that are below the Fund portfolio's current earnings rate; (iii) prepayment risk, which is the risk that during periods of declining interest rates, the issuer of a security may exercise its option to prepay principal earlier than scheduled, forcing the Fund to reinvest in lower yielding securities; and (iv) credit risk, which is the risk that a security in the Fund's portfolio will decline in price or the issuer fails to make interest payments when due because the issuer of the security experiences a decline in its financial status. INTEREST RATE RISK: The Fund is also subject to interest rate risk. Interest rate risk is the risk that fixed-income securities will decline in value because of changes in market interest rates. Investments in debt securities with long-term maturities may experience significant price declines if long-term interest rates increase. Page 21 NOTES TO FINANCIAL STATEMENTS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 9. SUBSEQUENT EVENTS On January 20, 2009, the Fund declared a dividend of $0.1200 per share to Common Shareholders of record February 4, 2009, payable February 17, 2009. On February 20, 2009, the Fund declared a dividend of $0.1000 per share to Common Shareholders of record March 4, 2009, payable March 16, 2009. On March 20, 2009, the Fund declared a dividend of $0.1000 per share to common shareholders of record April 3, 2009, payable April 15, 2009. Page 22 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST STRATEGIC HIGH INCOME FUND III: We have audited the accompanying statement of assets and liabilities, including the portfolio of investments, of First Trust Strategic High Income Fund III (the "Fund") as of January 31, 2009, and the related statements of operations and cash flows for the year then ended, the statements of changes in net assets for the year then ended and for the period February 20, 2007 (inception) through January 31, 2008, and the financial highlights for the periods presented. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of January 31, 2009 by correspondence with the custodian. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of First Trust Strategic High Income Fund III as of January 31, 2009 and the related statements of operations and cash flows for the year then ended, the statements of changes in net assets for assets for the year then ended and for the period February 20, 2007 (inception) through January 31, 2008, and the financial highlights for the periods presented, in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 2A to the Fund's financial statements, the statement of assets and liabilities includes investments with a value of $3,546,826 (21.3% of total investments) as of January 31, 2009, whose values have been determined based on prices supplied by dealers. These values may differ from the values that would have been used had a ready market for these investments existed, and the differences could be material. (DELOITTE & TOUCHE LLP) Chicago, Illinois March 24, 2009 Page 23 ADDITIONAL INFORMATION FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED) DIVIDEND REINVESTMENT PLAN If your Common Shares are registered directly with the Fund or if you hold your Common Shares with a brokerage firm that participates in the Fund's Dividend Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund, to receive cash distributions, all dividends, including any capital gain distributions, on your Common Shares will be automatically reinvested by PNC Global Investment Servicing (U.S.) Inc. (the "Plan Agent"), in additional Common Shares under the Plan. If you elect to receive cash distributions, you will receive all distributions in cash paid by check mailed directly to you by the Plan Agent, as dividend paying agent. If you decide to participate in the Plan, the number of Common Shares you will receive will be determined as follows: (1) If Common Shares are trading at or above NAV at the time of valuation, the Fund will issue new shares at a price equal to the greater of (i) NAV per Common Share on that date or (ii) 95% of the market price on that date. (2) If Common Shares are trading below NAV at the time of valuation, the Plan Agent will receive the dividend or distribution in cash and will purchase Common Shares in the open market, on the NYSE or elsewhere, for the participants' accounts. It is possible that the market price for the Common Shares may increase before the Plan Agent has completed its purchases. Therefore, the average purchase price per share paid by the Plan Agent may exceed the market price at the time of valuation, resulting in the purchase of fewer shares than if the dividend or distribution had been paid in Common Shares issued by the Fund. The Plan Agent will use all dividends and distributions received in cash to purchase Common Shares in the open market within 30 days of the valuation date except where temporary curtailment or suspension of purchases is necessary to comply with federal securities laws. Interest will not be paid on any uninvested cash payments. You may elect to opt-out of or withdraw from the Plan at any time by giving written notice to the Plan Agent, or by telephone at (800) 334-1710, in accordance with such reasonable requirements as the Plan Agent and the Fund may agree upon. If you withdraw or the Plan is terminated, you will receive a certificate for each whole share in your account under the Plan and you will receive a cash payment for any fraction of a share in your account. If you wish, the Plan Agent will sell your shares and send you the proceeds, minus brokerage commissions. The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives written confirmation of all transactions in the accounts, including information you may need for tax records. Common Shares in your account will be held by the Plan Agent in non-certificated form. The Plan Agent will forward to each participant any proxy solicitation material and will vote any shares so held only in accordance with proxies returned to the Fund. Any proxy you receive will include all Common Shares you have received under the Plan. There is no brokerage charge for reinvestment of your dividends or distributions in Common Shares. However, all participants will pay a pro rata share of brokerage commissions incurred by the Plan Agent when it makes open market purchases. Automatically reinvesting dividends and distributions does not mean that you do not have to pay income taxes due upon receiving dividends and distributions. Capital gains and income are realized, although cash is not received by you. Consult your financial advisor for more information. If you hold your Common Shares with a brokerage firm that does not participate in the Plan, you will not be able to participate in the Plan and any dividend reinvestment may be effected on different terms than those described above. The Fund reserves the right to amend or terminate the Plan if in the judgment of the Board of Trustees the change is warranted. There is no direct service charge to participants in the Plan; however, the Fund reserves the right to amend the Plan to include a service charge payable by the participants. Additional information about the Plan may be obtained by writing PNC Global Investment Servicing (U.S.) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809. PROXY VOTING POLICIES AND PROCEDURES A description of the policies and procedures that the Fund uses to determine how to vote proxies and information on how the Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 is available (1) without charge, upon request, by calling (800) 988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; and (3) on the Securities and Exchange Commission's website at http://www.sec.gov. Page 24 ADDITIONAL INFORMATION - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED) PORTFOLIO HOLDINGS The Fund files its complete schedule of portfolio holdings with the Securities and Exchange Commission ("SEC") for the first and third quarters of each fiscal year on Form N-Q. The Fund's Forms N-Q are available (1) by calling (800) 988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3) on the SEC's website at http://www.sec.gov; and (4) for review and copying at the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding the operation of the PRR may be obtained by calling (800) SEC-0330. NYSE CERTIFICATION INFORMATION In accordance with Section 303A-12 of the New York Stock Exchange ("NYSE") Listed Company Manual, the Fund's President has certified to the NYSE that, as of May 14, 2008, he was not aware of any violation by the Fund of NYSE corporate governance listing standards. In addition, the Fund's reports to the SEC on Forms N-CSR, N-CSRS and N-Q contain certifications by the Fund's principal executive officer and principal financial officer that relate to the Fund's public disclosure in such reports and are required by Rule 30a-2 under the 1940 Act. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS The Annual Meeting of Shareholders of the Common Shares of First Trust Strategic High Income Fund III was held on June 9, 2008. At the Annual Meeting, Trustee Robert F. Keith was elected for a three-year term. The number of votes cast in favor of Mr. Keith was 8,351,424, the number of votes against was 94,464 and the number of abstentions was 547,480. James A. Bowen, Richard E. Erickson, Thomas R. Kadlec and Niel B. Nielson are the other current and continuing Trustees. TAX INFORMATION Of the ordinary income (including short-term capital gain) distributions made by the Fund during the year ended January 31, 2009, none qualify for the corporate dividends received deduction available to corporate shareholders or as qualified dividend income. CHANGE IN TEMPORARY DEFENSIVE POLICY On September 15, 2008, the Fund's Board of Trustees approved a change in the Fund's temporary defensive policy. Previously, the temporary defensive policy of the Fund permitted it to deviate from its investment strategy and invest all or any portion of its managed assets in cash or cash equivalents. Cash equivalents, in general terms, include: U.S. Government securities, certificates of deposit, repurchase agreements, commercial paper, bankers' acceptances, bank time deposits and money market funds. Under the revised temporary defensive policy, the Fund may deviate from its investment strategy and invest all or any portion of its total assets in cash, cash equivalents and certain other defensive instruments, including manufactured home loan-backed securities; certain securities guaranteed by the U.S. Government or its agencies or instrumentalities; asset-backed securities representing direct or indirect participations in, or secured by and payable from, pools of leases of aircrafts and/or loans to purchase aircrafts; asset-backed securities representing direct or indirect participations in, or secured by and payable from, loans or other obligations of franchises; corporate bonds; and any other securities rated in the AA category or better by at least one nationally recognized statistical rating organization (collectively, the "Defensive Instruments"). The revised temporary defensive policy is set forth below. When the Fund is assuming a temporary defensive position it may not pursue or achieve its investment objectives during such times and may deviate from its investment strategies, including its concentration policy. Investments in a Fund assuming temporary defensive positions in reliance on its temporary defensive policy remain subject to risks, including investment risk and the possible loss of the money invested in the Fund. Some of the risks related to the Fund have been set forth in Note 8 - - Risk Considerations in the Notes to the Financial Statements. TEMPORARY DEFENSIVE POLICY OF THE FUND: During the period in which the net proceeds of any offering of Common Shares, Preferred Shares, commercial paper or notes and/or borrowings, if any, are being invested, or during periods in which First Trust Advisors L.P. (the "Advisor") or Valhalla Capital Partners, LLC (the "Sub-Advisor") determines that it is temporarily unable to follow the Fund's investment strategy or that it is impractical to do so, the Fund may deviate from its investment strategy and invest all or any portion of its Managed Assets in cash and Defensive Instruments (as such term is defined below) and/or may use such cash and proceeds from the sale of Defensive Instruments or other assets to pay down any leverage of the Fund. The Advisor's or the Sub-Advisor's determination that it is temporarily unable to follow the Fund's investment strategy or that it is impractical to do so will generally occur only in situations in which a market disruption event has occurred and where trading in the securities selected through application of the Fund's investment strategy is extremely limited or absent. In such a case, the Fund may not pursue or achieve its investment objectives. Page 25 ADDITIONAL INFORMATION - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED) Defensive Instruments are defined to include: A. Cash Equivalents - (1) U.S. Government securities, including bills, notes and bonds differing as to maturity and rates of interest that are either issued or guaranteed by the U.S. Treasury or by U.S. Government agencies or instrumentalities. U.S. Government agency securities include securities issued by: (a) the Federal Housing Administration, Farmers Home Administration, Export Import Bank of the United States, Small Business Administration, and the Government National Mortgage Association, whose securities are supported by the full faith and credit of the United States; (b) the Federal Home Loan Banks, Federal Intermediate Credit Banks, and the Tennessee Valley Authority, whose securities are supported by the right of the agency to borrow from the U.S. Treasury; (c) the Federal National Mortgage Association, whose securities are supported by the discretionary authority of the U.S. Government to purchase certain obligations of the agency or instrumentality; and (d) the Student Loan Marketing Association, whose securities are supported only by its credit. While the U.S. Government provides financial support to such U.S. Government sponsored agencies or instrumentalities, no assurance can be given that it always will do so since it is not so obligated by law. The U.S. Government, its agencies and instrumentalities do not guarantee the market value of their securities. Consequently, the value of such securities may fluctuate. (2) Certificates of deposit issued against funds deposited in a bank or a savings and loan association. Such certificates are for a definite period of time, earn a specified rate of return, and are normally negotiable. The issuer of a certificate of deposit 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. (3) Repurchase agreements, which involve purchases of debt securities. At the time the Fund purchases securities pursuant to a repurchase agreement, it simultaneously agrees to resell and redeliver such securities to the seller, who also simultaneously agrees to buy back the securities 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. Purchasing securities pursuant to a repurchase agreement affords an opportunity for the Fund to invest temporarily available cash. Pursuant to the Fund's policies and procedures, 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 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 Sub-Advisor monitors 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 Sub-Advisor does 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. (4) Commercial paper, which consists of 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 such notes. However, they are redeemable by the Fund at any time. The Sub-Advisor will consider the financial condition of the corporation (E.G., earning power, cash flow, and other liquidity measures) and will continuously monitor the corporation's ability to meet all its financial obligations, because the Fund's liquidity might be impaired if the corporation were unable to pay principal and interest on demand. Investments in commercial paper will be limited to commercial paper rated in the highest categories by a nationally recognized statistical rating organization ("NRSRO") and which mature within one year of the date of purchase or carry a variable or floating rate of interest. Page 26 ADDITIONAL INFORMATION - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED) (5) 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. (6) 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. (7) Shares of money market funds purchased in accordance with the provisions of the 1940 Act. B. Manufactured Home Loan-Backed Securities - securities representing a direct or indirect participation in, or secured by and payable from, pools of loans used to purchase manufactured housing and the security interest therein.* C. Securities guaranteed by the U.S. Government or its agencies or instrumentalities that are not included as cash equivalents above or as residential mortgage-backed securities ("RMBS").* D. Asset-backed securities representing direct or indirect participations in, or secured by and payable from, pools of leases of aircrafts and/or loans to purchase aircrafts.* E. Asset-backed securities representing direct or indirect participations in, or secured by and payable from, loans or other obligations of franchises.* F. Corporate bonds - debt obligations issued by corporations.* G. Any other securities rated in the AA category or better by at least one NRSRO.* If the rating on a security is subsequently downgraded, the Advisor and/or Sub-Advisor will determine whether to retain the security as a Defensive Instrument, retain the security but not as a Defensive Instrument or dispose of the security. * To be eligible as a Defensive Instrument, the Sub-Advisor must determine in each case at the time of purchase that the security to be purchased is less risky than RMBS currently available in the marketplace that would be consistent with the Fund's investment strategy. Page 27 BOARD OF TRUSTEES AND OFFICERS FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED)
NUMBER OF PORTFOLIOS IN OTHER NAME, ADDRESS, THE FIRST TRUST TRUSTEESHIPS OR DATE OF BIRTH AND TERM OF OFFICE AND PRINCIPAL OCCUPATIONS FUND COMPLEX DIRECTORSHIPS POSITION WITH THE FUND LENGTH OF SERVICE(1) DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE - ----------------------------- ---------------------- -------------------------- ------------------- ------------------------ INDEPENDENT TRUSTEES Richard E. Erickson, Trustee - Two Year Term Physician; President, 60 None c/o First Trust Advisors L.P. - Since Fund Wheaton Orthopedics; 120 E. Liberty Drive, Inception Co-owner and Co-Director Suite 400 (January 1996 to May Wheaton, IL 60187 2007), Sports Med Center D.OB.: 04/51 for Fitness; Limited Partner, Gundersen Real Estate Limited Partnership; Member, Sportsmed LLC Thomas R. Kadlec, Trustee - Two Year Term Senior Vice President and 60 Director of ADM c/o First Trust Advisors L.P. - Since Fund Chief Financial Officer Investor Services, Inc. 120 E. Liberty Drive, Inception (May 2007 to Present), and Director of Archer Suite 400 Vice President and Chief Financial Services, Inc. Wheaton, IL 60187 Financial Officer (1990 to D.O.B.: 11/57 May 2007), ADM Investor Services, Inc. (Futures Commission Merchant); President (May 2005 to Present), ADM Derivatives, Inc.; Registered Representative (2000 to Present), Segerdahl & Company, Inc., a FINRA member (Broker-Dealer) Robert F. Keith, Trustee - Three Year Term President (2003 to 60 None c/o First Trust Advisors L.P. - Since Fund Present), Hibs Enterprises 120 E. Liberty Drive, Inception (Financial and Suite 400 Management Consulting); Wheaton, IL 60187 President (2001 to 2003), D.O.B.: 11/56 Aramark Management Services LP; President and Chief Operating Officer (1998 to 2003), ServiceMaster Management Services LP
- ---------- (1) Currently, Robert F. Keith, as a Class I Trustee, is serving as a trustee until the Fund's 2011 annual meeting of shareholders. Richard E. Erickson and Thomas R. Kadlec, as Class II Trustees, are each serving as trustees until the Fund's 2009 annual meeting of shareholders. James A. Bowen and Niel B. Nielson, as Class III Trustees, are each serving as trustees until the Fund's 2010 annual meeting. Officers of the Fund have an indefinite term. Page 28 BOARD OF TRUSTEES AND OFFICERS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED)
NUMBER OF PORTFOLIOS IN OTHER NAME, ADDRESS, THE FIRST TRUST TRUSTEESHIPS OR DATE OF BIRTH AND TERM OF OFFICE AND PRINCIPAL OCCUPATIONS FUND COMPLEX DIRECTORSHIPS POSITION WITH THE FUND LENGTH OF SERVICE(1) DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE - ----------------------------- ---------------------- -------------------------- ------------------- ------------------------ INDEPENDENT TRUSTEES - (CONTINUED) Niel B. Nielson, Trustee - Three Year Term President (June 2002 to 60 Director of Covenant c/o First Trust Advisors L.P. - Since Fund Present), Covenant Transport Inc. 120 E. Liberty Drive, Inception College Suite 400 Wheaton, IL 60187 D.O.B.: 03/54 INTERESTED TRUSTEE James A. Bowen, Trustee(2), - Three Year Trustee President, First Trust 60 Trustee of Wheaton President, Chairman of the Term and Indefinite Advisors L.P. and First College Board and CEO Officer Term Trust Portfolios L.P.; 120 E. Liberty Drive, - Since Fund Chairman of the Board of Suite 400 Inception Directors, BondWave LLC Wheaton, IL 60187 (Software Development D.O.B.: 09/55 Company/Broker- Dealer/Investment Advisor) and Stonebridge Advisors LLC (Investment Advisor)
NAME, ADDRESS POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS - ----------------------------- ---------------------- ------------------------ --------------------------------------- OFFICERS WHO ARE NOT TRUSTEES(3) Mark R. Bradley Treasurer, Controller, - Indefinite Term Chief Financial Officer, 120 E. Liberty Drive, Chief Financial - Since Fund Inception First Trust Advisors L.P. Suite 400 Officer and Chief and First Trust Portfolios Wheaton, IL 60187 Accounting Officer L.P.; Chief Financial D.O.B.: 11/57 Officer, BondWave LLC (Software Development Company/Broker- Dealer/Investment Advisor) and Stonebridge Advisors LLC (Investment Advisor)
- ---------- (1) Currently, Robert F. Keith, as a Class I Trustee, is serving as a trustee until the Fund's 2011 annual meeting of shareholders. Richard E. Erickson and Thomas R. Kadlec, as Class II Trustees, are each serving as trustees until the Fund's 2009 annual meeting of shareholders. James A. Bowen and Niel B. Nielson, as Class III Trustees, are each serving as trustees until the Fund's 2010 annual meeting. Officers of the Fund have an indefinite term. (2) Mr. Bowen is deemed an "interested person" of the Fund due to his position as President of First Trust Advisors L.P., investment advisor of the Fund. (3) The term "officer" means the president, vice president, secretary, treasurer, controller or any other officer who performs a policy making function. Page 29 BOARD OF TRUSTEES AND OFFICERS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED)
NAME, ADDRESS POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS - ----------------------------- ---------------------- ------------------------ --------------------------------------- OFFICERS WHO ARE NOT TRUSTEES(3) - (CONTINUED) James M. Dykas Assistant Treasurer - Indefinite Term Senior Vice President (April 2007 to 120 E. Liberty Drive, - Since Fund Present), Vice President (January 2005 Suite 400 Inception to April 2007), First Trust Advisors Wheaton, IL 60187 L.P. and First Trust Portfolios L.P.; D.O.B.: 01/66 Executive Director (December 2002 to January 2005), Vice President (December 2000 to December 2002), Van Kampen Asset Management and Morgan Stanley Investment Management Christopher R. Fallow Assistant Vice - Indefinite Term Assistant Vice President (August 2006 120 E. Liberty Drive, President - Since Fund to Present), Associate (January 2005 Suite 400 Inception to August 2006), First Trust Advisors Wheaton, IL 60187 L.P. and First Trust Portfolios L.P.; D.O.B.: 04/79 Municipal Bond Trader (July 2001 to January 2005), BondWave LLC (Software Development Company/Broker-Dealer/Investment Advisor) W. Scott Jardine Secretary and Chief - Indefinite Term General Counsel, First Trust Advisors 120 E. Liberty Drive, Compliance Officer - Since Fund L.P. and First Trust Portfolios L.P.; Suite 400 Inception Secretary, BondWave LLC (Software Wheaton, IL 60187 Development Company/Broker- D.O.B.: 05/60 Dealer/Investment Advisor) and Stonebridge Advisors LLC (Investment Advisor) Daniel J. Lindquist Vice President - Indefinite Term Senior Vice President (September 120 E. Liberty Drive, - Since Fund 2005 to Present), Vice President (April Suite 400 Inception 2004 to September 2005), First Trust Wheaton, IL 60187 Advisors L.P. and First Trust D.O.B.: 02/70 Portfolios L.P.; Chief Operating Officer (January 2004 to April 2004), Mina Capital Management, LLC; Chief Operating Officer (April 2000 to January 2004), Samaritan Asset Management Services, Inc.
