0001445546-15-002068.txt : 20150422
0001445546-15-002068.hdr.sgml : 20150422
20150422161709
ACCESSION NUMBER: 0001445546-15-002068
CONFORMED SUBMISSION TYPE: 485BPOS
PUBLIC DOCUMENT COUNT: 3
FILED AS OF DATE: 20150422
DATE AS OF CHANGE: 20150422
EFFECTIVENESS DATE: 20150501
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: FIRST TRUST EXCHANGE-TRADED FUND VII
CENTRAL INDEX KEY: 0001561785
IRS NUMBER: 000000000
STATE OF INCORPORATION: MA
FILING VALUES:
FORM TYPE: 485BPOS
SEC ACT: 1933 Act
SEC FILE NUMBER: 333-184918
FILM NUMBER: 15785878
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
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: FIRST TRUST EXCHANGE-TRADED FUND VII
CENTRAL INDEX KEY: 0001561785
IRS NUMBER: 000000000
STATE OF INCORPORATION: MA
FILING VALUES:
FORM TYPE: 485BPOS
SEC ACT: 1940 Act
SEC FILE NUMBER: 811-22767
FILM NUMBER: 15785879
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
0001561785
S000039654
First Trust Global Tactical Commodity Strategy Fund
C000122820
First Trust Global Tactical Commodity Strategy Fund
FTGC
485BPOS
1
etf7_485b.txt
POST-EFFECTIVE AMENDMENT
As filed with the Securities and Exchange Commission on April 22, 2015
================================================================================
1933 Act Registration No. 333-184918
1940 Act Registration No. 811-22767
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [ ]
Pre-Effective Amendment No. __ [ ]
Post-Effective Amendment No. 4 [X]
and
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 [ ]
Amendment No. 6 [X]
FIRST TRUST EXCHANGE-TRADED FUND VII
(Exact Name of Registrant as Specified in Charter)
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(Address of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (800) 621-1675
W. Scott Jardine, Esq., Secretary
First Trust Exchange-Traded Fund VII
First Trust Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(Name and Address of Agent for Service)
Copy to:
Eric F. Fess, Esq.
Chapman and Cutler LLP
111 West Monroe Street
Chicago, Illinois 60603
It is proposed that this filing will become effective (check appropriate box):
[ ] immediately upon filing pursuant to paragraph (b)
[X] on May 1, 2015 pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] on (date) pursuant to paragraph (a)(1)
[ ] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
[ ] this post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
CONTENTS OF POST-EFFECTIVE AMENDMENT NO. 4
This Registration Statement comprises the following papers and contents:
The Facing Sheet
Part A - Prospectus for the First Trust Global Tactical Commodity Strategy
Fund
Part B - Statement of Additional Information for the First Trust Global
Tactical Commodity Strategy Fund
Part C - Other Information
Signatures
Index to Exhibits
Exhibits
First Trust
FIRST TRUST Exchange-Traded Fund VII
--------------------------------------------------------------------------------
First Trust Global Tactical Commodity Strategy Fund
Ticker Symbol: FTGC
Exchange: NASDAQ(R)
First Trust Global Tactical Commodity Strategy Fund (the "Fund") is a series of
First Trust Exchange-Traded Fund VII (the "Trust") and an exchange-traded fund
organized as a separate series of a registered management investment company.
The Fund lists and principally trades its shares on The NASDAQ Stock Market(R)
("NASDAQ(R)"). Market prices may differ to some degree from the net asset value
of the shares. Unlike mutual funds, the Fund issues and redeems shares at net
asset value, only in large specified blocks each consisting of 50,000 shares
(each such block of shares called a "Creation Unit," and collectively, the
"Creation Units"). The Fund's Creation Units are issued and redeemed for
securities in which the Fund invests and/or cash, and only to and from
broker-dealers and large institutional investors that have entered into
participation agreements.
The Fund is an actively managed exchange-traded fund and except when aggregated
in Creation Units, the shares are not redeemable securities of the Fund.
The Securities and Exchange Commission and the Commodity Futures Trading
Commission have not approved or disapproved of these securities or passed upon
the adequacy or accuracy of this prospectus. Any representation to the contrary
is a criminal offense.
NOT FDIC INSURED MAY LOSE VALUE NO BANK GUARANTEE
---------------------
May 1, 2015
---------------------
TABLE OF CONTENTS
Summary Information............................................................1
Additional Information on the Fund's Investment Objective and Strategies.......8
Fund Investments...............................................................8
Additional Risks of Investing in the Fund......................................9
Fund Organization.............................................................14
Management of the Fund........................................................14
How to Buy and Sell Shares....................................................16
Dividends, Distributions and Taxes............................................17
Federal Tax Matters...........................................................17
Distribution Plan.............................................................21
Net Asset Value...............................................................21
Fund Service Providers........................................................22
Premium/Discount Information..................................................22
Total Return Information......................................................23
Financial Highlights..........................................................24
Other Information.............................................................25
--------------------------------------------------------------------------------
SUMMARY INFORMATION
--------------------------------------------------------------------------------
INVESTMENT OBJECTIVE
The Fund seeks to provide total return by providing investors with commodity
exposure while seeking a relatively stable risk profile.
FEES AND EXPENSES OF THE FUND
The following table describes the fees and expenses you may pay if you buy and
hold shares of the Fund. Investors purchasing and selling shares may be subject
to costs (including customary brokerage commissions) charged by their broker,
which are not reflected in the table below.
SHAREHOLDER FEES (fees paid directly from your investment)
Maximum Sales Charge (Load) Imposed on Purchases (as a percentage of offering price) None
ANNUAL FUND OPERATING EXPENSES (expenses that you pay each year as a percentage of the
value of your investment)
Management Fees 0.95%
Distribution and Service (12b-1) Fees (1) 0.00%
Total Other Expenses
Other Expenses of the Fund 0.00%
Expenses of the Subsidiary 0.00%
-----------
Total Annual Fund Operating Expenses 0.95%
EXAMPLE
The example below is intended to help you compare the cost of investing in
the Fund with the cost of investing in other funds. This example does not
take into account customary brokerage commissions that you pay when
purchasing or selling shares of the Fund in the secondary market.