- ---------- (3) The term "officer" means the president, vice president, secretary, treasurer, controller or any other officer who performs a policy making function. Page 30 BOARD OF TRUSTEES AND OFFICERS - (CONTINUED) FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED)
NAME, ADDRESS POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS - ----------------------------- ---------------------- ------------------------ --------------------------------------- OFFICERS WHO ARE NOT TRUSTEES3 - (CONTINUED) Coleen D. Lynch Assistant Vice - Indefinite Term Assistant Vice President (January 120 E. Liberty Drive, President - Since July 2008 2008 to Present), First Trust Advisors Suite 400 L.P. and First Trust Portfolios L.P.; Wheaton, IL 60187 Vice President (May 1998 to January D.O.B.: 07/58 2008), Van Kampen Asset Management and Morgan Stanley Investment Management Kristi A. Maher Assistant Secretary - Indefinite Term Deputy General Counsel (May 2007 to 120 E. Liberty Drive, - Since Fund Present), Assistant General Counsel Suite 400 Inception (March 2004 to May 2007), First Trust Wheaton, IL 60187 Advisors L.P. and First Trust D.O.B.: 12/66 Portfolios L.P.; Associate (December 1995 to March 2004), Chapman and Cutler LLP
- ---------- (3) The term "officer" means the president, vice president, secretary, treasurer, controller or any other officer who performs a policy making function. Page 31 PRIVACY POLICY FIRST TRUST STRATEGIC HIGH INCOME FUND III JANUARY 31, 2009 (UNAUDITED) PRIVACY POLICY The open-end and closed-end funds advised by First Trust Advisors L.P. (each a "Fund") consider your privacy an important priority in maintaining our relationship. We are committed to protecting the security and confidentiality of your personal information. SOURCES OF INFORMATION We may collect nonpublic personal information about you from the following sources: - Information we receive from you or your broker-dealer, investment adviser or financial representative through interviews, applications, agreements or other forms; - Information about your transactions with us, our affiliates or others; - Information we receive from your inquiries by mail, e-mail or telephone; and - Information we collect on our website through the use of "cookies." For example, we may identify the pages on our website that your browser requests or visits. INFORMATION COLLECTED The type of data we collect may include your name, address, social security number, age, financial status, assets, income, tax information, retirement and estate plan information, transaction history, account balance, payment history, investment objectives, marital status, family relationships and other personal information. DISCLOSURE OF INFORMATION We do not disclose any nonpublic personal information about our customers or former customers to anyone, except as permitted by law. The permitted uses include the disclosure of such information to unaffiliated companies for the following reasons: - In order to provide you with products and services and to effect transactions that you request or authorize, we may disclose your personal information as described above to unaffiliated financial service providers and other companies that perform administrative or other services on our behalf, such as transfer agents, custodians and trustees, or that assist us in the distribution of investor materials such as trustees, banks, financial representatives and printers. - We may release information we have about you if you direct us to do so, if we are compelled by law to do so, or in other legally limited circumstances (for example to protect your account from fraud). In addition, in order to alert you to our other financial products and services, we may share your personal information with affiliates of the Fund. Please note, however, that the California Financial Information Privacy Act contains an "opt out" mechanism that California consumers may use to prevent us from sharing nonpublic personal information with affiliates. CONFIDENTIALITY AND SECURITY With regard to our internal security procedures, the Fund restricts access to your nonpublic personal information to those individuals who need to know that information to provide products or services to you. We maintain physical, electronic and procedural safeguards to protect your nonpublic personal information. POLICY UPDATES AND INQUIRIES As required by federal law, we will notify you of our privacy policy annually. We reserve the right to modify this policy at any time; however, if we do change it, we will tell you promptly. For questions about our policy, or for additional copies of this notice, please contact us at (800) 621-1675. Page 32 (FIRST TRUST LOGO) INVESTMENT ADVISOR First Trust Advisors L.P. 1001 Liberty Drive, Suite 400 Wheaton, IL 60187 INVESTMENT SUB-ADVISOR Valhalla Capital Partners, LLC 13011 W. Hwy 42, Suite 201 Prospect, Kentucky 40059 ADMINISTRATOR, FUND ACCOUNTANT, TRANSFER AGENT & BOARD ADMINISTRATOR PNC Global Investment Servicing (U.S.) Inc. 301 Bellevue Parkway Wilmington, DE 19809 CUSTODIAN PFPC Trust Company 8800 Tinicum Boulevard Philadelphia, PA 19153 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP 111 S. Wacker Drive Chicago, IL 60606 LEGAL COUNSEL Chapman and Cutler LLP 111 W. Monroe Street Chicago, IL 60603 ITEM 2. CODE OF ETHICS. (a) The registrant, as of the end of the period covered by this report, has adopted a code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party. (c) There have been no amendments, during the period covered by this report, to a provision of the code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party, and that relates to any element of the code of ethics description. (d) The registrant has not granted any waivers, including an implicit waiver, from a provision of the code of ethics that applies to the registrant's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the registrant or a third party, that relates to one or more of the items set forth in paragraph (b) of this item's instructions. ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT. As of the end of the period covered by the report, the Registrant's board of trustees has determined that Thomas R. Kadlec and Robert F. Keith are qualified to serve as audit committee financial experts serving on its audit committee and that each of them is "independent," as defined by Item 3 of Form N-CSR. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. (a) Audit Fees (Registrant) -- The aggregate fees billed for each of the last two fiscal years for professional services rendered by the principal accountant for the audit of the registrant's annual financial statements or services that are normally provided by the accountant in connection with statutory and regulatory filings or engagements for those fiscal years were $51,000 from the inception of the registrant on May 25, 2007 through January 31, 2008 and $15,500 for the fiscal year ended January 31, 2009. (b) Audit-Related Fees (Registrant) -- The aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of this Item were $0 from the inception of the registrant on May 25, 2007 through January 31, 2008 and $9,157 for the fiscal year ended January 31, 2009. These fees were for additional audit work. Audit-Related Fees (Investment Adviser) -- The aggregate fees billed in each of the last two fiscal years for assurance and related services by the principal accountant that are reasonably related to the performance of the audit of the registrant's financial statements and are not reported under paragraph (a) of this Item were $7,500 from the inception of the registrant on May 25, 2007 through January 31, 2008 and $24,657 for the fiscal year ended January 31, 2009. These fees were for additional audit work. (c) Tax Fees (Registrant) -- The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning to the registrant were $0 from the inception of the registrant on May 25, 2007 through January 31, 2008 and $5,000 for the fiscal year ended January 31, 2009. These fees were for tax consultation. Tax Fees (Investment Adviser) -- The aggregate fees billed in each of the last two fiscal years for professional services rendered by the principal accountant for tax compliance, tax advice, and tax planning to the registrant's adviser were $0 from the inception of the registrant on May 25, 2007 through January 31, 2008 and $0 for the fiscal year ended January 31, 2009. (d) All Other Fees (Registrant) -- The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant to the registrant, other than the services reported in paragraphs (a) through (c) of this Item were $0 from the inception of the registrant on May 25, 2007 through January 31, 2008 and $0 for the fiscal year ended January 31, 2009. All Other Fees (Investment Adviser) -- The aggregate fees billed in each of the last two fiscal years for products and services provided by the principal accountant to the registrant's investment adviser, other than the services reported in paragraphs (a) through (c) of this Item were $0 from the inception of the registrant on May 25, 2007 through January 31, 2008 and $0 for the fiscal year ended January 31, 2009. (e)(1) Disclose the audit committee's pre-approval policies and procedures described in paragraph (c) (7) of Rule 2-01 of Regulation S-X. Pursuant to its charter and its Audit and Non-Audit Services Pre-Approval Policy, the Audit Committee (the "Committee") is responsible for the pre-approval of all audit services and permitted non-audit services (including the fees and terms thereof) to be performed for the registrant by its independent auditors. The Chairman of the Committee is authorized to give such pre-approvals on behalf of the Committee up to $25,000 and report any such pre-approval to the full Committee. The Committee is also responsible for the pre-approval of the independent auditor's engagements for non-audit services with the registrant's adviser (not including a sub-adviser whose role is primarily portfolio management and is sub-contracted or overseen by another investment adviser) and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant, if the engagement relates directly to the operations and financial reporting of the registrant, subject to the DE MINIMIS exceptions for non-audit services described in Rule 2-01 of Regulation S-X. If the independent auditor has provided non-audit services to the registrant's adviser (other than any sub-adviser whose role is primarily portfolio management and is sub-contracted with or overseen by another investment adviser) and any entity controlling, controlled by or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to its policies, the Committee will consider whether the provision of such non-audit services is compatible with the auditor's independence. (e)(2) The percentage of services described in each of paragraphs (b) through (d) for the registrant and the registrant's investment adviser of this Item that were approved by the audit committee pursuant to the pre-approval exceptions included in paragraph (c)(7)(i)(c) or paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X are as follows: (b) 0% (c) 0% (d) 0% (f) The percentage of hours expended on the principal accountant's engagement to audit the registrant's financial statements for the most recent fiscal year that were attributed to work performed by persons other than the principal accountant's full-time, permanent employees was less than fifty percent. (g) The aggregate non-audit fees billed by the registrant's accountant for services rendered to the registrant, and rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the adviser that provides ongoing services to the registrant from the inception of the registrant on May 25, 2007 through January 31, 2008, were $0 for the registrant and $7,000 for the registrant's investment adviser, and for the fiscal year ended January 31, 2009, were $5,000 for the registrant and $12,143 for the registrant's investment adviser. (h) The registrant's audit committee of its Board of Trustees has determined that the provision of non-audit services that were rendered to the registrant's investment adviser (not including any sub-adviser whose role is primarily portfolio management and is subcontracted with or overseen by another investment adviser), and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule 2-01 of Regulation S-X is compatible with maintaining the principal accountant's independence. ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. (a) The Registrant has a separately designated audit committee consisting of all the independent directors of the Registrant. The members of the audit committee are: Thomas R. Kadlec, Niel B. Nielson, Richard E. Erickson and Robert F. Keith. ITEM 6. INVESTMENTS. (a) Schedule of Investments in securities of unaffiliated issuers as of the close of the reporting period is included as part of the report to shareholders filed under Item 1 of this form. (b) Not applicable. ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. The Proxy Voting Policies are attached herewith. First Trust Advisors L.P. (the "ADVISER") serves as investment adviser providing discretionary investment advisory services for several open or closed-end investment companies (the "FUNDS"). As part of these services, the Adviser has full responsibility for proxy voting and related duties. In fulfilling these duties, the Adviser and Funds have adopted the following policies and procedures: 1. It is the Adviser's policy to seek to ensure that proxies for securities held by a Fund are voted consistently and solely in the best economic interests of the respective Fund. 2. The Adviser shall be responsible for the oversight of a Fund's proxy voting process and shall assign a senior member of its staff to be responsible for this oversight. 3. The Adviser has engaged the services of Institutional Shareholder Services, Inc. ("ISS") to make recommendations to the Adviser on the voting of proxies related to securities held by a Fund. ISS provides voting recommendations based on established guidelines and practices. The Adviser has adopted these ISS Proxy Voting Guidelines. 4. The Adviser shall review the ISS recommendations and generally will vote the proxies in accordance with such recommendations. Notwithstanding the foregoing, the Adviser may not vote in accordance with the ISS recommendations if the Adviser believes that the specific ISS recommendation is not in the best interests of the respective Fund. 5. If the Adviser manages the assets or pension fund of a company and any of the Adviser's clients hold any securities in that company, the Adviser will vote proxies relating to such company's securities in accordance with the ISS recommendations to avoid any conflict of interest. In addition, if the Adviser has actual knowledge of any other type of material conflict of interest between itself and the respective Fund with respect to the voting of a proxy, the Adviser shall vote the applicable proxy in accordance with the ISS recommendations to avoid such conflict of interest. 6. If a Fund requests the Adviser to follow specific voting guidelines or additional guidelines, the Adviser shall review the request and follow such guidelines, unless the Adviser determines that it is unable to follow such guidelines. In such case, the Adviser shall inform the Fund that it is not able to follow the Fund's request. 7. The Adviser may have clients in addition to the Funds which have provided the Adviser with discretionary authority to vote proxies on their behalf. In such cases, the Adviser shall follow the same policies and procedures. (RISKMETRICS GROUP LOGO) ---------- 2008 U.S. Proxy Voting Guidelines Summary ISS Governance Services December 17, 2007 ---------- Copyright (C) 2007 by RiskMetrics Group. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopy, recording, or any information storage and retrieval system, without permission in writing from the publisher. Requests for permission to make copies of any part of this work should be sent to: RiskMetrics Group Marketing Department, One Chase Manhattan Plaza, 44th Floor, New York, NY 10005. RiskMetrics Group is a trademark used herein under license. Risk Management | RiskMetrics Labs | ISS Governance Services | Financial Research & Analysis www.riskmetrics.com RISKMETRICS Group www.riskmetrics.com ISS GOVERANCE SERVICES 2008 U.S. PROXY VOTING GUIDELINES SUMMARY EFFECTIVE FOR MEETINGS ON OR AFTER FEB 1, 2008 UPDATED DEC 17, 2007 The following is a condensed version of the proxy voting recommendations contained in the ISS Governance Services ("ISS") Proxy Voting Manual. Table of Contents 1. OPERATIONAL ITEMS ...................................................... 6 Adjourn Meeting ........................................................ 6 Amend Quorum Requirements .............................................. 6 Amend Minor Bylaws ..................................................... 6 Auditor Indemnification and Limitation of Liability .................... 6 Auditor Ratification ................................................... 6 Change Company Name .................................................... 7 Change Date, Time, or Location of Annual Meeting ....................... 7 Transact Other Business ................................................ 7 2. BOARD OF DIRECTORS: .................................................... 8 Voting on Director Nominees in Uncontested Elections ................... 8 2008 Classification of Directors ....................................... 10 Age Limits ............................................................. 11 Board Size ............................................................. 11 Classification/Declassification of the Board ........................... 12 Cumulative Voting ...................................................... 12 Director and Officer Indemnification and Liability Protection .......... 12 Establish/Amend Nominee Qualifications ................................. 12 Filling Vacancies/Removal of Directors ................................. 13 Independent Chair (Separate Chair/CEO) ................................. 13 Majority of Independent Directors/Establishment of Committees .......... 14 Majority Vote Shareholder Proposals .................................... 14 Office of the Board .................................................... 14 Open Access ............................................................ 14 Performance Test for Directors ......................................... 15 Stock Ownership Requirements ........................................... 16 Term Limits ............................................................ 16 3. PROXY CONTESTS ......................................................... 17 Voting for Director Nominees in Contested Elections .................... 17 Reimbursing Proxy Solicitation Expenses ................................ 17 Confidential Voting .................................................... 17 4. ANTITAKEOVER DEFENSES AND VOTING RELATED ISSUES ........................ 18 Advance Notice Requirements for Shareholder Proposals/Nominations ...... 18 Amend Bylaws without Shareholder Consent ............................... 18 Poison Pills ........................................................... 18 Shareholder Ability to Act by Written Consent .......................... 18 Shareholder Ability to Call Special Meetings ........................... 19
2008 US PROXY VOTING GUIDELINES SUMMARY -2- RISKMETRICS Group www.riskmetrics.com Supermajority Vote Requirements ........................................ 19 5. MERGERS AND CORPORATE RESTRUCTURINGS ................................... 20 OVERALL APPROACH .......................................................... 20 Appraisal Rights ....................................................... 20 Asset Purchases ........................................................ 20 Asset Sales ............................................................ 20 Bundled Proposals ...................................................... 21 Conversion of Securities ............................................... 21 Corporate Reorganization/Debt Restructuring/Prepackaged Bankruptcy Plans/Reverse Leveraged Buyouts/Wrap Plans .......................... 21 Formation of Holding Company ........................................... 21 Going Private Transactions (LBOs, Minority Squeezeouts, and Going Dark) ............................................................... 22 Joint Ventures ......................................................... 22 Liquidations ........................................................... 22 Mergers and Acquisitions/ Issuance of Shares to Facilitate Merger or Acquisition ......................................................... 22 Private Placements/Warrants/Convertible Debentures ..................... 23 Spinoffs ............................................................... 23 Value Maximization Proposals ........................................... 23 6. STATE OF INCORPORATION ................................................. 24 Control Share Acquisition Provisions ................................... 24 Control Share Cash-Out Provisions ...................................... 24 Disgorgement Provisions ................................................ 24 Fair Price Provisions .................................................. 24 Freeze-Out Provisions .................................................. 25 Greenmail .............................................................. 25 Reincorporation Proposals .............................................. 25 Stakeholder Provisions ................................................. 25 State Antitakeover Statutes ............................................ 25 7. CAPITAL STRUCTURE ...................................................... 26 Adjustments to Par Value of Common Stock ............................... 26 Common Stock Authorization ............................................. 26 Dual-Class Stock ....................................................... 26 Issue Stock for Use with Rights Plan ................................... 26 Preemptive Rights ...................................................... 26 Preferred Stock ........................................................ 27 Recapitalization ....................................................... 27 Reverse Stock Splits ................................................... 27 Share Repurchase Programs .............................................. 28 Stock Distributions: Splits and Dividends .............................. 28 Tracking Stock ......................................................... 28 8. EXECUTIVE AND DIRECTOR COMPENSATION .................................... 29 EQUITY COMPENSATION PLANS ................................................. 29 Cost of Equity Plans ................................................... 29 Repricing Provisions ................................................... 29 Pay-for-Performance Disconnect ......................................... 30 Three-Year Burn Rate/Burn Rate Commitment .............................. 31 Poor Pay Practices ..................................................... 33 SPECIFIC TREATMENT OF CERTAIN AWARD TYPES IN EQUITY PLAN EVALUATIONS: ..... 34 Dividend Equivalent Rights ............................................. 34
2008 US PROXY VOTING GUIDELINES SUMMARY -3- RISKMETRICS Group www.riskmetrics.com Liberal Share Recycling Provisions ..................................... 34 Option Overhang Cost ................................................... 34 OTHER COMPENSATION PROPOSALS AND POLICIES ................................. 35 401(k) Employee Benefit Plans .......................................... 35 Advisory Vote on Executive Compensation (Say-on-Pay) Management Proposals ........................................................... 35 Director Compensation .................................................. 36 Director Retirement Plans .............................................. 36 Employee Stock Ownership Plans (ESOPs) ................................. 36 Employee Stock Purchase Plans-- Qualified Plans ........................ 37 Employee Stock Purchase Plans-- Non-Qualified Plans .................... 37 Incentive Bonus Plans and Tax Deductibility Proposals (OBRA-Related Compensation Proposals) ............................................. 37 Options Backdating ..................................................... 38 Option Exchange Programs/Repricing Options ............................. 38 Stock Plans in Lieu of Cash ............................................ 39 Transfer Programs of Stock Options ..................................... 39 SHAREHOLDER PROPOSALS ON COMPENSATION ..................................... 40 Advisory Vote on Executive Compensation (Say-on-Pay) ................... 40 Compensation Consultants- Disclosure of Board or Company's Utilization ......................................................... 40 Disclosure/Setting Levels or Types of Compensation for Executives and Directors ........................................................... 40 Pay for Superior Performance ........................................... 40 Performance-Based Awards ............................................... 41 Pension Plan Income Accounting ......................................... 41 Pre-Arranged Trading Plans (10b5-1 Plans) .............................. 41 Recoup Bonuses ......................................................... 42 Severance Agreements for Executives/Golden Parachutes .................. 42 Share Buyback Holding Periods .......................................... 42 Stock Ownership or Holding Period Guidelines ........................... 42 Supplemental Executive Retirement Plans (SERPs) ........................ 43 Tax Gross-Up Proposals ................................................. 43 9. CORPORATE SOCIAL RESPONSIBILITY (CSR) ISSUES ........................... 44 ANIMAL WELFARE ............................................................ 44 Animal Testing ......................................................... 44 Animal Welfare Policies ................................................ 44 Controlled Atmosphere Killing (CAK) .................................... 44 CONSUMER ISSUES ........................................................... 44 Genetically Modified Ingredients ....................................... 44 Consumer Lending ....................................................... 45 Pharmaceutical Pricing ................................................. 45 Pharmaceutical Product Reimportation ................................... 45 Product Safety and Toxic Materials ..................................... 46 Tobacco ................................................................ 46 DIVERSITY ................................................................. 47 Board Diversity ........................................................ 47 Equality of Opportunity and Glass Ceiling .............................. 47 Sexual Orientation and Domestic Partner Benefits ....................... 48 CLIMATE CHANGE AND THE ENVIRONMENT ........................................ 48 Climate Change ......................................................... 48 Concentrated Area Feeding Operations (CAFO) ............................ 48 Energy Efficiency ...................................................... 48 Facility Safety (Nuclear and Chemical Plant Safety) .................... 49
2008 US PROXY VOTING GUIDELINES SUMMARY -4- RISKMETRICS Group www.riskmetrics.com General Environmental Reporting ........................................ 49 Greenhouse Gas Emissions ............................................... 49 Operations in Protected Areas .......................................... 49 Recycling .............................................................. 49 Renewable Energy ....................................................... 49 GENERAL CORPORATE ISSUES .................................................. 50 Charitable Contributions ............................................... 50 CSR Compensation-Related Proposals ..................................... 50 HIV/AIDS ............................................................... 50 Lobbying Expenditures/Initiatives ...................................... 51 Political Contributions and Trade Associations Spending ................ 51 INTERNATIONAL ISSUES, LABOR ISSUES, AND HUMAN RIGHTS ...................... 51 China Principles ....................................................... 51 Codes of Conduct ....................................................... 52 Community Impact Assessments ........................................... 52 Foreign Military Sales/Offsets ......................................... 52 Internet Privacy and Censorship ........................................ 52 MacBride Principles .................................................... 53 Nuclear and Depleted Uranium Weapons ................................... 53 Operations in High Risk Markets ........................................ 53 Outsourcing/Offshoring ................................................. 53 Vendor Standards ....................................................... 53 SUSTAINABILITY ............................................................ 54 Sustainability Reporting ............................................... 54 10. MUTUAL FUND PROXIES ................................................... 55 Election of Directors .................................................. 55 Converting Closed-end Fund to Open-end Fund ............................ 55 Proxy Contests ......................................................... 55 Investment Advisory Agreements ......................................... 55 Approving New Classes or Series of Shares .............................. 55 Preferred Stock Proposals .............................................. 55 1940 Act Policies ...................................................... 56 Changing a Fundamental Restriction to a Nonfundamental Restriction ..... 56 Change Fundamental Investment Objective to Nonfundamental .............. 56 Name Change Proposals .................................................. 56 Change in Fund's Subclassification ..................................... 56 Disposition of Assets/Termination/Liquidation .......................... 56 Changes to the Charter Document ........................................ 56 Changing the Domicile of a Fund ........................................ 57 Authorizing the Board to Hire and Terminate Subadvisors Without Shareholder Approval ................................................ 57 Distribution Agreements ................................................ 57 Master-Feeder Structure ................................................ 57 Mergers ................................................................ 57 SHAREHOLDER PROPOSALS FOR MUTUAL FUNDS .................................... 57 Establish Director Ownership Requirement ............................... 57 Reimburse Shareholder for Expenses Incurred ............................ 58 Terminate the Investment Advisor ....................................... 58
2008 US PROXY VOTING GUIDELINES SUMMARY -5- RISKMETRICS Group www.riskmetrics.com 1. Operational Items ADJOURN MEETING Generally vote AGAINST proposals to provide management with the authority to adjourn an annual or special meeting absent compelling reasons to support the proposal. Vote FOR proposals that relate specifically to soliciting votes for a merger or transaction if supporting that merger or transaction. Vote AGAINST proposals if the wording is too vague or if the proposal includes "other business." AMEND QUORUM REQUIREMENTS Vote AGAINST proposals to reduce quorum requirements for shareholder meetings below a majority of the shares outstanding unless there are compelling reasons to support the proposal. AMEND MINOR BYLAWS Vote FOR bylaw or charter changes that are of a housekeeping nature (updates or corrections). AUDITOR INDEMNIFICATION AND LIMITATION OF LIABILITY Consider the issue of auditor indemnification and limitation of liability on a CASE-BY-CASE basis. Factors to be assessed include, but are not limited to: - The terms of the auditor agreement- the degree to which these agreements impact shareholders' rights; - Motivation and rationale for establishing the agreements; - Quality of disclosure; and - Historical practices in the audit area. WTHHOLD or vote AGAINST members of an audit committee in situations where 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. AUDITOR RATIFICATION Vote FOR proposals to ratify auditors, unless any of the following apply: - An auditor has a financial interest in or association with the company, and is therefore not independent; - There is reason to believe that the independent auditor has rendered an opinion which is neither accurate nor indicative of the company's financial position; - Poor accounting practices are identified that rise to a serious level of concern, such as: fraud; misapplication of GAAP; and material weaknesses identified in Section 404 disclosures; or - Fees for non-audit services ("Other" fees) are excessive. Non-audit fees are excessive if: Non-audit ("other") fees >audit fees + audit-related fees + tax compliance/preparation fees 2008 US PROXY VOTING GUIDELINES SUMMARY -6- RISKMETRICS Group www.riskmetrics.com Tax compliance and preparation include the preparation of original and amended tax returns, refund claims and tax payment planning. All other services in the tax category, such as tax advice, planning or consulting should be added to "Other" fees. If the breakout of tax fees cannot be determined, add all tax fees to "Other" fees. In circumstances where "Other" fees include fees related to significant one-time capital structure events: initial public offerings, bankruptcy emergence, and spin-offs; and the company makes public disclosure of the amount and nature of those fees which are an exception to the standard "non-audit fee" category, then such fees may be excluded from the non-audit fees considered in determining the ratio of non-audit to audit/audit-related fees/tax compliance and preparation for purposes of determining whether non-audit fees are excessive. Vote CASE-BY-CASE on shareholder proposals asking companies to prohibit or limit their auditors from engaging in non-audit services. Vote CASE-BY-CASE on shareholder proposals asking for audit firm rotation, taking into account: - The tenure of the audit firm; - The length of rotation specified in the proposal; - Any significant audit-related issues at the company; - The number of Audit Committee meetings held each year; - The number of financial experts serving on the committee; and - Whether the company has a periodic renewal process where the auditor is evaluated for both audit quality and competitive price. CHANGE COMPANY NAME Vote FOR proposals to change the corporate name. CHANGE DATE, TIME, OR LOCATION OF ANNUAL MEETING Vote FOR management proposals to change the date, time, and/or location of the annual meeting unless the proposed change is unreasonable. Vote AGAINST shareholder proposals to change the date, time, and/or location of the annual meeting unless the current scheduling or location is unreasonable. TRANSACT OTHER BUSINESS Vote AGAINST proposals to approve other business when it appears as voting item. 2008 US PROXY VOTING GUIDELINES SUMMARY -7- RISKMETRICS Group www.riskmetrics.com 2. Board of Directors: VOTING ON DIRECTOR NOMINEES IN UNCONTESTED ELECTIONS Vote on director nominees should be determined on a CASE-BY-CASE basis. Vote AGAINST or WITHHOLD(1) from individual directors who: - Attend less than 75 percent of the board and committee meetings without a valid excuse (such as illness, service to the nation, work on behalf of the company); - Sit on more than six public company boards; - 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. Vote AGAINST or WITHHOLD from all nominees of the board of directors, (except from new nominees, who should be considered on a CASE-BY-CASE basis) if: - The company's proxy indicates that not all directors attended 75% of the aggregate of their board and committee meetings, but fails to provide the required disclosure of the names of the directors involved. If this information cannot be obtained, vote against/withhold from all incumbent directors; - The company's poison pill has a dead-hand or modified dead-hand feature. Vote against/withhold every year until this feature is removed; - The board adopts or renews a poison pill without shareholder approval, does not commit to putting it to shareholder vote within 12 months of adoption (or in the case of an newly public company, does not commit to put the pill to a shareholder vote within 12 months following the IPO), or reneges on a commitment to put the pill to a vote, and has not yet received a withhold/against recommendation for this issue; - The board failed to act on a shareholder proposal that received approval by a majority of the shares outstanding the previous year (a management proposal with other than a FOR recommendation by management will not be considered as sufficient action taken); - The board failed to act on a shareholder proposal that received approval of the majority of shares cast for the previous two consecutive years (a management proposal with other than a FOR recommendation by management will not be considered as sufficient action taken); - The board failed to act on takeover offers where the majority of the shareholders tendered their shares; - 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 underlying issue(s) that caused the high withhold/against vote; - The company is a Russell 3000 company that underperformed its industry group (GICS group) under the criteria discussed in the section "Performance Test for Directors"; - 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- any or all appropriate nominees (except new) may be held accountable. - ---------- (1) In general, companies with a plurality vote standard use "Withhold" as the valid 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. 2008 US PROXY VOTING GUIDELINES SUMMARY -8- RISKMETRICS Group www.riskmetrics.com Vote AGAINST or WITHHOLD from Inside Directors and Affiliated Outside Directors (per the Classification of Directors below) when: - The inside or affiliated outside director serves on any of the three key committees: audit, compensation, or nominating; - The company lacks an audit, compensation, or nominating committee so that the full board functions as that committee; - The company lacks a formal nominating committee, even if board attests that the independent directors fulfill the functions of such a committee; - The full board is less than majority independent. Vote AGAINST or WITHHOLD from the members of the Audit Committee if: - The non - audit fees paid to the auditor are excessive (see discussion under Auditor Ratification); - Poor accounting practices are identified which rise to a level of serious concern, such as: fraud; misapplication of GAAP; and material weaknesses identified in Section 404 disclosures; or - 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 AGAINST or WITHHOLD from the members of the Compensation Committee if: - There is a negative correlation between the chief executive's pay and company performance (see discussion under Equity Compensation Plans); - The company reprices underwater options for stock, cash or other consideration without prior shareholder approval, even if allowed in their equity plan; - The company fails to submit one-time transfers of stock options to a shareholder vote; - The company fails to fulfill the terms of a burn rate commitment they made to shareholders; - The company has backdated options (see "Options Backdating" policy); - The company has poor compensation practices (see "Poor Pay Practices" policy). Poor pay practices may warrant withholding votes from the CEO and potentially the entire board as well. Vote AGAINST or WITHHOLD from directors, individually or the entire board, for egregious actions or failure to replace management as appropriate. 2008 US PROXY VOTING GUIDELINES SUMMARY -9- RISKMETRICS Group www.riskmetrics.com 2008 CLASSIFICATION OF DIRECTORS INSIDE DIRECTOR (I) - Employee of the company or one of its affiliates(1); - Non-employee officer of the company if among the five most highly paid individuals (excluding interim CEO); - Listed as a Section 16 officer(2); - Current interim CEO; - Beneficial owner of more than 50 percent of the company's voting power (this may be aggregated if voting power is distributed among more than one member of a defined group). AFFILIATED OUTSIDE DIRECTOR (AO) - Board attestation that an outside director is not independent; - Former CEO of the company(3); - Former CEO of an acquired company within the past five years; - Former interim CEO if the service was longer than 18 months. If the service was between twelve and eighteen months an assessment of the interim CEO's employment agreement will be made;(4) - Former executive(2) of the company, an affiliate or an acquired firm within the past five years; - Executive(2) of a former parent or predecessor firm at the time the company was sold or split off from the parent/predecessor within the past five years; - Executive(2), former executive, general or limited partner of a joint venture or partnership with the company; - Relative(5) of a current Section 16 officer of company or its affiliates; - Relative(5) of a current employee of company or its affiliates where additional factors raise concern (which may include, but are not limited to, the following: a director related to numerous employees; the company or its affiliates employ relatives of numerous board members; or a non-Section 16 officer in a key strategic role); - Relative(5) of former Section 16 officer, of company or its affiliate within the last five years; - Currently provides (or a relative(5) provides) professional services(6) to the company, to an affiliate of the company or an individual officer of the company or one of its affiliates in excess of $10,000 per year; - Employed by (or a relative(5) is employed by) a significant customer or supplier(7); - Has (or a relative(5) has) any transactional relationship with the company or its affiliates excluding investments in the company through a private placement; (7) - Any material financial tie or other related party transactional relationship to the company; - Party to a voting agreement to vote in line with management on proposals being brought to shareholder vote; - Has (or a relative(5) has) an interlocking relationship as defined by the SEC involving members of the board of directors or its Compensation and Stock Option Committee; (8) - Founder (9) of the company but not currently an employee; - Is (or a relative(5) is) a trustee, director or employee of a charitable or non-profit organization that receives grants or endowments(7) from the company or its affiliates(1). INDEPENDENT OUTSIDE DIRECTOR (IO) - No material(10) connection to the company other than a board seat. FOOTNOTES: (1) "Affiliate" includes a subsidiary, sibling company, or parent company. ISS uses 50 percent control ownership by the parent company as the standard for applying its affiliate designation. (2) "Executives" (officers subject to Section 16 of the Securities and Exchange Act of 1934) include the chief 2008 US PROXY VOTING GUIDELINES SUMMARY -10- RISKMETRICS Group www.riskmetrics.com executive, operating, financial, legal, technology, and accounting officers of a company (including the president, treasurer, secretary, controller, or any vice president in charge of a principal business unit, division or policy function). A non-employee director serving as an officer due to statutory requirements (e.g. corporate secretary) will be classified as an Affiliated Outsider. If the company provides additional disclosure that the director is not receiving additional compensation for serving in that capacity, then the director will be classified as an Independent Outsider. (3) Includes any former CEO of the company prior to the company's initial public offering (IPO). (4) ISS will look at the terms of the interim CEO's employment contract to determine if it contains severance pay, long-term health and pension benefits or other such standard provisions typically contained in contracts of permanent, non-temporary CEOs. ISS will also consider if a formal search process was underway for a full-time CEO at the time. (5) "Relative" follows the SEC's new definition of "immediate family members" which covers spouses, parents, children, step-parents, step-children, siblings, in-laws, and any person (other than a tenant or employee) sharing the household of any director, nominee for director, executive officer, or significant shareholder of the company. (6) Professional services can be characterized as advisory in nature and generally include the following: investment banking / financial advisory services; commercial banking (beyond deposit services); investment services; insurance services; accounting/audit services; consulting services; marketing services; and legal services. The case of participation in a banking syndicate by a non-lead bank should be considered a transaction (and hence subject to the associated materiality test) rather than a professional relationship. (7) If the company makes or receives annual payments exceeding the greater of $200,000 or 5 percent of the recipient's gross revenues. (The recipient is the party receiving the financial proceeds from the transaction). (8) Interlocks include: (a) executive officers serving as directors on each other's compensation or similar committees (or, in the absence of such a committee, on the board); or (b) executive officers sitting on each other's boards and at least one serves on the other's compensation or similar committees (or, in the absence of such a committee, on the board). (9) The operating involvement of the Founder with the company will be considered. Little to no operating involvement may cause ISS to deem the Founder as an independent outsider. (10) For purposes of ISS' director independence classification, "material" will be defined as a standard of relationship (financial, personal or otherwise) that a reasonable person might conclude could potentially influence one's objectivity in the boardroom in a manner that would have a meaningful impact on an individual's ability to satisfy requisite fiduciary standards on behalf of shareholders. AGE LIMITS Vote AGAINST shareholder or management proposals to limit the tenure of outside directors through mandatory retirement ages. BOARD SIZE Vote FOR proposals seeking to fix the board size or designate a range for the board size. Vote AGAINST proposals that give management the ability to alter the size of the board outside of a specified range without shareholder approval. 2008 US PROXY VOTING GUIDELINES SUMMARY -11- RISKMETRICS Group www.riskmetrics.com CLASSIFICATION/DECLASSIFICATION OF THE BOARD Vote AGAINST proposals to classify the board. Vote FOR proposals to repeal classified boards and to elect all directors annually. CUMULATIVE VOTING Generally vote AGAINST proposals to eliminate cumulative voting. Generally vote FOR proposals to restore or provide for cumulative voting unless: - The company has proxy access or a similar structure(2) to allow shareholders to nominate directors to the company's ballot; and - The company has adopted a majority vote standard, with a carve-out for plurality voting in situations where there are more nominees than seats, and a director resignation policy to address failed elections. Vote FOR proposals for cumulative voting at controlled companies (insider voting power > 50%). DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY PROTECTION Vote CASE-BY-CASE on proposals on director and officer indemnification and liability protection using Delaware law as the standard. Vote AGAINST proposals to eliminate entirely directors' and officers' liability for monetary damages for violating the duty of care. Vote AGAINST indemnification proposals that would expand coverage beyond just legal expenses to liability for acts, such as negligence, that are more serious violations of fiduciary obligation than mere carelessness. Vote AGAINST proposals that would expand the scope of indemnification to provide for mandatory indemnification of company officials in connection with acts that previously the company was permitted to provide indemnification for at the discretion of the company's board (i.e., "permissive indemnification") but that previously the company was not required to indemnify. Vote FOR only those proposals providing such expanded coverage in cases when a director's or officer's legal defense was unsuccessful if both of the following apply: - If the director was found to have acted in good faith and in a manner that he reasonably believed was in the best interests of the company; and - If only the director's legal expenses would be covered. ESTABLISH/AMEND NOMINEE QUALIFICATIONS - ---------- (2) Similar structure" would be a structure that allows shareholders to nominate candidates who the company will include on the management ballot IN ADDITION TO management's nominees, and their bios are included in management's proxy. 2008 US PROXY VOTING GUIDELINES SUMMARY -12- RISKMETRICS Group www.riskmetrics.com Vote CASE-BY-CASE on proposals that establish or amend director qualifications. Votes should be based on how reasonable the criteria are and to what degree they may preclude dissident nominees from joining the board. Vote AGAINST shareholder proposals requiring two candidates per board seat. FILLING VACANCIES/REMOVAL OF DIRECTORS Vote AGAINST proposals that provide that directors may be removed only for cause. Vote FOR proposals to restore shareholders' ability to remove directors with or without cause. Vote AGAINST proposals that provide that only continuing directors may elect replacements to fill board vacancies. Vote FOR proposals that permit shareholders to elect directors to fill board vacancies. INDEPENDENT CHAIR (SEPARATE CHAIR/CEO) Generally vote FOR shareholder proposals requiring that the chairman's position be filled by an independent director, unless there are compelling reasons to recommend against the proposal, such as a counterbalancing governance structure. This should include all the following: - Designated lead director, elected by and from the independent board members with clearly delineated and comprehensive duties. (The role may alternatively reside with a presiding director, vice chairman, or rotating lead director; however the director must serve a minimum of one year in order to qualify as a lead director.) The duties should include, but are not limited to, the following: - presides at all meetings of the board at which the chairman is not present, including executive sessions of the independent directors; - serves as liaison between the chairman and the independent directors; - approves information sent to the board; - approves meeting agendas for the board; - approves meeting schedules to assure that there is sufficient time for discussion of all agenda items; - has the authority to call meetings of the independent directors; - if requested by major shareholders, ensures that he is available for consultation and direct communication; - The company publicly discloses a comparison of the duties of its independent lead director and its chairman; - The company publicly discloses a sufficient explanation of why it chooses not to give the position of chairman to the independent lead director, and instead combine the chairman and CEO positions; - Two-thirds independent board; - All independent key committees; - Established governance guidelines; - The company should not have underperformed both its peers and index on the basis of both one-year and three-year total shareholder returns*, unless there has been a change in the Chairman/CEO position within that time; and - The company does not have any problematic governance issues. Vote FOR the proposal if the company does not provide disclosure with respect to any or all of the bullet points above. If disclosure is provided, evaluate on a CASE-BY-CASE basis. 