The example assumes that you invest $10,000 in the Fund for the time periods
indicated. The example also assumes that your investment has a 5% return each
year and that the Fund's operating expenses remain at current levels until
April 30, 2016, and thereafter at 1.20% to represent the imposition of the
12b-1 fee of 0.25% per annum of the Fund's average daily net assets. Although
your actual costs may be higher or lower, based on these assumptions your
costs would be:
1 Year 3 Years 5 Years 10 Years
$97 $356 $636 $1,432
---------------
(1) Although the Fund has adopted a 12b-1 plan that permits it to pay up to
0.25% per annum, it will not pay 12b-1 fees at any time before April 30,
2016.
PORTFOLIO TURNOVER
The Fund pays transaction costs, such as commissions, when it buys and sells
securities, or through the Subsidiary, as defined below, when it buys and
sells Commodities Instruments, as defined below (or "turns over" its
portfolio). A higher portfolio turnover rate may indicate higher transaction
costs and may result in higher taxes when Fund shares are held in a taxable
account. These costs, which are not reflected in annual fund operating
expenses or in the example, affect the Fund's performance. During the fiscal
year ended December 31, 2014, the Fund's portfolio turnover rate was 0% of
the average value of its portfolio.
PRINCIPAL INVESTMENT STRATEGIES
The Fund is an actively managed exchange-traded fund that seeks to achieve
attractive risk adjusted return by investing in commodity futures contracts and
exchange-traded commodity linked instruments (collectively, "Commodities
Instruments") through a wholly-owned subsidiary of the Fund organized under the
laws of the Cayman Islands (the "Subsidiary"). The Fund will not invest directly
in Commodities Instruments. The Fund expects to gain exposure to these
investments exclusively by investing in the Subsidiary. The Subsidiary is
advised by First Trust Advisors L.P., the Fund's investment advisor.
The Fund's investment in the Subsidiary is intended to provide the Fund with
exposure to commodity markets within the limits of current federal income tax
laws applicable to investment companies such as the Fund, which limit the
ability of investment companies to invest directly in Commodities Instruments.
The Subsidiary has the same investment objective as the Fund, but unlike the
1
Fund, it may invest without limitation in Commodities Instruments. Except as
otherwise noted, for purposes of this prospectus, references to the Fund's
investments include the Fund's indirect investments through the Subsidiary. The
Fund will invest up to 25% of its total assets in the Subsidiary.
The Subsidiary seeks to make investments generally in Commodities Instruments
while managing volatility. Investment weightings of the underlying Commodities
Instruments held by the Subsidiary are rebalanced in an attempt to stabilize
risk levels. The dynamic weighting process is designed to result in a
disciplined, systematic investment process, which is keyed off of the Fund's
investment advisor's volatility forecasting process.
The Subsidiary's holdings in Commodities Instruments will consist, in part, of
futures contracts, which are contractual agreements to buy or sell a particular
commodity or financial instrument at a pre-determined price in the future. The
Subsidiary may also invest in commodity-linked instruments, which include: (1)
exchange-traded funds that provide exposure to commodities; and (2) pooled
investment vehicles that invest primarily in commodities and commodity-related
instruments. The Subsidiary may have both long and short positions in
Commodities Instruments. However, for a given Commodity Instrument the
Subsidiary will provide a net long exposure. Net long exposure means to hold or
be exposed to a security or instrument with the expectation that its value will
increase over time. As U.S. and London exchanges list additional contracts, as
currently listed contracts on those exchanges gain sufficient liquidity or as
other exchanges list sufficiently liquid contracts, the Fund's investment
advisor will include those contracts in the list of possible investments of the
Subsidiary. The list of Commodities Instruments and commodities markets
considered for investment can and will change over time.
The remainder of the Fund's assets will primarily be invested in: (1) short-term
investment grade fixed income securities that include U.S. government and agency
securities, sovereign debt obligations of non-U.S. countries and repurchase
agreements; (2) money market instruments; (3) exchange-traded funds and other
investment companies registered under the Investment Company Act of 1940, as
amended (the "1940 Act"); and (4) cash and other cash equivalents. The Fund uses
such instruments as investments and to collateralize the Subsidiary's
Commodities Instruments exposure on a day-to-day basis. The Fund may also invest
directly in exchange-traded funds and other investment companies, including
closed-end funds, that provide exposure to Commodities Instruments, equity
securities and fixed income securities to the extent permitted under the 1940
Act.
The Fund may enter into repurchase agreements with counterparties that are
deemed to present acceptable credit risks. A repurchase agreement is a
transaction in which the Fund purchases securities or other obligations from a
bank or securities dealer and simultaneously commits to resell them to a
counterparty at an agreed-upon date or upon demand and at a price reflecting a
market rate of interest unrelated to the coupon rate or maturity of the
purchased obligations.
PRINCIPAL RISKS
You could lose money by investing in the Fund. An investment in the Fund is not
a deposit of a bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other governmental agency. There can be no
assurance that the Fund's investment objective will be achieved. The risks of
the Fund will result from both the Fund's direct investments and its indirect
investments made through the Subsidiary. Accordingly, the risks that result from
the Subsidiary's activities will be described herein as the Fund's risks.
CASH TRANSACTIONS RISK. The Fund will, under most circumstances, effect a
portion of creations and redemptions for cash, rather than in-kind securities.
As a result, an investment in the Fund may be less tax-efficient than an
investment in an exchange-traded fund that effects its creations and redemption
for in-kind securities. Because the Fund may effect a portion of redemptions for
cash, it may be required to sell portfolio securities in order to obtain the
cash needed to distribute redemption proceeds. A sale of shares may result in
capital gains or losses and may also result in higher brokerage costs.
CLEARING BROKER RISK. The failure or bankruptcy of the Fund's and the
Subsidiary's clearing broker could result in a substantial loss of Fund assets.