2008 US PROXY VOTING GUIDELINES SUMMARY -13- RISKMETRICS Group www.riskmetrics.com * The industry peer group used for this evaluation is the average of the 12 companies in the same 6-digit GICS group that are closest in revenue to the company. To fail, the company must under-perform its index and industry group on all 4 measures (1 and 3 year on industry peers and index). MAJORITY OF INDEPENDENT DIRECTORS/ESTABLISHMENT OF COMMITTEES Vote FOR shareholder proposals asking that a majority or more of directors be independent unless the board composition already meets the proposed threshold by ISS' definition of independent outsider. (See Classification of Directors.) Vote FOR shareholder proposals asking that board audit, compensation, and/or nominating committees be composed exclusively of independent directors if they currently do not meet that standard. MAJORITY VOTE SHAREHOLDER PROPOSALS Generally vote FOR precatory and binding resolutions requesting that the board change the company's bylaws to stipulate that directors need to be elected with an affirmative majority of votes cast, provided it does not conflict with the state law where the company is incorporated. Binding resolutions need to allow for a carve-out for a plurality vote standard when there are more nominees than board seats. Companies are strongly encouraged to also adopt a post-election policy (also know as a director resignation policy) that will provide guidelines so that the company will promptly address the situation of a holdover director. OFFICE OF THE BOARD Generally vote FOR shareholders proposals requesting that the board establish an Office of the Board of Directors in order to facilitate direct communications between shareholders and non-management directors, unless the company has all of the following: - Established a communication structure that goes beyond the exchange requirements to facilitate the exchange of information between shareholders and members of the board; - Effectively disclosed information with respect to this structure to its shareholders; - Company has not ignored majority-supported shareholder proposals or a majority withhold vote on a director nominee; and - The company has an independent chairman or a lead/presiding director, according to ISS' definition. This individual must be made available for periodic consultation and direct communication with major shareholders. OPEN ACCESS Vote shareholder proposals asking for open or proxy access on a CASE-BY-CASE basis, taking into account: - The ownership threshold proposed in the resolution; - The proponent's rationale for the proposal at the targeted company in terms of board and director conduct. 2008 US PROXY VOTING GUIDELINES SUMMARY -14- RISKMETRICS Group www.riskmetrics.com PERFORMANCE TEST FOR DIRECTORS On a CASE-BY-CASE basis, Vote AGAINST or WITHHOLD from directors of Russell 3000 companies that underperformed relative to their industry peers. The criterion used to evaluate such underperformance is a combination of four performance measures: One measurement is a market-based performance metric and three measurements are tied to the company's operational performance. The market performance metric in the methodology is five-year Total Shareholder Return (TSR) on a relative basis within each four-digit GICS group. The three operational performance metrics are sales growth, EBITDA growth (or operating income growth for companies in the financial sector), and pre-tax operating Return on Invested Capital (ROIC) (or Return on Average Assets (ROAA) for companies in the financial sector) on a relative basis within each four-digit GICS group. All four metrics will be time-weighted as follows: 40 percent on the trailing 12 month period and 60 percent on the 48 month period prior to the trailing 12 months. This methodology emphasizes the company's historical performance over a five-year period yet also accounts for near-term changes in a company's performance. The table below summarizes the framework:
METRICS BASIS OF EVALUATION WEIGHTING 2ND WEIGHTING - ------- ---------------------------------- --------- ------------- Operational Performance 50% 5-year Average pre-tax operating Management efficiency in deploying 33.3% ROIC or ROAA* assets 5-year Sales Growth Top-Line 33.3% 5-year EBITDA Growth or Operating Core-earnings 33.3% Income Growth* Sub Total 100% Stock Performance 50% 5-year TSR Market Total 100%
* Metric applies to companies in the financial sector Adopt a two-phase approach. In Year 1, the worst performers (bottom 5 percent) within each of the 24 GICS groups receive are noted. In Year 2, consider a vote AGAINST or WITHHOLD votes from director nominees if a company continues to be in the bottom five percent within its GICS group for that respective year and shows no improvement in its most recent trailing 12 months operating and market performance relative to its peers in its GICS group. Take into account various factors including: - Year-to-date performance; - Situational circumstances; - Change in management/board; - Overall governance practices. 2008 US PROXY VOTING GUIDELINES SUMMARY -15- RISKMETRICS Group www.riskmetrics.com STOCK OWNERSHIP REQUIREMENTS Generally vote AGAINST shareholder proposals that mandate a minimum amount of stock that directors must own in order to qualify as a director or to remain on the board. While stock ownership on the part of directors is desired, the company should determine the appropriate ownership requirement. Vote CASE-BY-CASE on shareholder proposals asking that the company adopt a holding or retention period for its executives (for holding stock after the vesting or exercise of equity awards), taking into account any stock ownership requirements or holding period/retention ratio already in place and the actual ownership level of executives. TERM LIMITS Vote AGAINST shareholder or management proposals to limit the tenure of outside directors through term limits. However, scrutinize boards where the average tenure of all directors exceeds 15 years for independence from management and for sufficient turnover to ensure that new perspectives are being added to the board. 2008 US PROXY VOTING GUIDELINES SUMMARY -16- RISKMETRICS Group www.riskmetrics.com 3. 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: - Long-term financial performance of the target company relative to its industry; - Management's track record; - Background to the proxy contest; - Qualifications of director nominees (both slates); - Strategic plan of dissident slate and quality of critique against management; - Likelihood that the proposed goals and objectives can be achieved (both slates); - Stock ownership positions. REIMBURSING PROXY SOLICITATION EXPENSES Vote CASE-BY-CASE on proposals to reimburse proxy solicitation expenses. When voting in conjunction with support of a dissident slate, vote FOR the reimbursement of all appropriate proxy solicitation expenses associated with the election. Generally vote FOR shareholder proposals calling for the reimbursement of reasonable costs incurred in connection with nominating one or more candidates in a contested election where the following apply: - The election of fewer than 50% of the directors to be elected is contested in the election; - One or more of the dissident's candidates is elected; - Shareholders are not permitted to cumulate their votes for directors; and - The election occurred, and the expenses were incurred, after the adoption of this bylaw. CONFIDENTIAL VOTING Vote FOR shareholder proposals requesting that corporations adopt confidential voting, use independent vote tabulators, and use independent inspectors of election, as long as the proposal includes a provision for proxy contests as follows: In the case of a contested election, management should be permitted to request that the dissident group honor its confidential voting policy. If the dissidents agree, the policy remains in place. If the dissidents will not agree, the confidential voting policy is waived. Vote FOR management proposals to adopt confidential voting. 2008 US PROXY VOTING GUIDELINES SUMMARY -17- RISKMETRICS Group www.riskmetrics.com 4. Antitakeover Defenses and Voting Related Issues ADVANCE NOTICE REQUIREMENTS FOR SHAREHOLDER PROPOSALS/NOMINATIONS Vote CASE-BY-CASE on advance notice proposals, supporting those proposals which allow shareholders to submit proposals as close to the meeting date as reasonably possible and within the broadest window possible. AMEND BYLAWS WITHOUT SHAREHOLDER CONSENT Vote AGAINST proposals giving the board exclusive authority to amend the bylaws. Vote FOR proposals giving the board the ability to amend the bylaws in addition to shareholders. POISON PILLS Vote FOR shareholder proposals requesting that the company submit its poison pill to a shareholder vote or redeem it UNLESS the company has: (1) A shareholder approved poison pill in place; or (2) The company has adopted a policy concerning the adoption of a pill in the future specifying that the board will only adopt a shareholder rights plan if either: - Shareholders have approved the adoption of the plan; or - The board, in its exercise of its fiduciary responsibilities, determines that it is in the best interest of shareholders under the circumstances to adopt a pill without the delay in adoption that would result from seeking stockholder approval (i.e., the "fiduciary out" provision). A poison pill adopted under this fiduciary out will be put to a shareholder ratification vote within 12 months of adoption or expire. If the pill is not approved by a majority of the votes cast on this issue, the plan will immediately terminate. Vote FOR shareholder proposals calling for poison pills to be put to a vote within a time period of less than one year after adoption. If the company has no non-shareholder approved poison pill in place and has adopted a policy with the provisions outlined above, vote AGAINST the proposal. If these conditions are not met, vote FOR the proposal, but with the caveat that a vote within 12 months would be considered sufficient. 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: - No lower than a 20% trigger, flip-in or flip-over; - A term of no more than three years; - No dead-hand, slow-hand, no-hand or similar feature that limits the ability of a future board to redeem the pill; - 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. SHAREHOLDER ABILITY TO ACT BY WRITTEN CONSENT Vote AGAINST proposals to restrict or prohibit shareholder ability to take action by written consent. Vote FOR proposals to allow or make easier shareholder action by written consent. 2008 US PROXY VOTING GUIDELINES SUMMARY -18- RISKMETRICS Group www.riskmetrics.com SHAREHOLDER ABILITY TO CALL SPECIAL MEETINGS Vote AGAINST proposals to restrict or prohibit shareholder ability to call special meetings. Vote FOR proposals that remove restrictions on the right of shareholders to act independently of management. SUPERMAJORITY VOTE REQUIREMENTS Vote AGAINST proposals to require a supermajority shareholder vote. Vote FOR proposals to lower supermajority vote requirements. 2008 US PROXY VOTING GUIDELINES SUMMARY -19- RISKMETRICS Group www.riskmetrics.com 5. Mergers and Corporate Restructurings OVERALL APPROACH For mergers and acquisitions, review and evaluate the merits and drawbacks of the proposed transaction, balancing various and sometimes countervailing factors including: - 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. - MARKET REACTION - How has the market responded to the proposed deal? A negative market reaction should cause closer scrutiny of a deal. - 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. - 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. - 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. - GOVERNANCE - Will the combined company have a better or worse governance profile than the current governance profiles of the 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. APPRAISAL RIGHTS Vote FOR proposals to restore, or provide shareholders with rights of appraisal. ASSET PURCHASES Vote CASE-BY-CASE on asset purchase proposals, considering the following factors: - Purchase price; - Fairness opinion; - Financial and strategic benefits; - How the deal was negotiated; - Conflicts of interest; - Other alternatives for the business; - Non-completion risk. ASSET SALES Vote CASE-BY-CASE on asset sales, considering the following factors: 2008 US PROXY VOTING GUIDELINES SUMMARY -20- RISKMETRICS Group www.riskmetrics.com - Impact on the balance sheet/working capital; - Potential elimination of diseconomies; - Anticipated financial and operating benefits; - Anticipated use of funds; - Value received for the asset; - Fairness opinion; - How the deal was negotiated; - Conflicts of interest. BUNDLED PROPOSALS Vote CASE-BY-CASE on bundled or "conditional" proxy proposals. In the case of items that are conditioned upon each other, examine the benefits and costs of the packaged items. In instances when the joint effect of the conditioned items is not in shareholders' best interests, vote AGAINST the proposals. If the combined effect is positive, support such proposals. CONVERSION OF SECURITIES Vote CASE-BY-CASE on proposals regarding conversion of securities. When evaluating these proposals the investor should review the dilution to existing shareholders, the conversion price relative to market value, financial issues, control issues, termination penalties, and conflicts of interest. Vote FOR the conversion if it is expected that the company will be subject to onerous penalties or will be forced to file for bankruptcy if the transaction is not approved. CORPORATE REORGANIZATION/DEBT RESTRUCTURING/PREPACKAGED BANKRUPTCY PLANS/REVERSE LEVERAGED BUYOUTS/WRAP PLANS Vote CASE-BY-CASE on proposals to increase common and/or preferred shares and to issue shares as part of a debt restructuring plan, taking into consideration the following: - Dilution to existing shareholders' position; - Terms of the offer; - Financial issues; - Management's efforts to pursue other alternatives; - Control issues; - Conflicts of interest. Vote FOR the debt restructuring if it is expected that the company will file for bankruptcy if the transaction is not approved. FORMATION OF HOLDING COMPANY Vote CASE-BY-CASE on proposals regarding the formation of a holding company, taking into consideration the following: - The reasons for the change; - Any financial or tax benefits; - Regulatory benefits; - Increases in capital structure; 2008 US PROXY VOTING GUIDELINES SUMMARY -21- RISKMETRICS Group www.riskmetrics.com - Changes to the articles of incorporation or bylaws of the company. Absent compelling financial reasons to recommend the transaction, vote AGAINST the formation of a holding company if the transaction would include either of the following: - Increases in common or preferred stock in excess of the allowable maximum (see discussion under "Capital Structure"); - Adverse changes in shareholder rights. GOING PRIVATE TRANSACTIONS (LBOS, MINORITY SQUEEZEOUTS, AND GOING DARK) Vote CASE-BY-CASE on going private transactions, taking into account the following: - Offer price/premium; - Fairness opinion; - How the deal was negotiated; - Conflicts of interest; - Other alternatives/offers considered; and - Non-completion risk. Vote CASE-BY-CASE on "going dark" transactions, determining whether the transaction enhances shareholder value by taking into consideration: - Whether the company has attained benefits from being publicly-traded (examination of trading volume, liquidity, and market research of the stock); - Cash-out value; - Whether the interests of continuing and cashed-out shareholders are balanced; and - The market reaction to public announcement of transaction. JOINT VENTURES Vote CASE-BY-CASE on proposals to form joint ventures, taking into account the following: - Percentage of assets/business contributed; - Percentage ownership; - Financial and strategic benefits; - Governance structure; - Conflicts of interest; - Other alternatives; - Noncompletion risk. LIQUIDATIONS Vote CASE-BY-CASE on liquidations, taking into account the following: - Management's efforts to pursue other alternatives; - Appraisal value of assets; and - The compensation plan for executives managing the liquidation. Vote FOR the liquidation if the company will file for bankruptcy if the proposal is not approved. MERGERS AND ACQUISITIONS/ ISSUANCE OF SHARES TO FACILITATE MERGER OR ACQUISITION 2008 US PROXY VOTING GUIDELINES SUMMARY -22- RISKMETRICS Group www.riskmetrics.com Vote CASE-BY-CASE on mergers and acquisitions, determining whether the transaction enhances shareholder value by giving consideration to items listed under "Mergers and Corporate Restructurings: Overall Approach." PRIVATE PLACEMENTS/WARRANTS/CONVERTIBLE DEBENTURES Vote CASE-BY-CASE on proposals regarding private placements, taking into consideration: - Dilution to existing shareholders' position; - Terms of the offer; - Financial issues; - Management's efforts to pursue other alternatives; - Control issues; - Conflicts of interest. Vote FOR the private placement if it is expected that the company will file for bankruptcy if the transaction is not approved. SPINOFFS Vote CASE-BY-CASE on spin-offs, considering: - Tax and regulatory advantages; - Planned use of the sale proceeds; - Valuation of spinoff; - Fairness opinion; - Benefits to the parent company; - Conflicts of interest; - Managerial incentives; - Corporate governance changes; - Changes in the capital structure. VALUE MAXIMIZATION PROPOSALS Vote CASE-BY-CASE on shareholder proposals seeking to maximize shareholder value by hiring a financial advisor to explore strategic alternatives, selling the company or liquidating the company and distributing the proceeds to shareholders. These proposals should be evaluated based on the following factors: - Prolonged poor performance with no turnaround in sight; - Signs of entrenched board and management; - Strategic plan in place for improving value; - Likelihood of receiving reasonable value in a sale or dissolution; and - Whether company is actively exploring its strategic options, including retaining a financial advisor. 2008 US PROXY VOTING GUIDELINES SUMMARY -23- RISKMETRICS Group www.riskmetrics.com 6. State of Incorporation CONTROL SHARE ACQUISITION PROVISIONS Control share acquisition statutes function by denying shares their voting rights when they contribute to ownership in excess of certain thresholds. Voting rights for those shares exceeding ownership limits may only be restored by approval of either a majority or supermajority of disinterested shares. Thus, control share acquisition statutes effectively require a hostile bidder to put its offer to a shareholder vote or risk voting disenfranchisement if the bidder continues buying up a large block of shares. Vote FOR proposals to opt out of control share acquisition statutes unless doing so would enable the completion of a takeover that would be detrimental to shareholders. Vote AGAINST proposals to amend the charter to include control share acquisition provisions. Vote FOR proposals to restore voting rights to the control shares. CONTROL SHARE CASH-OUT PROVISIONS Control share cash-out statutes give dissident shareholders the right to "cash-out" of their position in a company at the expense of the shareholder who has taken a control position. In other words, when an investor crosses a preset threshold level, remaining shareholders are given the right to sell their shares to the acquirer, who must buy them at the highest acquiring price. Vote FOR proposals to opt out of control share cash-out statutes. DISGORGEMENT PROVISIONS Disgorgement provisions require an acquirer or potential acquirer of more than a certain percentage of a company's stock to disgorge, or pay back, to the company any profits realized from the sale of that company's stock purchased 24 months before achieving control status. All sales of company stock by the acquirer occurring within a certain period of time (between 18 months and 24 months) prior to the investor's gaining control status are subject to these recapture-of-profits provisions. Vote FOR proposals to opt out of state disgorgement provisions. FAIR PRICE PROVISIONS Vote CASE-BY-CASE on proposals to adopt fair price provisions (provisions that stipulate that an acquirer must pay the same price to acquire all shares as it paid to acquire the control shares), evaluating factors such as the vote required to approve the proposed acquisition, the vote required to repeal the fair price provision, and the mechanism for determining the fair price. 2008 US PROXY VOTING GUIDELINES SUMMARY -24- RISKMETRICS Group www.riskmetrics.com Generally, vote AGAINST fair price provisions with shareholder vote requirements greater than a majority of disinterested shares. FREEZE-OUT PROVISIONS Vote FOR proposals to opt out of state freeze-out provisions. Freeze-out provisions force an investor who surpasses a certain ownership threshold in a company to wait a specified period of time before gaining control of the company. GREENMAIL Greenmail payments are targeted share repurchases by management of company stock from individuals or groups seeking control of the company. Since only the hostile party receives payment, usually at a substantial premium over the market value of its shares, the practice discriminates against all other shareholders. Vote FOR proposals to adopt anti-greenmail charter or bylaw amendments or otherwise restrict a company's ability to make greenmail payments. Vote CASE-BY-CASE on anti-greenmail proposals when they are bundled with other charter or bylaw amendments. REINCORPORATION PROPOSALS Vote CASE-BY-CASE on proposals to change a company's state of incorporation, taking into consideration both financial and corporate governance concerns, including: - The reasons for reincorporating; - A comparison of the governance provisions; - Comparative economic benefits; and - A comparison of the jurisdictional laws. Vote FOR re-incorporation when the economic factors outweigh any neutral or negative governance changes. STAKEHOLDER PROVISIONS Vote AGAINST proposals that ask the board to consider non-shareholder constituencies or other non-financial effects when evaluating a merger or business combination. STATE ANTITAKEOVER STATUTES Vote CASE-BY-CASE on proposals to opt in or out of state takeover statutes (including control share acquisition statutes, control share cash-out statutes, freeze-out provisions, fair price provisions, stakeholder laws, poison pill endorsements, severance pay and labor contract provisions, anti-greenmail provisions, and disgorgement provisions). 2008 US PROXY VOTING GUIDELINES SUMMARY -25- RISKMETRICS Group www.riskmetrics.com 7. Capital Structure ADJUSTMENTS TO PAR VALUE OF COMMON STOCK Vote FOR management proposals to reduce the par value of common stock. COMMON STOCK AUTHORIZATION Vote CASE-BY-CASE on proposals to increase the number of shares of common stock authorized for issuance using a model developed by ISS. Vote FOR proposals to approve increases beyond the allowable increase when a company's shares are in danger of being delisted or if a company's ability to continue to operate as a going concern is uncertain. In addition, for capital requests less than or equal to 300 percent of the current authorized shares that marginally fail the calculated allowable cap (i.e., exceed the allowable cap by no more than 5 percent), on a CASE-BY-CASE basis, vote FOR the increase based on the company's performance and whether the company's ongoing use of shares has shown prudence. Factors should include, at a minimum, the following: - Rationale; - Good performance with respect to peers and index on a five-year total shareholder return basis; - Absence of non-shareholder approved poison pill; - Reasonable equity compensation burn rate; - No non-shareholder approved pay plans; and - Absence of egregious equity compensation practices. DUAL-CLASS STOCK Vote AGAINST proposals to create a new class of common stock with superior voting rights. Vote AGAINST proposals at companies with dual-class capital structures to increase the number of authorized shares of the class of stock that has superior voting rights. Vote FOR proposals to create a new class of nonvoting or sub-voting common stock if: - It is intended for financing purposes with minimal or no dilution to current shareholders; - It is not designed to preserve the voting power of an insider or significant shareholder. ISSUE STOCK FOR USE WITH RIGHTS PLAN Vote AGAINST proposals that increase authorized common stock for the explicit purpose of implementing a non-shareholder approved shareholder rights plan (poison pill). PREEMPTIVE RIGHTS 2008 US PROXY VOTING GUIDELINES SUMMARY -26- RISKMETRICS Group www.riskmetrics.com Vote CASE-BY-CASE on shareholder proposals that seek preemptive rights, taking into consideration: the size of a company, the characteristics of its shareholder base, and the liquidity of the stock. PREFERRED STOCK Vote AGAINST proposals authorizing the creation of new classes of preferred stock with unspecified voting, conversion, dividend distribution, and other rights ("blank check" preferred stock). Vote FOR proposals to create "declawed" blank check preferred stock (stock that cannot be used as a takeover defense). Vote FOR proposals to authorize preferred stock in cases where the company specifies the voting, dividend, conversion, and other rights of such stock and the terms of the preferred stock appear reasonable. Vote AGAINST proposals to increase the number of blank check preferred stock authorized for issuance when no shares have been issued or reserved for a specific purpose. Vote CASE-BY-CASE on proposals to increase the number of blank check preferred shares after analyzing the number of preferred shares available for issue given a company's industry and performance in terms of shareholder returns. RECAPITALIZATION Vote CASE-BY-CASE on recapitalizations (reclassifications of securities), taking into account the following: - More simplified capital structure; - Enhanced liquidity; - Fairness of conversion terms; - Impact on voting power and dividends; - Reasons for the reclassification; - Conflicts of interest; and - Other alternatives considered. REVERSE STOCK SPLITS Vote FOR management proposals to implement a reverse stock split when the number of authorized shares will be proportionately reduced. Vote FOR management proposals to implement a reverse stock split to avoid delisting. Vote CASE-BY-CASE on proposals to implement a reverse stock split that do not proportionately reduce the number of shares authorized for issue based on the allowable increased calculated using the Capital Structure model. 