Under current Commodity Futures Trading Commission ("CFTC") regulations, a
clearing broker maintains customers' assets in a bulk segregated account. If a
clearing broker fails to do so, or is unable to satisfy a substantial deficit in
a customer account, its other customers may be subject to risk of loss of their
funds in the event of that clearing broker's bankruptcy. In that event, the
clearing broker's customers, such as the Fund and the Subsidiary, are entitled
to recover, even in respect of property specifically traceable to them, only a
proportional share of all property available for distribution to all of that
clearing broker's customers.
COMMODITY RISK. The value of Commodities Instruments typically is based upon the
price movements of a physical commodity or an economic variable linked to such
price movements. The prices of Commodities Instruments may fluctuate quickly and
dramatically and may not correlate to price movements in other asset classes. An
2
active trading market may not exist for certain commodities. Each of these
factors and events could have a significant negative impact on the Fund.
COUNTERPARTY RISK. The Fund bears the risk that the counterparty to a commodity,
derivative or other contract with a third party may default on its obligations
or otherwise fail to honor its obligations. If a counterparty defaults on its
payment obligations, the Fund will lose money and the value of an investment in
Fund shares may decrease. In addition, the Fund may engage in such investment
transactions with a limited number of counterparties.
CREDIT RISK. Credit risk is the risk that an issuer of a security will be unable
or unwilling to make dividend, interest and/or principal payments when due and
the related risk that the value of a security may decline because of concerns
about the issuer's ability to make such payments.
CURRENCY RISK. The Fund may hold investments that are denominated in non-U.S.
currencies, or in securities that provide exposure to such currencies, currency
exchange rates or interest rates denominated in such currencies. Changes in
currency exchange rates and the relative value of non-U.S. currencies will
affect the value of the Fund's investment and the value of Fund shares. Currency
exchange rates can be very volatile and can change quickly and unpredictably. As
a result, the value of an investment in the Fund may change quickly and without
warning and you may lose money.
EXCHANGE-TRADED FUND RISK. An exchange-traded fund trades like common stock and
represents a portfolio of securities. The risks of owning an exchange-traded
fund generally reflect the risks of owning the underlying securities, although
lack of liquidity in an exchange-traded fund could result in it being more
volatile and exchange-traded funds have management fees that increase their
costs.
FOREIGN COMMODITY MARKETS RISK. The Fund, through the Subsidiary, engages in
trading on commodity markets outside the United States on behalf of the Fund.
Trading on such markets is not regulated by any United States government agency
and may involve certain risks not applicable to trading on United States
exchanges. The Fund may not have the same access to certain trades as do various
other participants in foreign markets. Furthermore, as the Fund determines its
net assets in United States dollars, with respect to trading in foreign markets
the Fund is subject to the risk of fluctuations in the exchange rate between the
local currency and dollars as well as the possibility of exchange controls.
Certain futures contracts traded on foreign exchanges are treated differently
for federal income tax purposes than are domestic contracts.
FREQUENT TRADING RISK. The Fund regularly purchases and subsequently sells,
i.e., "rolls," individual commodity futures contracts throughout the year so as
to maintain a fully invested position. As the commodity contracts near their
expiration dates, the Fund rolls them into new contracts. This frequent trading
of contracts may increase the amount of commissions or mark-ups to
broker-dealers that the Fund pays when it buys and sells contracts, which may
detract from the Fund's performance.
FUTURES RISK. The Fund invests in futures through the Subsidiary. All futures
and futures-related products are highly volatile. Price movements are influenced
by, among other things, changing supply and demand relationships; climate;
government agricultural, trade, fiscal, monetary and exchange control programs
and policies; national and international political and economic events; crop
diseases; the purchasing and marketing programs of different nations; and
changes in interest rates. In addition, governments from time to time intervene,
directly and by regulation, in certain markets, particularly those in
currencies.
GAP RISK. The Fund is subject to the risk that a commodity price will change
from one level to another with no trading in between. Usually such movements
occur when there are adverse news announcements, which can cause a commodity
price to drop substantially from the previous day's closing price.
INCOME RISK. Income from the Fund's fixed income investments could decline
during periods of falling interest rates.
INTEREST RATE RISK. Interest rate risk is the risk that the value of the
securities in the Fund will decline because of rising market interest rates. The
Fund may be subject to a greater risk of rising interest rates than would
normally be the case due to the recent period of historically low rates and the
effect of potential government fiscal policy initiatives and resulting market
reaction to those initiatives. Interest rate risk is generally lower for
shorter-term investments and higher for longer-term investments.
INVESTMENT COMPANIES RISK. The Fund may invest in securities of other investment
companies, including exchange-traded funds. As a shareholder in other investment
companies, the Fund will bear its ratable share of that investment company's
expenses, and would remain subject to payment of the Fund's advisory and
administrative fees with respect to assets so invested. Shareholders would
therefore be subject to duplicative expenses to the extent the Fund invests in
3
other investment companies. In addition, the Fund will incur brokerage costs
when purchasing and selling shares of exchange-traded funds or other
exchange-traded investment companies.
LIQUIDITY RISK. The Fund invests in Commodities Instruments, which may be less
liquid than other types of investments. The illiquidity of Commodities
Instruments could have a negative effect on the Fund's ability to achieve its
investment objective and may result in losses to Fund shareholders.
MANAGEMENT RISK. The Fund is subject to management risk because it is an
actively managed portfolio. The Fund's investment advisor will apply investment
techniques and risk analyses in making investment decisions for the Fund, but
there can be no guarantee that the Fund will meet its investment objective.
MARKET RISK. The trading prices of commodities futures, fixed income securities
and other instruments fluctuate in response to a variety of factors. The Fund's
net asset value and market price may fluctuate significantly in response to
these factors. As a result, an investor could lose money over short or long
periods of time.
NON-DIVERSIFICATION RISK. The Fund is classified as "non-diversified" under the
1940 Act. As a result, the Fund is only limited as to the percentage of its
assets that may be invested in the securities of any one issuer by the
diversification requirements imposed by the Internal Revenue Code of 1986, as
amended. The Fund may invest a relatively high percentage of its assets in a
limited number of issuers. As a result, the Fund may be more susceptible to a
single adverse economic or regulatory occurrence affecting one or more of these
issuers, experience increased volatility and be highly invested in certain
issuers.