2008 US PROXY VOTING GUIDELINES SUMMARY -27- RISKMETRICS Group www.riskmetrics.com SHARE REPURCHASE PROGRAMS Vote FOR management proposals to institute open-market share repurchase plans in which all shareholders may participate on equal terms. STOCK DISTRIBUTIONS: SPLITS AND DIVIDENDS Vote FOR management proposals to increase the common share authorization for a stock split or share dividend, provided that the increase in authorized shares would not result in an excessive number of shares available for issuance as determined using a model developed by ISS. TRACKING STOCK Vote CASE-BY-CASE on the creation of tracking stock, weighing the strategic value of the transaction against such factors as: - Adverse governance changes; - Excessive increases in authorized capital stock; - Unfair method of distribution; - Diminution of voting rights; - Adverse conversion features; - Negative impact on stock option plans; and - Alternatives such as spin-off. 2008 US PROXY VOTING GUIDELINES SUMMARY -28- RISKMETRICS Group www.riskmetrics.com 8. Executive and Director Compensation EQUITY COMPENSATION PLANS Vote CASE-BY-CASE on equity-based compensation plans. Vote AGAINST the equity plan if any of the following factors apply: - The total cost of the company's equity plans is unreasonable; - The plan expressly permits the repricing of stock options without prior shareholder approval; - There is a disconnect between CEO pay and the company's performance; - The company's three year burn rate exceeds the greater of 2% and the mean plus one standard deviation of its industry group; or - The plan is a vehicle for poor pay practices. Each of these factors is described below: COST OF EQUITY PLANS Generally, vote AGAINST equity plans if the cost is unreasonable. For non-employee director plans, vote FOR the plan if certain factors are met (see Director Compensation section). The cost of the equity plans is expressed as Shareholder Value Transfer (SVT), which is measured using a binomial option pricing model that assesses the amount of shareholders' equity flowing out of the company to employees and directors. SVT is expressed as both a dollar amount and as a percentage of market value, and includes the new shares proposed, shares available under existing plans, and shares granted but unexercised. All award types are valued. For omnibus plans, unless limitations are placed on the most expensive types of awards (for example, full value awards), the assumption is made that all awards to be granted will be the most expensive types. See discussion of specific types of awards. The Shareholder Value Transfer is reasonable if it falls below the company-specific allowable cap. The allowable cap is determined as follows: The top quartile performers in each industry group (using the Global Industry Classification Standard GICS) are identified. Benchmark SVT levels for each industry are established based on these top performers' historic SVT. Regression analyses are run on each industry group to identify the variables most strongly correlated to SVT. The benchmark industry SVT level is then adjusted upwards or downwards for the specific company by plugging the company-specific performance measures, size and cash compensation into the industry cap equations to arrive at the company's allowable cap. REPRICING PROVISIONS Vote AGAINST plans that expressly permit the repricing of underwater stock options without prior shareholder approval, even if the cost of the plan is reasonable. Also, vote AGAINST OR WITHHOLD from members of the Compensation Committee who approved and/or implemented an option exchange program by repricing and buying out underwater options for stock, cash or other consideration or canceling underwater options and regranting options with a lower exercise price without prior shareholder approval, even if such repricings are allowed in their equity plan. 2008 US PROXY VOTING GUIDELINES SUMMARY -29- RISKMETRICS Group www.riskmetrics.com Vote AGAINST plans if the company has a history of repricing options without shareholder approval, and the applicable listing standards would not preclude them from doing so. PAY-FOR-PERFORMANCE DISCONNECT Generally vote AGAINST plans in which: - There is a disconnect between the CEO's pay and company performance (an increase in pay and a decrease in performance); - The main source of the pay increase (over half) is equity-based; and - The CEO is a participant of the equity proposal. Performance decreases are based on negative one- and three-year total shareholder returns. CEO pay increases are based on the CEO's total direct compensation (salary, cash bonus, value of non-equity incentive payouts, present value of stock options, face value of restricted stock, target value of performance-based awards, change in pension value and nonqualified deferred compensation earnings, and all other compensation) increasing over the previous year. Vote AGAINST or WITHHOLD votes from the Compensation Committee members when the company has a pay-for-performance disconnect. On a CASE-BY-CASE basis, vote for equity plans and FOR compensation committee members with a pay-for-performance disconnect if compensation committee members can present strong and compelling evidence of improved committee performance. This evidence must go beyond the usual compensation committee report disclosure. This additional evidence necessary includes all of the following: - The compensation committee has reviewed all components of the CEO's compensation, including the following: - Base salary, bonus, long-term incentives; - Accumulative realized and unrealized stock option and restricted stock gains; - Dollar value of perquisites and other personal benefits to the CEO and the total cost to the company; - Earnings and accumulated payment obligations under the company's nonqualified deferred compensation program; - Actual projected payment obligations under the company's supplemental executive retirement plan (SERPs). - A tally sheet with all the above components should be disclosed for the following termination scenarios: - Payment if termination occurs within 12 months: $_____; - Payment if "not for cause" termination occurs within 12 months: $_____; - Payment if "change of control" termination occurs within 12 months: $_____. - The compensation committee is committed to providing additional information on the named executives' annual cash bonus program and/or long-term incentive cash plan for the current fiscal year. The compensation committee will provide full disclosure of the qualitative and quantitative performance criteria and hurdle rates used to determine the payouts of the cash program. From this 2008 US PROXY VOTING GUIDELINES SUMMARY -30- RISKMETRICS Group www.riskmetrics.com disclosure, shareholders will know the minimum level of performance required for any cash bonus to be delivered, as well as the maximum cash bonus payable for superior performance. The repetition of the compensation committee report does not meet ISS' requirement of compelling and strong evidence of improved disclosure. The level of transparency and disclosure is at the highest level where shareholders can understand the mechanics of the annual cash bonus and/or long-term incentive cash plan based on the additional disclosure. - The compensation committee is committed to granting a substantial portion of performance-based equity awards to the named executive officers. A substantial portion of performance-based awards would be at least 50 percent of the shares awarded to each of the named executive officers. Performance-based equity awards are earned or paid out based on the achievement of company performance targets. The company will disclose the details of the performance criteria (e.g., return on equity) and the hurdle rates (e.g., 15 percent) associated with the performance targets. From this disclosure, shareholders will know the minimum level of performance required for any equity grants to be made. The performance-based equity awards do not refer to non-qualified stock options(3) or performance-accelerated grants.(4) Instead, performance-based equity awards are performance-contingent grants where the individual will not receive the equity grant by not meeting the target performance and vice versa. The level of transparency and disclosure is at the highest level where shareholders can understand the mechanics of the performance-based equity awards based on the additional disclosure. - The compensation committee has the sole authority to hire and fire outside compensation consultants. The role of the outside compensation consultant is to assist the compensation committee to analyze executive pay packages or contracts and understand the company's financial measures. THREE-YEAR BURN RATE/BURN RATE COMMITMENT Generally vote AGAINST plans if the company's most recent three-year burn rate exceeds one standard deviation in excess of the industry mean (per the following Burn Rate Table) and is over 2 percent of common shares outstanding. The three-year burn rate policy does not apply to non-employee director plans unless outside directors receive a significant portion of shares each year. The annual burn rate is calculated as follows: Annual Burn rate = (# of options granted + # of full value shares awarded * Multiplier) / Weighted Average common shares outstanding) - ---------- (3) Non-qualified stock options are not performance-based awards unless the grant or the vesting of the stock options is tied to the achievement of a pre-determined and disclosed performance measure. A rising stock market will generally increase share prices of all companies, despite of the company's underlying performance. (4) Performance-accelerated grants are awards that vest earlier based on the achievement of a specified measure. However, these grants will ultimately vest over time even without the attainment of the goal(s). 2008 US PROXY VOTING GUIDELINES SUMMARY -31- RISKMETRICS Group www.riskmetrics.com However, vote FOR equity plans if the company fails this burn rate test but the company commits in a public filing to a three-year average burn rate equal to its GICS group burn rate mean plus one standard deviation (or 2%, whichever is greater), assuming all other conditions for voting FOR the plan have been met. If a company fails to fulfill its burn rate commitment, vote AGAINST or WITHHOLD from the compensation committee. 2008 BURN RATE TABLE
RUSSELL 3000 NON-RUSSELL 3000 ---------------- ---------------- STANDARD STANDARD GICS DESCRIPTION MEAN DEVIATION MEAN+STDEV MEAN DEVIATION MEAN+STDEV - ---------------- ---------------------------------------- ---- --------- ---------- ---- --------- ---------- 1010 Energy 1.71% 1.39% 3.09% 2.12% 2.31% 4.43% 1510 Materials 1.16% 0.77% 1.93% 2.23% 2.26% 4.49% 2010 Capital Goods 1.51% 1.04% 2.55% 2.36% 2.03% 4.39% 2020 Commercial Services & Supplies 2.35% 1.70% 4.05% 2.20% 2.03% 4.23% 2030 Transportation 1.59% 1.22% 2.80% 2.02% 2.08% 4.10% 2510 Automobiles & Components 1.89% 1.10% 2.99% 1.73% 2.05% 3.78% 2520 Consumer Durables & Apparel 2.02% 1.31% 3.33% 2.10% 1.94% 4.04% 2530 Hotels Restaurants & Leisure 2.15% 1.18% 3.33% 2.32% 1.93% 4.25% 2540 Media 1.92% 1.35% 3.27% 3.33% 2.60% 5.93% 2550 Retailing 1.86% 1.04% 2.90% 3.15% 2.65% 5.80% 3010, 3020, 3030 Food & Staples Retailing 1.69% 1.23% 2.92% 1.82% 2.03% 3.85% 3510 Health Care Equipment & Services 2.90% 1.67% 4.57% 3.75% 2.65% 6.40% 3520 Pharmaceuticals & Biotechnology 3.30% 1.66% 4.96% 4.92% 3.77% 8.69% 4010 Banks 1.27% 0.88% 2.15% 1.07% 1.12% 2.19% 4020 Diversified Financials 2.45% 2.07% 4.52% 4.41% 5.31% 9.71% 4030 Insurance 1.21% 0.93% 2.14% 2.07% 2.28% 4.35% 4040 Real Estate 1.04% 0.81% 1.85% 0.80% 1.21% 2.02% 4510 Software & Services 3.81% 2.30% 6.11% 5.46% 3.81% 9.27% 4520 Technology Hardware & Equipment 3.07% 1.74% 4.80% 3.43% 2.40% 5.83% 4530 Semiconductors & Semiconductor Equipment 3.78% 1.81% 5.59% 4.51% 2.30% 6.81% 5010 Telecommunication Services 1.57% 1.23% 2.80% 2.69% 2.41% 5.10% 5510 Utilities 0.72% 0.50% 1.22% 0.59% 0.66% 1.25%
For companies that grant both full value awards and stock options to their employees, apply a premium on full value awards for the past three fiscal years. The guideline for applying the premium is as follows:
ANNUAL STOCK PRICE VOLATILITY MULTIPLIER - ----------------------------------- -------------------------------------------------- 54.6% and higher 1 full-value award will count as 1.5 option shares 36.1% or higher and less than 54.6% 1 full-value award will count as 2.0 option shares 24.9% or higher and less than 36.1% 1 full-value award will count as 2.5 option shares 16.5% or higher and less than 24.9% 1 full-value award will count as 3.0 option shares 7.9% or higher and less than 16.5% 1 full-value award will count as 3.5 option shares Less than 7.9% 1 full-value award will count as 4.0 option shares
2008 US PROXY VOTING GUIDELINES SUMMARY -32- RISKMETRICS Group www.riskmetrics.com POOR PAY PRACTICES Vote AGAINST or WITHHOLD from compensation committee members, CEO, and potentially the entire board, if the company has poor compensation practices. Vote AGAINST equity plans if the plan is a vehicle for poor compensation practices. The following practices, while not exhaustive, are examples of poor compensation practices that may warrant voting against or withholding votes: - Egregious employment contracts: - Contracts containing multi-year guarantees for salary increases, bonuses, and equity compensation; - Excessive perks: - Overly generous cost and/or reimbursement of taxes for personal use of corporate aircraft, personal security systems maintenance and/or installation, car allowances, and/or other excessive arrangements relative to base salary; - Abnormally large bonus payouts without justifiable performance linkage or proper disclosure: - Performance metrics that are changed, canceled, or replaced during the performance period without adequate explanation of the action and the link to performance; - Egregious pension/SERP (supplemental executive retirement plan) payouts: - Inclusion of additional years of service not worked that result in significant payouts - Inclusion of performance-based equity awards in the pension calculation; - New CEO with overly generous new hire package: - Excessive "make whole" provisions; - Any of the poor pay practices listed in this policy; - Excessive severance and/or change-in-control provisions: - Inclusion of excessive change-in-control or severance payments, especially those with a multiple in excess of 3X cash pay; - Severance paid for a "performance termination," (i.e., due to the executive's failure to perform job functions at the appropriate level); - Change-in-control payouts without loss of job or substantial diminution of job duties (single-triggered); - Perquisites for former executives such as car allowances, personal use of corporate aircraft, or other inappropriate arrangements; - Poor disclosure practices: - Unclear explanation of how the CEO is involved in the pay setting process; - Retrospective performance targets and methodology not discussed; - Methodology for benchmarking practices and/or peer group not disclosed and explained; - Internal Pay Disparity: - Excessive differential between CEO total pay and that of next highest-paid named executive officer (NEO); - Options backdating (covered in a separate policy); - Other excessive compensation payouts or poor pay practices at the company. 2008 US PROXY VOTING GUIDELINES SUMMARY -33- RISKMETRICS Group www.riskmetrics.com SPECIFIC TREATMENT OF CERTAIN AWARD TYPES IN EQUITY PLAN EVALUATIONS: DIVIDEND EQUIVALENT RIGHTS Options that have Dividend Equivalent Rights (DERs) associated with them will have a higher calculated award value than those without DERs under the binomial model, based on the value of these dividend streams. The higher value will be applied to new shares, shares available under existing plans, and shares awarded but not exercised per the plan specifications. DERS transfer more shareholder equity to employees and non-employee directors and this cost should be captured. LIBERAL SHARE RECYCLING PROVISIONS Under net share counting provisions, shares tendered by an option holder to pay for the exercise of an option, shares withheld for taxes or shares repurchased by the company on the open market can be recycled back into the equity plan for awarding again. All awards with such provisions should be valued as full-value awards. Stock-settled stock appreciation rights (SSARs) will also be considered as full-value awards if a company counts only the net shares issued to employees towards their plan reserve. OPTION OVERHANG COST Companies with sustained positive stock performance and high overhang cost (the overhang alone exceeds the allowable cap) attributable to in-the-money options outstanding in excess of six years may warrant a carve-out of these options from the overhang as long as the dilution attributable to the new share request is reasonable and the company exhibits sound compensation practices. Consider, on a CASE-BY-CASE basis, a carve-out of a portion of cost attributable to overhang, considering the following criteria: - PERFORMANCE: Companies with sustained positive stock performance will merit greater scrutiny. Five-year total shareholder return (TSR), year-over-year performance, and peer performance could play a significant role in this determination. - OVERHANG DISCLOSURE: Assess whether optionees have held in-the-money options for a prolonged period (thus reflecting their confidence in the prospects of the company). Note that this assessment would require additional disclosure regarding a company's overhang. Specifically, the following disclosure would be required: - The number of in-the-money options outstanding in excess of six or more years with a corresponding weighted average exercise price and weighted average contractual remaining term; - The number of all options outstanding less than six years and underwater options outstanding in excess of six years with a corresponding weighted average exercise price and weighted average contractual remaining term; - The general vesting provisions of option grants; and - The distribution of outstanding option grants with respect to the named executive officers; - DILUTION: Calculate the expected duration of the new share request in addition to all shares currently available for grant under the equity compensation program, based on the company's three-year average burn rate (or a burn-rate commitment that the company makes for future years). The expected duration will be calculated by multiplying the company's unadjusted (options and full-value awards accounted on a one-for-one basis) three-year average burn rate by the most recent fiscal year's weighted average shares outstanding (as used in the company's calculation of basic EPS) and divide the 2008 US PROXY VOTING GUIDELINES SUMMARY -34- RISKMETRICS Group www.riskmetrics.com sum of the new share request and all available shares under the company's equity compensation program by the product. For example, an expected duration in excess of five years could be considered problematic; and - COMPENSATION PRACTICES: An evaluation of overall practices could include: (1) stock option repricing provisions, (2) high concentration ratios (of grants to top executives), or (3) additional practices outlined in the Poor Pay Practices policy. OTHER COMPENSATION PROPOSALS AND POLICIES 401(K) EMPLOYEE BENEFIT PLANS Vote FOR proposals to implement a 401(k) savings plan for employees. ADVISORY VOTE ON EXECUTIVE COMPENSATION (SAY-ON-PAY) MANAGEMENT PROPOSALS Vote CASE-BY-CASE on management proposals for an advisory vote on executive compensation. Vote AGAINST these resolutions in cases where boards have failed to demonstrate good stewardship of investors' interests regarding executive compensation practices. The following principles and factors should be considered: 1. The following FIVE GLOBAL PRINCIPLES apply to all markets: - 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 linkage between pay and performance; the mix between fixed and variable pay; performance goals; and equity-based plan costs; - Avoid arrangements that risk "pay for failure": This principle addresses the use and appropriateness of long or indefinite contracts, excessive severance packages, and guaranteed compensation; - 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); - 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; - 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. 2. For U.S. companies, vote CASE-BY-CASE considering the following factors in the context of each company's specific circumstances and the board's disclosed rationale for its practices: RELATIVE CONSIDERATIONS: - Assessment of performance metrics relative to business strategy, as discussed and explained in the CD&A; 2008 US PROXY VOTING GUIDELINES SUMMARY -35- RISKMETRICS Group www.riskmetrics.com - Evaluation of peer groups used to set target pay or award opportunities; - Alignment of company performance and executive pay trends over time (e.g., performance down: pay down); - Assessment of disparity between total pay of the CEO and other Named Executive Officers (NEOs). DESIGN CONSIDERATIONS: - Balance of fixed versus performance-driven pay; - Assessment of excessive practices with respect to perks, severance packages, supplemental executive pension plans, and burn rates. COMMUNICATION CONSIDERATIONS: - Evaluation of information and board rationale provided in CD&A about how compensation is determined (e.g., why certain elements and pay targets are used, and specific incentive plan goals, especially retrospective goals); - Assessment of board's responsiveness to investor input and engagement on compensation issues (e.g., in responding to majority-supported shareholder proposals on executive pay topics). DIRECTOR COMPENSATION Vote CASE-BY-CASE on compensation plans for non-employee directors, based on the cost of the plans against the company's allowable cap. On occasion, director stock plans that set aside a relatively small number of shares when combined with employee or executive stock compensation plans will exceed the allowable cap. Vote for the plan if ALL of the following qualitative factors in the board's compensation are met and disclosed in the proxy statement: - Director stock ownership guidelines with a minimum of three times the annual cash retainer. - Vesting schedule or mandatory holding/deferral period: - A minimum vesting of three years for stock options or restricted stock; or - Deferred stock payable at the end of a three-year deferral period. - Mix between cash and equity: - A balanced mix of cash and equity, for example 40% cash/60% equity or 50% cash/50% equity; or - If the mix is heavier on the equity component, the vesting schedule or deferral period should be more stringent, with the lesser of five years or the term of directorship. - No retirement/benefits and perquisites provided to non-employee directors; and - Detailed disclosure provided on cash and equity compensation delivered to each non-employee director for the most recent fiscal year in a table. The column headers for the table may include the following: name of each non-employee director, annual retainer, board meeting fees, committee retainer, committee-meeting fees, and equity grants. DIRECTOR RETIREMENT PLANS Vote AGAINST retirement plans for non-employee directors. Vote FOR shareholder proposals to eliminate retirement plans for non-employee directors. EMPLOYEE STOCK OWNERSHIP PLANS (ESOPS) Vote FOR proposals to implement an ESOP or increase authorized shares for existing ESOPs, unless the number of shares allocated to the ESOP is excessive (more than five percent of outstanding shares). 2008 US PROXY VOTING GUIDELINES SUMMARY -36- RISKMETRICS Group www.riskmetrics.com EMPLOYEE STOCK PURCHASE PLANS-- QUALIFIED PLANS Vote CASE-BY-CASE on qualified employee stock purchase plans. Vote FOR employee stock purchase plans where all of the following apply: - Purchase price is at least 85 percent of fair market value; - Offering period is 27 months or less; and - The number of shares allocated to the plan is ten percent or less of the outstanding shares. Vote AGAINST qualified employee stock purchase plans where any of the following apply: - Purchase price is less than 85 percent of fair market value; or - Offering period is greater than 27 months; or - The number of shares allocated to the plan is more than ten percent of the outstanding shares. EMPLOYEE STOCK PURCHASE PLANS-- NON-QUALIFIED PLANS Vote CASE-by-CASE on nonqualified employee stock purchase plans. Vote FOR nonqualified employee stock purchase plans with all the following features: - Broad-based participation (i.e., all employees of the company with the exclusion of individuals with 5 percent or more of beneficial ownership of the company); - Limits on employee contribution, which may be a fixed dollar amount or expressed as a percent of base salary; - Company matching contribution up to 25 percent of employee's contribution, which is effectively a discount of 20 percent from market value; - No discount on the stock price on the date of purchase since there is a company matching contribution. Vote AGAINST nonqualified employee stock purchase plans when any of the plan features do not meet the above criteria. If the company matching contribution exceeds 25 percent of employee's contribution, evaluate the cost of the plan against its allowable cap. INCENTIVE BONUS PLANS AND TAX DEDUCTIBILITY PROPOSALS (OBRA-RELATED COMPENSATION PROPOSALS) Vote FOR proposals that simply amend shareholder-approved compensation plans to include administrative features or place a cap on the annual grants any one participant may receive to comply with the provisions of Section 162(m) of the Internal Revenue Code. Vote FOR proposals to add performance goals to existing compensation plans to comply with the provisions of Section 162(m) unless they are clearly inappropriate. Vote CASE-BY-CASE on amendments to existing plans to increase shares reserved and to qualify for favorable tax treatment under the provisions of Section 162(m) as long as the plan does not exceed the allowable cap and the plan does not violate any of the supplemental policies. 2008 US PROXY VOTING GUIDELINES SUMMARY -37- RISKMETRICS Group www.riskmetrics.com Generally vote FOR cash or cash and stock bonus plans that are submitted to shareholders for the purpose of exempting compensation from taxes under the provisions of Section 162(m) if no increase in shares is requested. OPTIONS BACKDATING In cases where a company has practiced options backdating, vote AGAINST or WITHHOLD on a CASE-BY-CASE basis from the members of the compensation committee, depending on the severity of the practices and the subsequent corrective actions on the part of the board. Vote AGAINST or WITHHOLD from the compensation committee members who oversaw the questionable options grant practices or from current compensation committee members who fail to respond to the issue proactively, depending on several factors, including, but not limited to: - Reason and motive for the options backdating issue, such as inadvertent vs. deliberate grant date changes; - Length of time of options backdating; - Size of restatement due to options backdating; - Corrective actions taken by the board or compensation committee, such as canceling or repricing backdated options, or recoupment of option gains on backdated grants; - Adoption of a grant policy that prohibits backdating, and creation of a fixed grant schedule or window period for equity grants going forward. OPTION EXCHANGE PROGRAMS/REPRICING OPTIONS Vote CASE-by-CASE on management proposals seeking approval to exchange/reprice options taking into consideration: - Historic trading patterns--the stock price should not be so volatile that the options are likely to be back "in-the-money" over the near term; - Rationale for the re-pricing--was the stock price decline beyond management's control? - Is this a value-for-value exchange? - Are surrendered stock options added back to the plan reserve? - Option vesting--does the new option vest immediately or is there a black-out period? - Term of the option--the term should remain the same as that of the replaced option; - Exercise price--should be set at fair market or a premium to market; - Participants--executive officers and directors should be excluded. If the surrendered options are added back to the equity plans for re-issuance, then also take into consideration the company's three-year average burn rate. In addition to the above considerations, evaluate the intent, rationale, and timing of the repricing proposal. The proposal should clearly articulate why the board is choosing to conduct an exchange program at this point in time. Repricing underwater options after a recent precipitous drop in the company's stock price demonstrates poor timing. Repricing after a recent decline in stock price triggers additional scrutiny and a potential AGAINST vote on the proposal. At a minimum, the decline should not have happened within the past year. Also, consider the terms of the surrendered options, such as the grant date, exercise price and vesting schedule. Grant dates of surrendered options should be far enough back (two to three years) so as not to 2008 US PROXY VOTING GUIDELINES SUMMARY -38- RISKMETRICS Group www.riskmetrics.com suggest that repricings are being done to take advantage of short-term downward price movements. Similarly, the exercise price of surrendered options should be above the 52-week high for the stock price. Vote FOR shareholder proposals to put option repricings to a shareholder vote. STOCK PLANS IN LIEU OF CASH Vote CASE-by-CASE on plans that provide participants with the option of taking all or a portion of their cash compensation in the form of stock. Vote FOR non-employee director-only equity plans that provide a dollar-for-dollar cash-for-stock exchange. Vote CASE-by-CASE on plans which do not provide a dollar-for-dollar cash for stock exchange. In cases where the exchange is not dollar-for-dollar, the request for new or additional shares for such equity program will be considered using the binomial option pricing model. In an effort to capture the total cost of total compensation, ISS will not make any adjustments to carve out the in-lieu-of cash compensation. TRANSFER PROGRAMS OF STOCK OPTIONS One-time Transfers: Vote AGAINST or WITHHOLD from compensation committee members if they fail to submit one-time transfers to shareholders for approval. Vote CASE-BY-CASE on one-time transfers. Vote FOR if: - Executive officers and non-employee directors are excluded from participating; - Stock options are purchased by third-party financial institutions at a discount to their fair value using option pricing models such as Black-Scholes or a Binomial Option Valuation or other appropriate financial models; - There is a two-year minimum holding period for sale proceeds (cash or stock) for all participants. Additionally, management should provide a clear explanation of why options are being transferred and whether the events leading up to the decline in stock price were beyond management's control. A review of the company's historic stock price volatility should indicate if the options are likely to be back "in-the-money" over the near term. Ongoing TSO program: Vote against equity plan proposals if the details of ongoing TSO programs are not provided to shareholders. Since TSOs will be one of the award types under a stock plan, the ongoing TSO program, structure and mechanics must be disclosed to shareholders. The specific criteria to be considered in evaluating these proposals include, but not limited, to the following: - Eligibility; - Vesting; - Bid-price; - Term of options; - Transfer value to third-party financial institution, employees and the company. 2008 US PROXY VOTING GUIDELINES SUMMARY -39- RISKMETRICS Group www.riskmetrics.com Amendments to existing plans that allow for introduction of transferability of stock options should make clear that only options granted post-amendment shall be transferable. SHAREHOLDER PROPOSALS ON COMPENSATION ADVISORY VOTE ON EXECUTIVE COMPENSATION (SAY-ON-PAY) Generally, vote FOR shareholder proposals that call for non-binding shareholder ratification of the compensation of the Named Executive Officers and the accompanying narrative disclosure of material factors provided to understand the Summary Compensation Table. COMPENSATION CONSULTANTS- DISCLOSURE OF BOARD OR COMPANY'S UTILIZATION Generally vote FOR shareholder proposals seeking disclosure regarding the Company, Board, or Compensation Committee's use of compensation consultants, such as company name, business relationship(s) and fees paid. DISCLOSURE/SETTING LEVELS OR TYPES OF COMPENSATION FOR EXECUTIVES AND DIRECTORS Generally, vote FOR shareholder proposals seeking additional disclosure of executive and director pay information, provided the information requested is relevant to shareholders' needs, would not put the company at a competitive disadvantage relative to its industry, and is not unduly burdensome to the company. Vote AGAINST shareholder proposals seeking to set absolute levels on compensation or otherwise dictate the amount or form of compensation. Vote AGAINST shareholder proposals requiring director fees be paid in stock only. Vote CASE-BY-CASE on all other shareholder proposals regarding executive and director pay, taking into account company performance, pay level versus peers, pay level versus industry, and long-term corporate outlook. PAY FOR SUPERIOR PERFORMANCE Generally vote FOR shareholder proposals based on a case-by-case analysis that requests the board establish a pay-for-superior performance standard in the company's executive compensation plan for senior executives. The proposal has the following principles: - Sets compensation targets for the Plan's annual and long-term incentive pay components at or below the peer group median; - Delivers a majority of the Plan's target long-term compensation through performance-vested, not simply time-vested, equity awards; - Provides the strategic rationale and relative weightings of the financial and non-financial performance metrics or criteria used in the annual and performance-vested long-term incentive components of the plan; - Establishes performance targets for each plan financial metric relative to the performance of the company's peer companies; 2008 US PROXY VOTING GUIDELINES SUMMARY -40- RISKMETRICS Group www.riskmetrics.com - Limits payment under the annual and performance-vested long-term incentive components of the plan to when the company's performance on its selected financial performance metrics exceeds peer group median performance. Consider the following factors in evaluating this proposal: - What aspects of the company's annual and long-term equity incentive programs are performance driven? - If the annual and long-term equity incentive programs are performance driven, are the performance criteria and hurdle rates disclosed to shareholders or are they benchmarked against a disclosed peer group? - Can shareholders assess the correlation between pay and performance based on the current disclosure? - What type of industry and stage of business cycle does the company belong to? PERFORMANCE-BASED AWARDS Vote CASE-BY-CASE on shareholder proposal requesting that a significant amount of future long-term incentive compensation awarded to senior executives shall be performance-based and requesting that the board adopt and disclose challenging performance metrics to shareholders, based on the following analytical steps: - - First, vote FOR shareholder proposals advocating the use of performance-based equity awards, such as performance contingent options or restricted stock, indexed options or premium-priced options, unless the proposal is overly restrictive or if the company has demonstrated that it is using a "substantial" portion of performance-based awards for its top executives. Standard stock options and performance-accelerated awards do not meet the criteria to be considered as performance-based awards. Further, premium-priced options should have a premium of at least 25 percent and higher to be considered performance-based awards. - - Second, assess the rigor of the company's performance-based equity program. If the bar set for the performance-based program is too low based on the company's historical or peer group comparison, generally vote FOR the proposal. Furthermore, if target performance results in an above target payout, vote FOR the shareholder proposal due to program's poor design. If the company does not disclose the performance metric of the performance-based equity program, vote FOR the shareholder proposal regardless of the outcome of the first step to the test. In general, vote FOR the shareholder proposal if the company does not meet both of the above two steps. PENSION PLAN INCOME ACCOUNTING Generally vote FOR shareholder proposals to exclude pension plan income in the calculation of earnings used in determining executive bonuses/compensation. PRE-ARRANGED TRADING PLANS (10B5-1 PLANS) Generally vote FOR shareholder proposals calling for certain principles regarding the use of prearranged trading plans (10b5-1 plans) for executives. These principles include: - Adoption, amendment, or termination of a 10b5-1 Plan must be disclosed within two business days in a Form 8-K; - Amendment or early termination of a 10b5-1 Plan is allowed only under extraordinary circumstances, as determined by the board; 2008 US PROXY VOTING GUIDELINES SUMMARY -41- RISKMETRICS Group www.riskmetrics.com - Ninety days must elapse between adoption or amendment of a 10b5-1 Plan and initial trading under the plan; - Reports on Form 4 must identify transactions made pursuant to a 10b5-1 Plan; - An executive may not trade in company stock outside the 10b5-1 Plan. - Trades under a 10b5-1 Plan must be handled by a broker who does not handle other securities transactions for the executive. RECOUP BONUSES Vote on a CASE-BY-CASE on proposals to recoup unearned incentive bonuses or other incentive payments made to senior executives if it is later determined that fraud, misconduct, or negligence significantly contributed to a restatement of financial results that led to the awarding of unearned incentive compensation, taking into consideration: - If the company has adopted a formal recoupment bonus policy; or - If the company has chronic restatement history or material financial problems. SEVERANCE AGREEMENTS FOR EXECUTIVES/GOLDEN PARACHUTES Vote FOR shareholder proposals requiring that golden parachutes or executive severance agreements be submitted for shareholder ratification, unless the proposal requires shareholder approval prior to entering into employment contracts. Vote on a CASE-BY-CASE basis on proposals to ratify or cancel golden parachutes. An acceptable parachute should include, but is not limited to, the following: - The triggering mechanism should be beyond the control of management; - The amount should not exceed three times base amount (defined as the average annual taxable W-2 compensation during the five years prior to the year in which the change of control occurs; - Change-in-control payments should be double-triggered, i.e., (1) after a change in control has taken place, and (2) termination of the executive as a result of the change in control. Change in control is defined as a change in the company ownership structure. SHARE BUYBACK HOLDING PERIODS Generally vote AGAINST shareholder proposals prohibiting executives from selling shares of company stock during periods in which the company has announced that it may or will be repurchasing shares of its stock. Vote FOR the proposal when there is a pattern of abuse by executives exercising options or selling shares during periods of share buybacks. STOCK OWNERSHIP OR HOLDING PERIOD GUIDELINES Generally vote AGAINST shareholder proposals that mandate a minimum amount of stock that directors must own in order to qualify as a director or to remain on the board. While ISS favors stock ownership on the part of directors, the company should determine the appropriate ownership requirement. Vote CASE-BY-CASE on shareholder proposals asking companies to adopt holding period or retention ratios for their executives, taking into account: - Whether the company has any holding period, retention ratio, or officer ownership requirements in place. These should consist of: 2008 US PROXY VOTING GUIDELINES SUMMARY -42- RISKMETRICS Group www.riskmetrics.com - Rigorous stock ownership guidelines, or - A short-term holding period requirement (six months to one year) coupled with a significant long-term ownership requirement, or - A meaningful retention ratio, - Actual officer stock ownership and the degree to which it meets or exceeds the proponent's suggested holding period/retention ratio or the company's own stock ownership or retention requirements. SUPPLEMENTAL EXECUTIVE RETIREMENT PLANS (SERPS) Generally vote FOR shareholder proposals requesting to put extraordinary benefits contained in SERP agreements to a shareholder vote unless the company's executive pension plans do not contain excessive benefits beyond what is offered under employee-wide plans. Generally vote FOR shareholder proposals requesting to limit the executive benefits provided under the company's supplemental executive retirement plan (SERP) by limiting covered compensation to a senior executive's annual salary and excluding of all incentive or bonus pay from the plan's definition of covered compensation used to establish such benefits. TAX GROSS-UP PROPOSALS Generally vote FOR proposals calling for companies to adopt a policy of not providing tax gross-up payments to executives, except in situations where gross-ups are provided pursuant to a plan, policy, or arrangement applicable to management employees of the company, such as a relocation or expatriate tax equalization policy. 2008 US PROXY VOTING GUIDELINES SUMMARY -43- RISKMETRICS Group www.riskmetrics.com 9. Corporate Social Responsibility (CSR) Issues ANIMAL WELFARE ANIMAL TESTING Generally vote AGAINST proposals to phase out the use of animals in product testing unless: - The company is conducting animal testing programs that are unnecessary or not required by regulation; - The company is conducting animal testing when suitable alternatives are accepted and used at peer firms; - The company has been the subject of recent, significant controversy related to its testing programs. ANIMAL WELFARE POLICIES Generally vote FOR proposals seeking a report on the company's animal welfare standards unless: - The company has already published a set of animal welfare standards and monitors compliance; - The company's standards are comparable to or better than those of peer firms; and - There are no recent, significant fines or litigation related to the company's treatment of animals. CONTROLLED ATMOSPHERE KILLING (CAK) Generally vote AGAINST proposals requesting the implementation of CAK methods at company and/or supplier operations unless such methods are required by legislation or generally accepted as the industry standard. Vote CASE-BY-CASE on proposals requesting a report on the feasibility of implementing CAK methods, considering the availability of existing research conducted by the company or industry groups on this topic and any fines or litigation related to current animal processing procedures at the company. CONSUMER ISSUES GENETICALLY MODIFIED INGREDIENTS Generally, vote AGAINST proposals asking restaurants and food retail companies to voluntarily label genetically engineered (GE) ingredients in their products or alternatively to provide interim labeling and eventually eliminate GE ingredients due to the costs and feasibility of labeling and/or phasing out the use of GE ingredients. Vote CASE-BY CASE on proposals asking food supply and genetic research companies to voluntarily label genetically engineered (GE) ingredients in their products or alternatively to provide interim labeling and eventually eliminate GE ingredients due to the costs and feasibility of labeling and/or phasing out the use of GE ingredients. Vote CASE-BY-CASE on proposals asking for a report on the feasibility of labeling products containing GE ingredients taking into account: - The relevance of the proposal in terms of the company's business and the proportion of it affected by the resolution; 2008 US PROXY VOTING GUIDELINES SUMMARY -44- RISKMETRICS Group www.riskmetrics.com - The quality of the company's disclosure on GE product labeling and related voluntary initiatives and how this disclosure compares with peer company disclosure; - Company's current disclosure on the feasibility of GE product labeling, including information on the related costs; - Any voluntary labeling initiatives undertaken or considered by the company. Generally vote AGAINST proposals seeking a report on the health and environmental effects of genetically modified organisms (GMOs). Health studies of this sort are better undertaken by regulators and the scientific community. Generally vote AGAINST proposals to completely phase out GE ingredients from the company's products or proposals asking for reports outlining the steps necessary to eliminate GE ingredients from the company's products. Such resolutions presuppose that there are proven health risks to GE ingredients (an issue better left to federal regulators) that outweigh the economic benefits derived from biotechnology. CONSUMER LENDING Vote CASE-BY CASE on requests for reports on the company's lending guidelines and procedures, including the establishment of a board committee for oversight, taking into account: - Whether the company has adequately disclosed mechanisms in place to prevent abusive lending practices; - Whether the company has adequately disclosed the financial risks of the lending products in question; - Whether the company has been subject to violations of lending laws or serious lending controversies; - Peer companies' policies to prevent abusive lending practices. PHARMACEUTICAL PRICING Generally vote AGAINST proposals requesting that companies implement specific price restraints on pharmaceutical products unless the company fails to adhere to legislative guidelines or industry norms in its product pricing. Vote CASE-BY-CASE on proposals requesting that the company evaluate their product pricing considering: - The existing level of disclosure on pricing policies; - Deviation from established industry pricing norms; - The company's existing initiatives to provide its products to needy consumers; - Whether the proposal focuses on specific products or geographic regions. PHARMACEUTICAL PRODUCT REIMPORTATION Generally vote FOR proposals requesting that companies report on the financial and legal impact of their policies regarding prescription drug reimportation unless such information is already publicly disclosed. Generally vote AGAINST proposals requesting that companies adopt specific policies to encourage or constrain prescription drug reimportation. 2008 US PROXY VOTING GUIDELINES SUMMARY -45- RISKMETRICS Group www.riskmetrics.com PRODUCT SAFETY AND TOXIC MATERIALS Generally vote FOR proposals requesting the company to report on its policies, initiatives/procedures, and oversight mechanisms related to toxic materials and/or product safety in its supply chain, unless: - The company already discloses similar information through existing reports or policies such as a Supplier Code of Conduct and/or a sustainability report; - The company has formally committed to the implementation of a toxic materials and/or product safety and supply chain reporting and monitoring program based on industry norms or similar standards within a specified time frame; and - The company has not been recently involved in relevant significant controversies or violations. Vote CASE-BY-CASE on resolutions requesting that companies develop a feasibility assessment to phase-out of certain toxic chemicals and/or evaluate and disclose the potential financial and legal risks associated with utilizing certain chemicals, considering: - Current regulations in the markets in which the company operates; - Recent significant controversy, litigation, or fines stemming from toxic chemicals or ingredients at the company; and - The current level of disclosure on this topic. Generally vote AGAINST resolutions requiring that a company reformulate its products. TOBACCO Most tobacco-related proposals should be evaluated on a CASE-BY-CASE basis, taking into account the following factors: Advertising to youth: - Whether the company complies with federal, state, and local laws on the marketing of tobacco or if it has been fined for violations; - Whether the company has gone as far as peers in restricting advertising; - Whether the company entered into the Master Settlement Agreement, which restricts marketing of tobacco to youth; - Whether restrictions on marketing to youth extend to foreign countries. Cease production of tobacco-related products or avoid selling products to tobacco companies: - The percentage of the company's business affected; - The economic loss of eliminating the business versus any potential tobacco-related liabilities. Investment in tobacco-related stocks or businesses: Vote AGAINST proposals prohibiting investment in tobacco equities. Such decisions are better left to portfolio managers. Second-hand smoke: - Whether the company complies with all local ordinances and regulations; - The degree that voluntary restrictions beyond those mandated by law might hurt the company's competitiveness; - The risk of any health-related liabilities. 