NON-U.S. INVESTMENT RISK. The Fund may invest in commodity futures contracts
traded on non-U.S. exchanges or enter into over-the-counter derivative contracts
with non-U.S. counterparties. Transactions on non-U.S. exchanges or with
non-U.S. counterparties present risks because they may not be subject to the
same degree of regulation as their U.S. counterparts.
PORTFOLIO TURNOVER RISK. The Fund's strategy may frequently involve buying and
selling portfolio securities by the Subsidiary to rebalance the Fund's exposure
to various market sectors. The Subsidiary's higher portfolio turnover may result
in the Fund paying higher levels of transaction costs and generating greater tax
liabilities for shareholders. Portfolio turnover risk may cause the Fund's
performance to be less than you expect.
REGULATORY RISK. The Fund's investment decisions may need to be modified, and
commodity contract positions held by the Fund may have to be liquidated at
disadvantageous times or prices, to avoid exceeding any applicable position
limits established by the CFTC, potentially subjecting the Fund to substantial
losses. The regulation of commodity transactions in the United States is a
rapidly changing area of law and is subject to ongoing modification by
government, self-regulatory and judicial action. The effect of any future
regulatory change with respect to any aspect of the Fund is impossible to
predict, but could be substantial and adverse to the Fund.
REPURCHASE AGREEMENT RISK. The Fund's investment in repurchase agreements may be
subject to market and credit risk with respect to the collateral securing the
repurchase agreements. Investments in repurchase agreements also may be subject
to the risk that the market value of the underlying obligations may decline
prior to the expiration of the repurchase agreement term.
SHORT SALES RISK. The Fund may engage in "short sale" transactions. The Fund
will lose value if the security or instrument that is the subject of a short
sale increases in value. The Fund also may enter into a short derivative
position through a futures contract. If the price of the security or derivative
that is the subject of a short sale increases, then the Fund will incur a loss
equal to the increase in price from the time that the short sale was entered
into plus any premiums and interest paid to a third party in connection with the
short sale. Therefore, short sales involve the risk that losses may be
exaggerated, potentially losing more money than the actual cost of the
investment. Also, there is the risk that the third party to the short sale may
fail to honor its contract terms, causing a loss to the Fund.
SUBSIDIARY INVESTMENT RISK. Changes in the laws of the United States and/or the
Cayman Islands, under which the Fund and the Subsidiary are organized,
respectively, could result in the inability of the Fund to operate as intended
and could negatively affect the Fund and its shareholders. The Subsidiary is not
registered under the 1940 Act and is not subject to all the investor protections
of the 1940 Act. Thus, the Fund, as an investor in the Subsidiary, will not have
all the protections offered to investors in registered investment companies.
TAX RISK. The Fund intends to treat any income it may derive from Commodities
Instruments (other than derivatives described in Revenue Rulings 2006-1 and
2006-31) received by the Subsidiary as "qualifying income" under the provisions
of the Internal Revenue Code of 1986, as amended, applicable to "regulated
investment companies" ("RICs"), based on a tax opinion received from special
counsel which was based, in part, on numerous private letter rulings ("PLRs")
4
provided to third parties not associated with the Fund or its affiliates (which
only those parties may rely on as precedent). Shareholders and potential
investors should be aware, however, that, in July 2011, the Internal Revenue
Service suspended the issuance of such PLRs pending its re-examination of the
policies underlying them, which was still ongoing at the date of this
prospectus. If, at the end of that re-examination, the Internal Revenue Service
changes its position with respect to the conclusions reached in those PLRs, then
the Fund may be required to restructure its investments to satisfy the
qualifying income requirement or might cease to qualify as a RIC.
If the Fund did not qualify as a RIC for any taxable year and certain relief
provisions were not available, the Fund's taxable income would be subject to tax
at the Fund level and to a further tax at the shareholder level when such income
is distributed. In such event, in order to re-qualify for taxation as a RIC, the
Fund might be required to recognize unrealized gains, pay substantial taxes and
interest and make certain distributions. This would cause investors to incur
higher tax liabilities than they otherwise would have incurred and would have a
negative impact on Fund returns. In such event, the Fund's Board of Trustees may
determine to reorganize or close the Fund or materially change the Fund's
investment objective and strategies. In the event that the Fund fails to qualify
as a RIC, the Fund will promptly notify shareholders of the implications of that
failure.
The Fund may invest a portion of its assets in equity repurchase agreements.
Recent changes in the law have the potential of changing the character and
source of such instruments potentially subjecting them to unexpected U.S.
taxation. Depending upon the terms of the contracts, the Fund may be required to
indemnify the counterparty for such increased tax.
U.S. GOVERNMENT AND AGENCY SECURITIES RISK. The Fund may invest in U.S.
government obligations. U.S. government obligations include U.S. Treasury
obligations and securities issued or guaranteed by various agencies of the U.S.
government or by various instrumentalities which have been established or
sponsored by the U.S. government. U.S. Treasury obligations are backed by the
"full faith and credit" of the U.S. government. Securities issued or guaranteed
by federal agencies and U.S. government sponsored instrumentalities may or may
not be backed by the full faith and credit of the U.S. government.
VOLATILITY RISK. Frequent or significant short-term price movements could
adversely impact the performance of the Fund. In addition, the net asset value
of the Fund over short-term periods may be more volatile than other investment
options because of the Fund's significant use of financial instruments that have
a leveraging effect. For example, because of the low margin deposits required,
futures trading involves an extremely high degree of leverage and as a result, a
relatively small price movement in a Commodities Instrument may result in
immediate and substantial losses to the Fund.
WHIPSAW MARKETS RISK. The Fund may be subject to the forces of "whipsaw" markets
(as opposed to choppy or stable markets), in which significant price movements
develop but then repeatedly reverse. Such market conditions could cause
substantial losses to the Fund.
ANNUAL TOTAL RETURN
The bar chart and table below illustrate the annual calendar year return of the
Fund based on net asset value for the past year, as well as the average annual
Fund return for the one year and since inception periods ended December 31,
2014. The bar chart and table provide an indication of the risks of investing in
the Fund by showing changes in the Fund's performance from year-to-year and by
showing how the Fund's average annual total returns based on net asset value
compare to those of a benchmark index, a specialized securities market index and
a broad-based securities market index. See "Total Return Information" for
additional performance information regarding the Fund. The Fund's performance
information is accessible on the Fund's website at www.ftportfolios.com.
Returns before taxes do not reflect the effects of any income or capital gains
taxes. All after-tax returns are calculated using the historical highest
individual federal marginal income tax rates and do not reflect the impact of
any state or local tax. Returns after taxes on distributions reflect the taxed
return on the payment of dividends and capital gains. Returns after taxes on
distributions and sale of shares assume you sold your shares at period end, and,
therefore, are also adjusted for any capital gains or losses incurred. Returns
for the market indices do not include expenses, which are deducted from Fund
returns, or taxes.
Your own actual after-tax returns will depend on your specific tax situation and
may differ from what is shown here. After-tax returns are not relevant to
investors who hold Fund shares in tax-deferred accounts such as individual
retirement accounts (IRAs) or employee-sponsored retirement plans.
5
FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND -- TOTAL RETURN
CALENDAR YEAR TOTAL RETURNS AS OF 12/31
Performance Year Total Return
---------------- ------------
2014 -11.89%
During the year ended December 31, 2014, the Fund's highest and lowest calendar
quarter returns were 14.44% and -13.20%, respectively, for the quarters ended
March 31, 2014 and September 30, 2014. The Fund's past performance (before and
after taxes) is not necessarily an indication of how the Fund will perform in
the future.
AVERAGE ANNUAL TOTAL RETURNS FOR THE PERIODS ENDED DECEMBER 31, 2014
1 Year Since Inception
(10/22/2013)
Return Before Taxes -11.89% -10.60%
Return After Taxes on Distributions -11.89% -10.60%
Return After Taxes on Distributions and Sale of Shares -6.73% -8.06%
Bloomberg Commodity Index(1)
(reflects no deduction for fees, expenses or taxes) -17.01% -15.80%
S&P GSCI(R) Total Return Index
(reflects no deduction for fees, expenses or taxes) -33.06% -28.89%
S&P 500(R) Index
(reflects no deduction for fees, expenses or taxes) 13.69% 16.76%
(1) The Bloomberg Commodity Index is the Fund's benchmark. The benchmark's
name changed from Dow Jones-UBS Commodity Index to Bloomberg Commodity
Index as of July 1, 2014.
MANAGEMENT
INVESTMENT ADVISOR
First Trust Advisors L.P. ("First Trust" or the "Advisor")
PORTFOLIO MANAGERS
The Fund's portfolio is managed by a team (the "Investment Committee")
consisting of:
o John Gambla, CFA, FRM, PRM, Senior Portfolio Manager, Alternatives
Investment Team of First Trust;
o Rob A. Guttschow, CFA, Senior Portfolio Manager, Alternatives
Investment Team of First Trust;
o Daniel J. Lindquist, Chairman of the Investment Committee and Managing
Director of First Trust;
o Jon C. Erickson, Senior Vice President of First Trust;
o David G. McGarel, Chief Investment Officer and Managing Director of
First Trust; and
o Roger F. Testin, Senior Vice President of First Trust.
The Investment Committee members are jointly responsible for the day-to-day
management of the Fund. Each Investment Committee member has served as a part
of the portfolio management team of the Fund since 2013.
6
PURCHASE AND SALE OF FUND SHARES
The Fund issues and redeems shares on a continuous basis, at net asset value,
only in Creation Units consisting of 50,000 shares. The Fund's Creation Units
are issued and redeemed for securities in which the Fund invests and/or cash and
only to and from broker-dealers and large institutional investors that have
entered into participation agreements. Individual shares of the Fund may only be
purchased and sold on NASDAQ(R) through a broker-dealer. Shares of the Fund
trade on NASDAQ(R) at market prices rather than net asset value, which may cause
the shares to trade at a price greater than net asset value (premium) or less
than net asset value (discount).
TAX INFORMATION
The Fund's distributions are taxable and will generally be taxed as ordinary
income or capital gains. Distributions on shares held in a tax-deferred account,
while not immediately taxable, will be subject to tax when the shares are no
longer held in a tax-deferred account.
PAYMENTS TO BROKER-DEALERS AND OTHER FINANCIAL INTERMEDIARIES
If you purchase shares of the Fund through a broker-dealer or other financial
intermediary (such as a bank), First Trust and First Trust Portfolios L.P., the
Fund's distributor, may pay the intermediary for the sale of Fund shares and
related services. These payments may create a conflict of interest by
influencing the broker-dealer or other intermediary and your salesperson to
recommend the Fund over another investment. Ask your salesperson or visit your
financial intermediary's website for more information.
7
ADDITIONAL INFORMATION ON THE FUND'S INVESTMENT OBJECTIVE AND STRATEGIES
The Fund's investment objective is a fundamental policy that may only
be changed with shareholder approval. Unless an investment policy is identified
as being fundamental, all investment policies included in the prospectus and the
Fund's Statement of Additional Information ("SAI") are non-fundamental and may
be changed by the Board of Trustees (the "Board") of the First Trust
Exchange-Traded Fund VII (the "Trust"), of which the Fund is a series, without
shareholder approval. If there is a material change to the Fund's principal
investment strategies, you should consider whether the Fund remains an
appropriate investment for you. There is no guarantee that the Fund will achieve
its investment objective.
Unlike the Fund, the Subsidiary is not an investment company registered under
the 1940 Act, and therefore may invest in Commodities Instruments to a greater
extent than the Fund.
FUND INVESTMENTS
COMMODITIES INSTRUMENTS
The Fund, through the Subsidiary, invests in a combination of exchange-listed
commodity futures contracts and commodity-linked instruments. A futures contract
is a financial instrument in which a party agrees to pay a fixed price for
securities or commodities at a specified future date. Futures contracts are
traded at market prices on exchanges pursuant to terms common to all market
participants. The Subsidiary may invest in futures contracts set forth in the
following table. These investments are subject to change.