2008 US PROXY VOTING GUIDELINES SUMMARY -46- RISKMETRICS Group www.riskmetrics.com Spin-off tobacco-related businesses: - The percentage of the company's business affected; - The feasibility of a spin-off; - Potential future liabilities related to the company's tobacco business. Stronger product warnings: Vote AGAINST proposals seeking stronger product warnings. Such decisions are better left to public health authorities. DIVERSITY BOARD DIVERSITY Generally vote FOR reports on the company's efforts to diversify the board, unless: - The board composition is reasonably inclusive in relation to companies of similar size and business; or - The board already reports on its nominating procedures and diversity initiatives. Generally vote AGAINST proposals that would call for the adoption of specific committee charter language regarding diversity initiatives unless the company fails to publicly disclose existing equal opportunity or non-discrimination policies. Vote CASE-BY-CASE on proposals asking the company to increase the representation of women and minorities on the board, taking into account: - The degree of board diversity; - Comparison with peer companies; - Established process for improving board diversity; - Existence of independent nominating committee; - Use of outside search firm; - History of EEO violations. EQUALITY OF OPPORTUNITY AND GLASS CEILING Generally vote FOR reports outlining the company's equal opportunity initiatives unless all of the following apply: - The company has well-documented equal opportunity programs; - The company already publicly reports on its diversity initiatives and/or provides data on its workforce diversity; and - The company has no recent EEO-related violations or litigation. Generally vote FOR requests for reports outlining the company's progress towards the Glass Ceiling Commission's business recommendations, unless: - The composition of senior management and the board is fairly inclusive; - The company has well-documented programs addressing diversity initiatives and leadership development; - The company already publicly reports on its company-wide affirmative-action initiatives and provides data on its workforce diversity; and 2008 US PROXY VOTING GUIDELINES SUMMARY -47- RISKMETRICS Group www.riskmetrics.com - The company has had no recent, significant EEO-related violations or litigation. Vote CASE-BY-CASE on proposals requesting disclosure of a company's EEO1 data or the composition of the company's workforce considering: - Existing disclosure on the company's diversity initiatives and policies; - Any recent, significant violations or litigation related to discrimination at the company. Generally vote AGAINST proposals seeking information on the diversity efforts of suppliers and service providers, which can pose a significant cost and administration burden on the company. SEXUAL ORIENTATION AND DOMESTIC PARTNER BENEFITS Generally, vote FOR proposals seeking to amend a company's EEO statement in order to prohibit discrimination based on sexual orientation, unless the change would result in excessive costs for the company. Generally vote AGAINST proposals to extend company benefits to, or eliminate benefits from domestic partners. Benefits decisions should be left to the discretion of the company. CLIMATE CHANGE AND THE ENVIRONMENT CLIMATE CHANGE In general, vote FOR resolutions requesting that a company disclose information on the impact of climate change on the company's operations unless: - The company already provides current, publicly-available information on the perceived impact that climate change may have on the company as well as associated policies and procedures to address such risks and/or opportunities; - The company's level of disclosure is comparable to or better than information provided by industry peers; and - There are no significant fines, penalties, or litigation associated with the company's environmental performance. CONCENTRATED AREA FEEDING OPERATIONS (CAFO) Generally vote FOR resolutions requesting that companies report to shareholders on the risks and liabilities associated with CAFOs unless: - The company has publicly disclosed guidelines for its corporate and contract farming operations, including compliance monitoring; or - The company does not directly source from CAFOs. ENERGY EFFICIENCY Vote CASE-BY-CASE on proposals requesting a company report on its energy efficiency policies, considering: - The current level of disclosure related to energy efficiency policies, initiatives, and performance measures; - The company's level of participation in voluntary energy efficiency programs and initiatives; 2008 US PROXY VOTING GUIDELINES SUMMARY -48- RISKMETRICS Group www.riskmetrics.com - The company's compliance with applicable legislation and/or regulations regarding energy efficiency; and - The company's energy efficiency policies and initiatives relative to industry peers. FACILITY SAFETY (NUCLEAR AND CHEMICAL PLANT SAFETY) Vote CASE-BY-CASE on resolutions requesting that companies report on risks associated with their operations and/or facilities, considering: - The company's compliance with applicable regulations and guidelines; - The level of existing disclosure related to security and safety policies, procedures, and compliance monitoring; and, - The existence of recent, significant violations, fines, or controversy related to the safety and security of the company's operations and/or facilities. GENERAL ENVIRONMENTAL REPORTING Generally vote FOR requests for reports disclosing the company's environmental policies unless it already has well-documented environmental management systems that are available to the public. GREENHOUSE GAS EMISSIONS Generally vote FOR proposals requesting a report on greenhouse gas emissions from company operations and/or products unless this information is already publicly disclosed or such factors are not integral to the company's line of business. Generally vote AGAINST proposals that call for reduction in greenhouse gas emissions by specified amounts or within a restrictive time frame unless the company lags industry standards and has been the subject of recent, significant fines or litigation resulting from greenhouse gas emissions. OPERATIONS IN PROTECTED AREAS Generally vote FOR requests for reports outlining potential environmental damage from operations in protected regions unless: - Operations in the specified regions are not permitted by current laws or regulations; - The company does not currently have operations or plans to develop operations in these protected regions; or, - The company provides disclosure on its operations and environmental policies in these regions comparable to industry peers. RECYCLING Vote CASE-BY-CASE on proposals to adopt a comprehensive recycling strategy, taking into account: - The nature of the company's business and the percentage affected; - The extent that peer companies are recycling; - The timetable prescribed by the proposal; - The costs and methods of implementation; - Whether the company has a poor environmental track record, such as violations of applicable regulations. RENEWABLE ENERGY 2008 US PROXY VOTING GUIDELINES SUMMARY -49- RISKMETRICS Group www.riskmetrics.com In general, vote FOR requests for reports on the feasibility of developing renewable energy sources unless the report is duplicative of existing disclosure or irrelevant to the company's line of business. Generally vote AGAINST proposals requesting that the company invest in renewable energy sources. Such decisions are best left to management's evaluation of the feasibility and financial impact that such programs may have on the company. GENERAL CORPORATE ISSUES CHARITABLE CONTRIBUTIONS Vote AGAINST proposals restricting the company from making charitable contributions. Charitable contributions are generally useful for assisting worthwhile causes and for creating goodwill in the community. In the absence of bad faith, self-dealing, or gross negligence, management should determine which contributions are in the best interests of the company. CSR COMPENSATION-RELATED PROPOSALS Vote CASE-BY-CASE on proposals to review ways of linking executive compensation to social factors, such as corporate downsizings, customer or employee satisfaction, community involvement, human rights, environmental performance, predatory lending, and executive/employee pay disparities. Such resolutions should be evaluated in the context of: - The relevance of the issue to be linked to pay; - The degree that social performance is already included in the company's pay structure and disclosed; - The degree that social performance is used by peer companies in setting pay; - Violations or complaints filed against the company relating to the particular social performance measure; - Artificial limits sought by the proposal, such as freezing or capping executive pay; - Independence of the compensation committee; - Current company pay levels. Generally vote AGAINST proposals calling for an analysis of the pay disparity between corporate executives and other employees as such comparisons may be arbitrary in nature and/or provide information of limited value to shareholders. HIV/AIDS Vote CASE-BY-CASE on requests for reports outlining the impact of the health pandemic (HIV/AIDS, malaria and tuberculosis) on the company's Sub-Saharan operations and how the company is responding to it, taking into account: - The nature and size of the company's operations in Sub-Saharan Africa and the number of local employees; - The company's existing healthcare policies, including benefits and healthcare access for local workers; and - Company donations to healthcare providers operating in the region. 2008 US PROXY VOTING GUIDELINES SUMMARY -50- RISKMETRICS Group www.riskmetrics.com Vote AGAINST proposals asking companies to establish, implement, and report on a standard of response to the HIV/AIDS, TB, and malaria health pandemic in Africa and other developing countries, unless the company has significant operations in these markets and has failed to adopt policies and/or procedures to address these issues comparable to those of industry peers. LOBBYING EXPENDITURES/INITIATIVES Vote CASE-BY-CASE on proposals requesting information on a company's lobbying initiatives, considering any significant controversy or litigation surrounding a company's public policy activities, the current level of disclosure on lobbying strategy, and the impact that the policy issue may have on the company's business operations. POLITICAL CONTRIBUTIONS AND TRADE ASSOCIATIONS SPENDING Generally vote AGAINST proposals asking the company to affirm political nonpartisanship in the workplace so long as: - The company is in compliance with laws governing corporate political activities; and - The company has procedures in place to ensure that employee contributions to company-sponsored political action committees (PACs) are strictly voluntary and not coercive. Vote AGAINST proposals to publish in newspapers and public media the company's political contributions as such publications could present significant cost to the company without providing commensurate value to shareholders. Vote CASE-BY-CASE on proposals to improve the disclosure of a company's political contributions and trade association spending considering: - Recent significant controversy or litigation related to the company's political contributions or governmental affairs; and - The public availability of a company policy on political contributions and trade association spending including information on the types of organizations supported, the business rationale for supporting these organizations, and the oversight and compliance procedures related to such expenditures of corporate assets. Vote AGAINST proposals barring the company from making political contributions. Businesses are affected by legislation at the federal, state, and local level and barring contributions can put the company at a competitive disadvantage. 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. INTERNATIONAL ISSUES, LABOR ISSUES, AND HUMAN RIGHTS CHINA PRINCIPLES Vote AGAINST proposals to implement the China Principles unless: - There are serious controversies surrounding the company's China operations; and 2008 US PROXY VOTING GUIDELINES SUMMARY -51- RISKMETRICS Group www.riskmetrics.com - The company does not have a code of conduct with standards similar to those promulgated by the International Labor Organization (ILO). CODES OF CONDUCT Vote CASE-BY-CASE on proposals to implement certain human rights standards and policies at company facilities. In evaluating these proposals, the following should be considered: - The degree to which existing human rights policies and practices are disclosed; - Whether or not existing policies are consistent with internationally recognized labor standards; - Whether company facilities are monitored and how; - Company participation in fair labor organizations or other internationally recognized human rights initiatives; - The company's primary business model and methods of operation; - Proportion of business conducted in markets known to have higher risk of workplace labor right abuse; - Whether the company has been recently involved in significant labor and human rights controversies or violations; - Peer company standards and practices; and - Union presence in company's international factories. COMMUNITY IMPACT ASSESSMENTS Vote CASE-BY-CASE on requests for reports outlining the potential community impact of company operations in specific regions considering: - Current disclosure of applicable risk assessment report(s) and risk management procedures; - The impact of regulatory non-compliance, litigation, remediation, or reputational loss that may be associated with failure to manage the company's operations in question, including the management of relevant community and stakeholder relations; - The nature, purpose, and scope of the company's operations in the specific region(s); and, - The degree to which company policies and procedures are consistent with industry norms. FOREIGN MILITARY SALES/OFFSETS Vote AGAINST reports on foreign military sales or offsets. Such disclosures may involve sensitive and confidential information. Moreover, companies must comply with government controls and reporting on foreign military sales. INTERNET PRIVACY AND CENSORSHIP Vote CASE-BY-CASE on resolutions requesting the disclosure and implementation of Internet privacy and censorship policies and procedures considering: - The level of disclosure of policies and procedures relating to privacy, freedom of speech, Internet censorship, and government monitoring of the Internet; - Engagement in dialogue with governments and/or relevant groups with respect to the Internet and the free flow of information; - The scope of business involvement and of investment in markets that maintain government censorship or monitoring of the Internet; - The market-specific laws or regulations applicable to Internet censorship or monitoring that may be imposed on the company; and, - The level of controversy or litigation related to the company's international human rights policies and procedures. 2008 US PROXY VOTING GUIDELINES SUMMARY -52- RISKMETRICS Group www.riskmetrics.com MACBRIDE PRINCIPLES Vote CASE-BY-CASE on proposals to endorse or increase activity on the MacBride Principles, taking into account: - Company compliance with or violations of the Fair Employment Act of 1989; - Company antidiscrimination policies that already exceed the legal requirements; - The cost and feasibility of adopting all nine principles; - The cost of duplicating efforts to follow two sets of standards (Fair Employment and the MacBride Principles); - The potential for charges of reverse discrimination; - The potential that any company sales or contracts in the rest of the United Kingdom could be negatively impacted; - The level of the company's investment in Northern Ireland; - The number of company employees in Northern Ireland; - The degree that industry peers have adopted the MacBride Principles; and - Applicable state and municipal laws that limit contracts with companies that have not adopted the MacBride Principles. NUCLEAR AND DEPLETED URANIUM WEAPONS Vote AGAINST proposals asking a company to cease production or report on the risks associated with the use of depleted uranium munitions or nuclear weapons components and delivery systems, including disengaging from current and proposed contracts. Such contracts are monitored by government agencies, serve multiple military and non-military uses, and withdrawal from these contracts could have a negative impact on the company's business. OPERATIONS IN HIGH RISK MARKETS Vote CASE-BY-CASE on requests for review and a report outlining the company's potential financial and reputation risks associated with operations in "high-risk" markets, such as a terrorism-sponsoring state or otherwise, taking into account: - The nature, purpose, and scope of the operations and business involved that could be affected by social or political disruption; - Current disclosure of applicable risk assessment(s) and risk management procedures; - Compliance with U.S. sanctions and laws; - Consideration of other international policies, standards, and laws; and - Whether the company has been recently involved in significant controversies or violations in "high-risk" markets. OUTSOURCING/OFFSHORING Vote CASE-BY-CASE on proposals calling for companies to report on the risks associated with outsourcing, considering: - Risks associated with certain international markets; - The utility of such a report to shareholders; - The existence of a publicly available code of corporate conduct that applies to international operations. VENDOR STANDARDS Generally vote FOR reports outlining vendor standards compliance unless any of the following apply: 2008 US PROXY VOTING GUIDELINES SUMMARY -53- RISKMETRICS Group www.riskmetrics.com - The company does not operate in countries with significant human rights violations; - The company has no recent human rights controversies or violations; or - The company already publicly discloses information on its vendor standards policies and compliance mechanisms. SUSTAINABILITY SUSTAINABILITY REPORTING Generally vote FOR proposals requesting the company to report on policies and initiatives related to social, economic, and environmental sustainability, unless: - The company already discloses similar information through existing reports or policies such as an Environment, Health, and Safety (EHS) report; a comprehensive Code of Corporate Conduct; and/or a Diversity Report; or - The company has formally committed to the implementation of a reporting program based on Global Reporting Initiative (GRI) guidelines or a similar standard within a specified time frame. 2008 US PROXY VOTING GUIDELINES SUMMARY -54- RISKMETRICS Group www.riskmetrics.com 10. Mutual Fund Proxies ELECTION OF DIRECTORS Vote CASE-BY-CASE on the election of directors and trustees, following the same guidelines for uncontested directors for public company shareholder meetings. However, mutual fund boards do not usually have compensation committees, so do not withhold for the lack of this committee. CONVERTING CLOSED-END FUND TO OPEN-END FUND Vote CASE-BY-CASE on conversion proposals, considering the following factors: - Past performance as a closed-end fund; - Market in which the fund invests; - Measures taken by the board to address the discount; and - Past shareholder activism, board activity, and votes on related proposals. PROXY CONTESTS Vote CASE-BY-CASE on proxy contests, considering the following factors: - Past performance relative to its peers; - Market in which fund invests; - Measures taken by the board to address the issues; - Past shareholder activism, board activity, and votes on related proposals; - Strategy of the incumbents versus the dissidents; - Independence of directors; - Experience and skills of director candidates; - Governance profile of the company; - Evidence of management entrenchment. INVESTMENT ADVISORY AGREEMENTS Vote CASE-BY-CASE on investment advisory agreements, considering the following factors: - Proposed and current fee schedules; - Fund category/investment objective; - Performance benchmarks; - Share price performance as compared with peers; - Resulting fees relative to peers; - Assignments (where the advisor undergoes a change of control). APPROVING NEW CLASSES OR SERIES OF SHARES Vote FOR the establishment of new classes or series of shares. PREFERRED STOCK PROPOSALS Vote CASE-BY-CASE on the authorization for or increase in preferred shares, considering the following factors: - Stated specific financing purpose; - Possible dilution for common shares; - Whether the shares can be used for antitakeover purposes. 2008 US PROXY VOTING GUIDELINES SUMMARY -55- RISKMETRICS Group www.riskmetrics.com 1940 ACT POLICIES Vote CASE-BY-CASE on policies under the Investment Advisor Act of 1940, considering the following factors: - Potential competitiveness; - Regulatory developments; - Current and potential returns; and - Current and potential risk. Generally vote FOR these amendments as long as the proposed changes do not fundamentally alter the investment focus of the fund and do comply with the current SEC interpretation. CHANGING A FUNDAMENTAL RESTRICTION TO A NONFUNDAMENTAL RESTRICTION Vote CASE-BY-CASE on proposals to change a fundamental restriction to a non-fundamental restriction, considering the following factors: - The fund's target investments; - The reasons given by the fund for the change; and - The projected impact of the change on the portfolio. CHANGE FUNDAMENTAL INVESTMENT OBJECTIVE TO NONFUNDAMENTAL Vote AGAINST proposals to change a fund's fundamental investment objective to non-fundamental. NAME CHANGE PROPOSALS Vote CASE-BY-CASE on name change proposals, considering the following factors: - Political/economic changes in the target market; - Consolidation in the target market; and - Current asset composition. CHANGE IN FUND'S SUBCLASSIFICATION Vote CASE-BY-CASE on changes in a fund's sub-classification, considering the following factors: - Potential competitiveness; - Current and potential returns; - Risk of concentration; - Consolidation in target industry. DISPOSITION OF ASSETS/TERMINATION/LIQUIDATION Vote CASE-BY-CASE on proposals to dispose of assets, to terminate or liquidate, considering the following factors: - Strategies employed to salvage the company; - The fund's past performance; - The terms of the liquidation. CHANGES TO THE CHARTER DOCUMENT Vote CASE-BY-CASE on changes to the charter document, considering the following factors: - The degree of change implied by the proposal; 2008 US PROXY VOTING GUIDELINES SUMMARY -56- RISKMETRICS Group www.riskmetrics.com - The efficiencies that could result; - The state of incorporation; - Regulatory standards and implications. Vote AGAINST any of the following changes: - Removal of shareholder approval requirement to reorganize or terminate the trust or any of its series; - Removal of shareholder approval requirement for amendments to the new declaration of trust; - Removal of shareholder approval requirement to amend the fund's management contract, allowing the contract to be modified by the investment manager and the trust management, as permitted by the 1940 Act; - Allow the trustees to impose other fees in addition to sales charges on investment in a fund, such as deferred sales charges and redemption fees that may be imposed upon redemption of a fund's shares; - Removal of shareholder approval requirement to engage in and terminate subadvisory arrangements; - Removal of shareholder approval requirement to change the domicile of the fund. CHANGING THE DOMICILE OF A FUND Vote CASE-BY-CASE on re-incorporations, considering the following factors: - Regulations of both states; - Required fundamental policies of both states; - The increased flexibility available. AUTHORIZING THE BOARD TO HIRE AND TERMINATE SUBADVISORS WITHOUT SHAREHOLDER APPROVAL Vote AGAINST proposals authorizing the board to hire/terminate subadvisors without shareholder approval. DISTRIBUTION AGREEMENTS Vote CASE-BY-CASE on distribution agreement proposals, considering the following factors: - Fees charged to comparably sized funds with similar objectives; - The proposed distributor's reputation and past performance; - The competitiveness of the fund in the industry; - The terms of the agreement. MASTER-FEEDER STRUCTURE Vote FOR the establishment of a master-feeder structure. MERGERS Vote CASE-BY-CASE on merger proposals, considering the following factors: - Resulting fee structure; - Performance of both funds; - Continuity of management personnel; - Changes in corporate governance and their impact on shareholder rights. SHAREHOLDER PROPOSALS FOR MUTUAL FUNDS ESTABLISH DIRECTOR OWNERSHIP REQUIREMENT 2008 US PROXY VOTING GUIDELINES SUMMARY -57- RISKMETRICS Group www.riskmetrics.com Generally vote AGAINST shareholder proposals that mandate a specific minimum amount of stock that directors must own in order to qualify as a director or to remain on the board. REIMBURSE SHAREHOLDER FOR EXPENSES INCURRED Vote CASE-BY-CASE on shareholder proposals to reimburse proxy solicitation expenses. When supporting the dissidents, vote FOR the reimbursement of the proxy solicitation expenses. TERMINATE THE INVESTMENT ADVISOR Vote CASE-BY-CASE on proposals to terminate the investment advisor, considering the following factors: - Performance of the fund's Net Asset Value (NAV); - The fund's history of shareholder relations; - The performance of other funds under the advisor's management. 2008 US PROXY VOTING GUIDELINES SUMMARY -58- ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES. (A)(1) IDENTIFICATION OF PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBERS AND DESCRIPTION OF ROLE OF PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBERS Valhalla Capital Partners, LLC ("Valhalla") serves as investment sub-advisor to the Registrant. Ramond P. Mecherle, CFA, and Justin L. Ventura serve as co-portfolio managers of the Registrant. As co-manager, Mr. Mecherle's role is to make investment decisions, analyze securities and the markets, trade the securities of the Registrant and provide support to Valhalla's and First Trust's administrative and compliance staff. Mr. Mecherle may also be asked to support client service and marketing in a limited manner. Mr. Mecherle may make investment decisions on behalf of the Registrant independently or in counsel with Mr. Ventura, the other co-manager of the Registrant. As co-manager of the Registrant, Mr. Ventura's role is to make investment decisions, analyze securities and the markets, trade the securities of the Registrant and provide support to the Valhalla's and First Trust's administrative and compliance staff. Mr. Ventura may also be asked to support client service and marketing in a limited manner. Mr. Ventura may make investment decisions on behalf of the Registrant independently or in counsel with Mr. Mecherle.