COMMODITY
Cattle, Live / Choice Average
Cocoa
Cotton / 1-1/16"
Feeder Cattle
Coffee 'C' / Colombian
Soybeans / No. 2 Yellow
Soybean Meal / 48% Protein
Soybean Oil / Crude
Corn / No. 2 Yellow
Wheat / No. 2 Hard Winter
Wheat / No. 2 Soft Red
Sugar #11 / World Raw
Hogs, Lean / Average Iowa/S Minn
Crude Oil, WTI / Global Spot
Crude Oil, Brent / Global Spot
NY Harbor ULSD (Heating Oil)
Gas-Oil-Petroleum
Natural Gas, Henry Hub
Gasoline, Blendstock (RBOB)
Gold
Silver
Platinum
Copper High Grade / Scrap No. 2 Wire
Aluminum, LME Primary 3 Month Rolling Forward
Lead, LME Primary 3 Month Rolling Forward
Nickel, LME Primary 3 Month Rolling Forward
Tin, LME Primary 3 Month Rolling Forward
Zinc, LME Primary 3 Month Rolling Forward
Commodity-linked instruments include: (1) exchange-traded funds that provide
exposure to commodities; and (2) pooled investment vehicles that invest
primarily in commodities and commodity-related instruments.
GOVERNMENT SECURITIES
The Fund may invest in short-term U.S. government securities. U.S. government
securities include U.S. Treasury obligations and securities issued or guaranteed
by various agencies of the U.S. government, or by various instrumentalities
which have been established or sponsored by the U.S. government. U.S. Treasury
obligations are backed by the "full faith and credit" of the U.S. government.
Securities issued or guaranteed by federal agencies and U.S. government
8
sponsored instrumentalities may or may not be backed by the full faith and
credit of the U.S. government. In addition, the Fund may invest in sovereign
debt obligations of non-U.S. countries.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
Normally, the Fund invests substantially all of its assets to meet its
investment objective. The Fund may invest the remainder of its assets in
securities with maturities of less than one year or cash equivalents, or it may
hold cash, in order to collateralize its (or the Subsidiary's) investments or
for temporary defensive purposes. In addition, the Fund may invest in repurchase
agreements. A repurchase agreement is a transaction where a party purchases
securities and simultaneously commits to resell them at an agreed-upon date at a
price reflecting a market rate of interest unrelated to the coupon rate or
maturity of the securities. The percentage of the Fund invested in such holdings
varies and depends on several factors, including market conditions. For
temporary defensive purposes and during periods of high cash inflows or
outflows, the Fund may depart from its principal investment strategies and
invest part or all of its assets in these securities or it may hold cash. During
such periods, the Fund may not be able to achieve its investment objective. The
Fund may adopt a defensive strategy when the portfolio managers believe
instruments in which the Fund normally invests have elevated risks due to
political or economic factors and in other extraordinary circumstances. For more
information on eligible short-term investments, see the SAI.
OTHER INVESTMENT COMPANIES AND POOLED INVESTMENT VEHICLES
The Fund may invest in securities of other investment companies, including
registered investment companies that are exchange-traded funds. Exchange-traded
funds trade on a securities exchange and their shares may, at times, trade at a
premium or discount to their net asset value. The Fund may also invest a portion
of its assets in pooled investment vehicles other than registered investment
companies. For example, some vehicles which are commonly referred to as
"exchange-traded funds" may not be registered investment companies because of
the nature of their underlying investments. As a stockholder in an investment
company or other pooled vehicle, the Fund will bear its ratable share of that
investment company's or vehicle's expenses, and would remain subject to payment
of the Fund's or vehicle's advisory and administrative fees with respect to
assets so invested.
DISCLOSURE OF PORTFOLIO HOLDINGS
A description of the policies and procedures with respect to the disclosure of
the Fund's portfolio securities is included in the Fund's SAI, which is
available on the Fund's website at www.ftportfolios.com.
ADDITIONAL RISKS OF INVESTING IN THE FUND
Risk is inherent in all investing. Investing in the Fund involves risk,
including the risk that you may lose all or part of your investment. There can
be no assurance that the Fund will meet its stated objective. The risks of the
Fund will result from both the Fund's direct investments and its indirect
investments made through the Subsidiary. Accordingly, the risks that result from
the Subsidiary's activities will be described herein as the Fund's risks. Before
you invest, you should consider the following risks in addition to the Principal
Risks set forth above in this prospectus:
PRINCIPAL RISKS
CASH TRANSACTIONS RISK. The Fund intends to effect a significant portion of
creations and redemptions for cash, rather than in-kind securities. As a result,
an investment in the Fund may be less tax-efficient than an investment in an
exchange-traded fund that effects its creations and redemptions for in-kind
securities. Exchange-traded funds are able to make in-kind redemptions and avoid
being taxed on gains on the distributed portfolio securities at the fund level.
Because the Fund intends to effect a significant portion of redemptions for
cash, it may be required to sell portfolio securities in order to obtain the
cash needed to distribute redemption proceeds. Any recognized gain on these
sales by the Fund will generally cause the Fund to recognize gain it might not
otherwise have recognized, or to recognize such gain sooner than would otherwise
be required if it were to distribute portfolio securities in-kind. The Fund
distributes these gains to shareholders to avoid being taxed on this gain at the
fund level and otherwise comply with the special tax rules that apply to it.
This strategy may cause shareholders to be subject to tax on gains they would
not otherwise be subject to, or at an earlier date than if they had made an
investment in a different exchange-traded fund. Moreover, cash transactions may
have to be carried out over several days if the securities market is relatively
illiquid, and such transactions may involve considerable brokerage fees and
taxes. These brokerage fees and taxes, which will be higher than if the Fund
sold and redeemed its shares principally in-kind, will be passed on to those
purchasing and redeeming Creation Units in the form of creation and redemption
transaction fees. In addition, these factors may result in wider spreads between
the bid and the offered prices of the Fund's shares than for exchange-traded
funds that distribute portfolio securities in-kind.
9
CLEARING BROKER RISK. The failure or bankruptcy of the Fund's and the
Subsidiary's clearing broker could result in a substantial loss of Fund assets.
Under current CFTC regulations, a clearing broker maintains customers' assets
that secure commodity futures positions in a bulk segregated account. If a
clearing broker fails to do so, or is unable to satisfy a substantial deficit in
a customer account, its other customers may be subject to risk of loss of their
funds in the event of that clearing broker's bankruptcy. In that event, the
clearing broker's customers, such as the Fund and the Subsidiary, are entitled
to recover, even in respect of property specifically traceable to them, only a
proportional share of all property available for distribution to all of that
clearing broker's customers.
COMMODITY RISK. The value of commodities and commodity-linked derivative
instruments typically is based upon the price movements of a physical commodity
or an economic variable linked to such price movements. Therefore, the value of
commodities and commodity-linked derivative instruments may be affected by, for
example, changes in overall economic conditions, changes in interest rates, or
factors affecting a particular commodity or industry, such as production,
supply, demand, drought, floods, weather, political, economic and regulatory
developments. The prices of commodities and commodity-linked derivative
instruments may fluctuate quickly and dramatically and may not correlate to
price movements in other asset classes, such as stocks, bonds and cash. An
active trading market may not exist for certain commodities. This may impair the
ability of the Subsidiary to sell its portfolio holdings quickly or for full
value. Each of these factors and events could have a significant negative impact
on the Fund.
COUNTERPARTY RISK. The Fund intends to engage in investment transactions or
enter into futures or other contracts with third parties (i.e.,
"counterparties"). The Fund bears the risk that the counterparty to such
contracts may default on its obligations or otherwise fail to honor its
obligations. If a counterparty defaults on its payment obligations, the
Subsidiary will lose money and the value of an investment in Fund shares may
decrease. In addition, the Subsidiary may engage in such investment transactions
with a limited number of counterparties, which may increase the Subsidiary's
exposure to counterparty credit risk. Futures contracts can be traded on futures
exchanges without material counterparty credit. After a trade is cleared, the
exchange is the ultimate counterparty for all contracts, so the counterparty
risk on a futures contract ultimately is the credit worthiness of the exchange's
clearing corporation.
CREDIT RISK. Credit risk is the risk that an issuer of a debt instrument,
futures or other instrument may be unable or unwilling to make dividend,
interest and/or principal payments when due and the related risk that the value
of an instrument may decline because of concerns about the issuer's ability or
unwillingness to make such payments.
CURRENCY RISK. Changes in currency exchange rates and the relative value of
non-U.S. currencies will affect the value of the Fund and Subsidiary's
investments and the value of Fund shares. Generally, when the U.S. dollar rises
in value against a foreign currency, an investment in that currency loses value
because the currency is worth fewer U.S. dollars. The value of the U.S. dollar
measured against other currencies is influenced by a variety of factors. These
factors include: interest rates, national debt levels and trade deficits,
changes in balances of payments and trade, global commodity and energy prices,
global interest rates and global inflation rates. Government intervention and
monetary policy will have a significant impact on currency exchange rates.
DERIVATIVES INVESTMENT RISK. The Fund, through the Subsidiary, invests in
products generally referred to as "derivatives." Derivatives are financial
instruments whose value depends upon, or is derived from, an underlying
reference asset, such as a commodity. Derivatives are subject to a number of
risks described elsewhere in this prospectus, such as credit risk, interest rate
risk and market risk. In addition, they involve the risk that changes in the
value of the derivative may not correlate perfectly or substantially with the
underlying asset. Fund losses are likely to occur if the values do not correlate
as expected. Derivatives can be volatile and may be less liquid than other
securities. A lack of liquidity could result in the Fund being unable to close
out a derivatives transaction in a cost-efficient manner. Moreover, unlike a
publicly traded security for which the value is readily ascertainable,
derivatives may at times be difficult to value.
The use of derivatives can lead to losses because of adverse movements in the
price or value of the underlying asset, which may be magnified by certain
features of the derivatives. Derivative instruments also involve the risk that
the other party to the derivative transaction will not meet its obligations.
These risks are heightened when derivatives are used to enhance the Fund's
return or as a substitute for a position or security, rather than solely to
hedge (or offset) the risk of a position or security held by the Fund.
The Fund's use of certain derivatives may create investment leverage. This means
that the derivative position may provide the Fund with investment exposure
greater than the value of the Fund's investment in the derivative. As a result,
these derivatives may magnify losses to the Fund, and even a small market
movement may result in significant losses to the Fund. The risk of loss from
certain short derivative positions is theoretically unlimited. The Fund may at
times be required to liquidate portfolio positions, including when it is not
advantageous to do so, in order to comply with the guidance from the Securities
and Exchange Commission regarding asset segregation requirements to cover
10
certain derivative positions. The success of the Fund's derivatives strategies
will depend on the Advisor's ability to manage these sophisticated instruments.
The U.S. government has recently enacted legislation which includes new
regulation of derivatives markets. Because the legislation leaves much to rule
making, and many rules are not yet final, the ultimate impact remains unclear.
Regulatory changes could restrict the ability of the Fund and Subsidiary to
engage in derivative transactions or increase the cost of these transactions,
which may make it difficult or impossible for the Fund to pursue its investment
strategy.
FOREIGN COMMODITY MARKETS RISK. The Fund, through the Subsidiary, will engage in
trading on commodity markets outside the United States on behalf of the Fund.
Trading on such markets is not regulated by any United States government agency
and may involve certain risks not applicable to trading on United States
exchanges. In a number of foreign markets, a substantial volume of trades which
in the United States could only be executed on a regulated exchange are executed
wholly off-exchanges, in privately negotiated transactions. In some cases, the
intermediaries through which the Fund may deal on foreign markets may in effect
take the opposite side of trades made for the Fund. The Fund may not have the
same access to certain trades as do various other participants in foreign
markets. Furthermore, as the Fund will determine its net assets in United States
dollars, with respect to trading in foreign markets the Fund will be subject to
the risk of fluctuations in the exchange rate between the local currency and
dollars as well as the possibility of exchange controls. Certain futures
contracts traded on foreign exchanges are treated differently for federal income
tax purposes than are domestic contracts.