BUSINESS EXPERIENCE PAST NAME TITLE LENGTH OF SERVICE 5 YEARS - ---- --------------------------------- ----------------- -------------------------------------------------- Ramond P. Mecherle, CFA Managing Partner and Co-Portfolio 40 mos. 12/2005 - Present: Valhalla Capital Partners - Manager Managing Partner, Portfolio Manager 11/2004 - 12/2005: Hilliard Lyons Asset Management - Director of Fixed Income, Portfolio Manager. 1998 - 11/2004: Morgan Asset Management - Assistant Portfolio Manager. Justin L. Ventura Managing Partner and Co-Portfolio 40 mos. 12/2005 - Present: Valhalla Capital Partners - Manager Managing Partner, Portfolio Manager. 6/2005 - 12/2005: Hilliard Lyons Asset Management - Portfolio Manager. 1999 - 11/2004: State Street Bank - Portfolio Manager.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBER AND POTENTIAL CONFLICTS OF INTEREST OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBER
# of Accounts Managed for Total Assets which for which Total # of Advisory Fee Advisory Fee Name of Portfolio Manager or Accounts Total Assets is Based on is Based on Team Member Type of Accounts* Managed $millions Performance Performance - ------------------------------ -------------------------------- ---------- ------------ ------------- ------------- 1. Ramond P. Mecherle, CFA Registered Investment Companies: 2 $104 million 0 $0 Other Pooled Investment 0 $0 0 $0 Vehicles: Other Accounts: 0 $0 0 $0 2. Justin L. Ventura Registered Investment Companies: 2 $104 million 0 $0 Other Pooled Investment 0 $0 0 $0 Vehicles: Other Accounts: 0 $0 0 $0
* Information provided as of January 31, 2009 POTENTIAL CONFLICTS OF INTERESTS Valhalla's allocation procedures seek to allocate investment opportunities among clients in the fairest possible way taking into account clients' best interests. Valhalla will follow procedures to ensure that allocations do not involve a practice of favoring or discriminating against any client or group of clients. Account performance is never a factor in trade allocations. All Employees are required to be aware of and comply with the following undertaking: notify the CCO promptly if they become aware of any practice that arguably involves Valhalla in a conflict of interest with any of its advisory accounts, including registered investment companies and unregistered investment funds. (A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS The co-portfolio managers of the Registrant are also principals of the Valhalla. The bulk of their compensation comes from their equity ownership interests in Valhalla. The co-portfolio managers also receive an industry competitive salary, bonuses based on Valhalla's profitability and distributions based on the profitability of the sub-adviser. Valhalla uses common industry practices to determine the compensation structure disclosed. Bonuses are not based on either performance of the Registrant or an increase in assets of the Registrant. Bonuses are subjective based on the Managing Partner's discretion. (A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
Name Dollar Range of Fund Shares Beneficially Owned - ------------------ ---------------------------------------------- Ramond P. Mecherle $0 Justin L. Ventura $1-$10,000
* Information provided as of January 31, 2009 (B) Not applicable. ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASERS. Not applicable. ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. There have been no material changes to the procedures by which the shareholders may recommend nominees to the registrant's board of directors, where those changes were implemented after the registrant last provided disclosure in response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR 229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)), or this Item. ITEM 11. CONTROLS AND PROCEDURES. (a) The registrant's principal executive and principal financial officers, or persons performing similar functions, have concluded that the registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended (the "1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within 90 days of the filing date of the report that includes the disclosure required by this paragraph, based on their evaluation of these controls and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or 240.15d-15(b)). (b) There were no changes in the registrant's internal control over financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17 CFR 270.30a-3(d)) that occurred during the registrant's second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. ITEM 12. EXHIBITS. (a)(1) Code of ethics, or any amendment thereto, that is the subject of disclosure required by Item 2 is attached hereto. (a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto. (a)(3) Not applicable. (b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and Section 906 of the Sarbanes- Oxley Act of 2002 are attached hereto. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. (registrant) First Trust Strategic High Income Fund III By (Signature and Title)* /s/ James A. Bowen ----------------------------------------------------- James A. Bowen, Chairman of the Board, President and Chief Executive Officer (principal executive officer) Date March 26, 2009 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By (Signature and Title)* /s/ James A. Bowen ----------------------------------------------------- James A. Bowen, Chairman of the Board, President and Chief Executive Officer (principal executive officer) Date March 26, 2009 By (Signature and Title)* /s/ Mark R. Bradley ----------------------------------------------------- Mark R. Bradley, Treasurer, Controller, Chief Financial Officer and Chief Accounting Officer (principal financial officer) Date March 26, 2009 * Print the name and title of each signing officer under his or her signature. EX-99.CODE ETH 2 codeofethics.txt CODE OF ETHICS SENIOR FINANCIAL OFFICER CODE OF CONDUCT I. INTRODUCTION. This code of conduct is being adopted by the investment companies advised by First Trust Advisors, L.P., set forth in Appendix A, as amended from time to time, (the "Funds"). The reputation and integrity of the Funds are valuable assets that are vital to the Funds' success. Each officer of the Funds, and officers and employees of the investment adviser to the Funds who work on Fund matters, including each of the Funds' senior financial officers ("SFOS"), is responsible for conducting each Fund's business in a manner that demonstrates a commitment to the highest standards of integrity. SFOs include the Principal Executive Officer (who is the President), the Controller (who is the principal accounting officer), and the Treasurer (who is the principal financial officer), and any person who performs a similar function. The Funds, First Trust Advisors, L.P. and First Trust Portfolios have adopted Codes of Ethics under Rule 17j-1 under the Investment Company Act of 1940 (the "RULE 17J-1 CODE"). These Codes of Ethics are designed to prevent certain conflicts of interest that may arise when officers, employees, or directors of the Funds and the foregoing entities know about present or future Fund transactions and/or have the power to influence those transactions, and engage in transactions with respect to those same securities in their personal account(s) or otherwise take advantage of their position and knowledge with respect to those securities. In an effort to prevent these conflicts and in accordance with Rule 17j-1, the Funds adopted their Rule 17j-1 Code to prohibit transactions and conduct that create conflicts of interest, and to establish compliance procedures. The Sarbanes-Oxley Act of 2002 was designed to address corporate malfeasance and to help assure investors that the companies in which they invest are accurately and completely disclosing financial information. Under Section 406 of the Act, all public companies (including the Funds) must either have a code of ethics for their SFOs, or disclose why they do not. The Act was intended to prevent future situations (such as occurred in well-reported situations involving such companies as Enron and WorldCom) where a company creates an environment in which employees are afraid to express their opinions or to question unethical and potentially illegal business practices. The Funds have chosen to adopt a senior financial officer Code of Conduct to encourage their SFOs, and other Fund officers and employees of First Trust Advisors or First Trust Portfolios, to act ethically and to question potentially unethical or illegal practices, and to strive to ensure that the Funds' financial disclosures are complete, accurate, and understandable. II. PURPOSES OF THIS CODE OF CONDUCT. The purposes of this Code are: A. To promote honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; B. To promote full, fair, accurate, timely, and understandable disclosure in reports and documents that the Funds file with, or submits to, the SEC and in other public communications the Funds make; C. To promote compliance with applicable governmental laws, rules and regulations; D. To encourage the prompt internal reporting to an appropriate person of violations of the Code; and E. To establish accountability for adherence to the Code. III. QUESTIONS ABOUT THIS CODE. The Funds' Boards of Trustees have designated Mitchell E. Mohr or other appropriate officer designated by the President of the respective Funds to be the Compliance Coordinator for the implementation and administration of the Code. IV. HANDLING OF FINANCIAL INFORMATION. The Funds have adopted guidelines under which its SFOs perform their duties. However, the Funds expect that ALL officers or employees of the adviser or distributor who participate in the preparation of any part of any Fund's financial statements follow these guidelines with respect to each Fund: A. Act with honesty and integrity and avoid violations of this Code, including actual or apparent conflicts of interest with the Fund in personal and professional relationships. B. Disclose to the Fund's Compliance Coordinator any material transaction or relationship that reasonably could be expected to give rise to any violations of the Code, including actual or apparent conflicts of interest with the Fund. You should disclose these transactions or relationships whether you are involved or have only observed the transaction or relationship. If it is not possible to disclose the matter to the Compliance Coordinator, it should be disclosed to the Fund's Principal Financial Officer or Principal Executive Officer. C. Provide information to the Fund's other officers and appropriate employees of service providers (adviser, administrator, outside auditor, outside counsel, -2- custodian, etc.) that is accurate, complete, objective, relevant, timely, and understandable. D. Endeavor to ensure full, fair, timely, accurate, and understandable disclosure in the Fund's periodic reports. E. Comply with the federal securities laws and other applicable laws and rules, such as the Internal Revenue Code. F. Act in good faith, responsibly, and with due care, competence and diligence, without misrepresenting material facts or allowing your independent judgment to be subordinated. G. Respect the confidentiality of information acquired in the course of your work except when you have Fund approval to disclose it or where disclosure is otherwise legally mandated. You may not use confidential information acquired in the course of your work for personal advantage. H. Share and maintain skills important and relevant to the Fund's needs. I. Proactively promote ethical behavior among peers in your work environment. J. Responsibly use and control all assets and resources employed or entrusted to you. K. Record or participate in the recording of entries in the Fund's books and records that are accurate to the best of your knowledge. V. WAIVERS OF THIS CODE. SFOs and other parties subject to this Code may request a waiver of a provision of this Code (or certain provisions of the Fund's Rule 17j-1 Code) by submitting their request in writing to the Compliance Coordinator for appropriate review. An executive officer of the Fund or the Audit Committee will decide whether to grant a waiver. All waivers of this Code must be disclosed to the Fund's shareholders to the extent required by SEC rules. A good faith interpretation of the provisions of this Code, however, shall not constitute a waiver. VI. ANNUAL CERTIFICATION. Each SFO will be asked to certify on an annual basis that he/she is in full compliance with the Code and any related policy statements. VII. REPORTING SUSPECTED VIOLATIONS. A. SFOs or other officers of the Funds or employees of the First Trust group who work on Fund matters who observe, learn of, or, in good faith, suspect a violation of the -3- Code MUST immediately report the violation to the Compliance Coordinator, another member of the Funds' or First Trust's senior management, or to the Audit Committee of the Fund Board. An example of a possible Code violation is the preparation and filing of financial disclosure that omits material facts, or that is accurate but is written in a way that obscures its meaning. B. Because service providers such as an administrator, outside accounting firm, and custodian provide much of the work relating to the Funds' financial statements, you should be alert for actions by service providers that may be illegal, or that could be viewed as dishonest or unethical conduct. You should report these actions to the Compliance Coordinator even if you know, or think, that the service provider has its own code of ethics for its SFOs or employees. C. SFOs or other officers or employees who report violations or suspected violations in good faith will not be subject to retaliation of any kind. Reported violations will be investigated and addressed promptly and will be treated confidentially to the extent possible. VIII. VIOLATIONS OF THE CODE. A. Dishonest, unethical or illegal conduct will constitute a violation of this Code, regardless of whether this Code specifically refers to that particular conduct. A violation of this Code may result in disciplinary action, up to and including termination of employment. A variety of laws apply to the Funds and their operations, including the Securities Act of 1933, the Investment Company Act of 1940, state laws relating to duties owed by Fund directors and officers, and criminal laws. The federal securities laws generally prohibit the Funds from making material misstatements in its prospectus and other documents filed with the SEC, or from omitting to state a material fact. These material misstatements and omissions include financial statements that are misleading or omit materials facts. B. Examples of criminal violations of the law include stealing, embezzling, misapplying corporate or bank funds, making a payment for an expressed purpose on a Fund's behalf to an individual who intends to use it for a different purpose; or making payments, whether corporate or personal, of cash or other items of value that are intended to influence the judgment or actions of political candidates, government officials or businesses in connection with any of the Funds' activities. The Funds must and will report all suspected criminal violations to the appropriate authorities for possible prosecution, and will investigate, address and report, as appropriate, non-criminal violations. -4- APPENDIX A ENERGY INCOME AND GROWTH FUND FIRST TRUST/FIDUCIARY ASSET MANAGEMENT COVERED CALL FUND FIRST TRUST VALUE LINE(R) 100 FUND FIRST TRUST VALUE LINE(R) DIVIDEND FUND FIRST TRUST/VALUE LINE(R) & IBBOTSON EQUITY ALLOCATION FUND FIRST TRUST/FOUR CORNERS SENIOR FLOATING RATE INCOME FUND FIRST TRUST/FOUR CORNERS SENIOR FLOATING RATE INCOME FUND II MACQUARIE/FIRST TRUST GLOBAL INFRASTRUCTURE/UTILITIES DIVIDEND & INCOME FUND FIRST TRUST ABERDEEN GLOBAL OPPORTUNITY INCOME FUND FIRST TRUST/FIDAC MORTGAGE INCOME FUND FIRST TRUST STRATEGIC HIGH INCOME FUND EX-99.CERT 3 cert302.txt EXHIBIT 302 CERTIFICATION PURSUANT TO RULE 30A-2(a) UNDER THE 1940 ACT AND SECTION 302 OF THE SARBANES-OXLEY ACT I, James A. Bowen, certify that: 1. I have reviewed this report on Form N-CSR of First Trust Strategic High Income Fund III; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3(d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 26, 2009 /s/ James A. Bowen ------------------------------------- James A. Bowen, Chairman of the Board, President and Chief Executive Officer (principal executive officer) CERTIFICATION PURSUANT TO RULE 30A-2(a) UNDER THE 1940 ACT AND SECTION 302 OF THE SARBANES-OXLEY ACT I, Mark R. Bradley, certify that: 1. I have reviewed this report on Form N-CSR of First Trust Strategic High Income Fund III; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) and internal control over financial reporting (as defined in Rule 30a-3 (d) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: March 26, 2009 /s/ Mark R. Bradley ------------------------------------- Mark R. Bradley, Treasurer, Controller, Chief Financial Officer and Chief Accounting Officer (principal financial officer) EX-99.906CERT 4 cert906.txt EXHIBIT 906 CERTIFICATION PURSUANT TO RULE 30A-2(b) UNDER THE 1940 ACT AND SECTION 906 OF THE SARBANES-OXLEY ACT I, James A. Bowen, Chairman of the Board, President and Chief Executive Officer of First Trust Strategic High Income Fund III (the "Registrant"), certify that: 1. The Form N-CSR of the Registrant (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: March 26, 2009 /s/ James A. Bowen ------------------------------------- James A. Bowen, Chairman of the Board, President and Chief Executive Officer (principal executive officer) I, Mark R. Bradley, Treasurer, Controller, Chief Financial Officer and Chief Accounting Officer of First Trust Strategic High Income Fund III (the "Registrant"), certify that: 1. The Form N-CSR of the Registrant (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: March 26, 2009 /s/ Mark R. Bradley ------------------------------------- Mark R. Bradley, Treasurer, Controller, Chief Financial Officer and Chief Accounting Officer (principal financial officer) -----END PRIVACY-ENHANCED MESSAGE-----