FOREIGN CURRENCY RISK. The Fund's investments which require foreign currency are
exposed to the risk of adverse changes of value of that currency in relation to
other currencies including the U.S. dollar. The currency of any country
continuously fluctuates in value in relation to other currencies, due to a vast
array of factors including interest rates, political developments, government
deficits, balances of trade, economic developments and governmental policies.
FUTURES RISK. Futures contracts may be highly volatile. Price movements may be
sudden and extreme, and are influenced by a variety of factors including, among
other things, changing supply and demand relationships; climate; government
agricultural, trade, fiscal, monetary and exchange control programs and
policies; national and international political and economic events; crop
diseases; the purchasing and marketing programs of different nations; and
changes in interest rates. In addition, governments from time to time intervene,
directly and by regulation, in certain markets, particularly those in
currencies. Such intervention is often intended to influence prices directly.
None of these factors can be controlled by the Fund and no assurances can be
given that the value of these investments will appreciate or that the Fund will
be profitable.
Although the Fund will not borrow money in order to increase the amount of its
trading, the low margin deposits normally required in futures trading permit an
extremely high degree of leverage on the investment itself; margin requirements
for futures trading being in some cases as little as 2% of the face value of the
contracts traded. For example, if at the time of purchase 10% of the price of
the futures contract is deposited as margin, a 10% decrease in the price of the
futures contract would, if the contract was then closed out, result in a total
loss of the margin deposit before any deduction for the trading commission. A
decrease of more than 10% would result in a loss of more than the total margin
deposit. Accordingly, a relatively small price movement in a futures contract
may result in immediate and substantial losses to the Fund. Like other leveraged
investments, any trade may result in losses in excess of the amount invested.
Certain commodities exchanges may limit the maximum net long or net short
speculative positions that a party may hold or control in any particular futures
contracts. Generally, all accounts (proprietary or client) owned or managed by
the Advisor will be combined for purposes of such limits, and the Fund could be
required to liquidate positions in order to comply with such limits. Any such
liquidation could result in substantial costs to Fund investors. Similar risks
would apply should the CFTC adopt final rules limiting futures positions.
Another risk of futures trading is that the futures markets can become illiquid.
United States futures exchanges impose "daily limits" on the amount by which the
price of most futures contracts traded on such exchanges may vary during a
single day. Daily limits prevent trades from being executed during a given
trading day at a price above or below the daily limit. Once the price of a
futures contract has moved to the limit price, it may be difficult, costly or
impossible to liquidate a position. Such limits could prevent prompt liquidation
of unfavorable positions. It is also possible for an exchange or the CFTC to
suspend trading in a particular contract (as, in fact, occurred in the case of
stock index futures on October 20, 1987), order immediate settlement of a
particular contract or order that trading in a particular contract be conducted
for liquidation only.
Another risk of futures trading is the possible insolvency of a futures
commission merchant ("FCM"). In such event, the Subsidiary may be subject to a
risk of loss of its funds and would be able to recover only a pro rata share,
specifically traceable to its trading account. In commodity broker insolvencies,
customers have, in fact, been unable to recover from the broker's estate the
full amount of their "customer" funds. In addition, under certain circumstances,
11
such as the inability of another client of the FCM or the FCM itself to satisfy
substantial deficiencies in such other client's account, a customer may be
subject to a risk of loss of his or her funds on deposit with the FCM, even if
such funds are properly segregated. In the case of any such bankruptcy or client
loss, a client might recover, even in respect of property specifically traceable
to the client, only a pro rata share of all property available for distribution
to all of the FCM's customers.
INCOME RISK. The Fund's income from its fixed income investments could decline
due to falling market interest rates. This is because, in a falling interest
rate environment, the Fund generally will have to invest the proceeds from sales
of Fund shares, as well as the proceeds from maturing debt securities, in
lower-yielding securities.
INTEREST RATE RISK. Interest rate risk is the risk that the value of the Fund's
fixed income investments will decline because of rising market interest rates.
Interest rate risk is generally lower for shorter-term investments and higher
for longer-term investments. Duration is a common measure of interest rate risk.
Duration measures a bond's expected life on a present value basis, taking into
account the bond's yield, interest payments and final maturity. Duration is a
reasonably accurate measure of a bond's price sensitivity to changes in interest
rates. The longer the duration of a bond, the greater the bond's price
sensitivity is to changes in interest rates.
LIQUIDITY RISK. The Fund may invest in Commodities Instruments and other
instruments that may be less liquid than other types of investments. Investments
that are less liquid or that trade less can be more difficult or more costly to
buy, or to sell, compared to other more liquid or active investments. This
liquidity risk is a factor of the trading volume of a particular investment, as
well as the size and liquidity of the market for such an investment. The
Commodities Instruments in which the Fund invests may not always be liquid. This
could have a negative effect on the Fund's ability to achieve its investment
objective and may result in losses to Fund shareholders.
Also, U.S. commodity exchanges impose "daily limits" on the amount by which the
price of most futures contracts traded on such exchanges may vary during a
single day. Daily limits prevent trades from being executed during a given
trading day at a price above or below the daily limit. Once the price of a
futures contract has moved to the limit price, it may be difficult, costly or
impossible to liquidate a position. Such limits could prevent the Fund from
promptly liquidating unfavorable positions held in the Fund's account. In
addition, even if futures prices have not moved the daily limit, the Fund may be
unable to execute trades at favorable prices if the liquidity of the market is
not adequate.
NON-U.S. INVESTMENT RISK. The Fund may invest in commodity futures contracts
traded on non-U.S. exchanges or enter into over-the-counter derivative contracts
with non-U.S. counterparties. Transactions on non-U.S. exchanges or with
non-U.S. counterparties present risks because they may not subject to the same
degree of regulation as their U.S. counterparts.
POOLED INVESTMENT VEHICLE RISK. The Fund may invest in securities of other
investment companies, including exchange-traded funds, and other pooled
investment vehicles. As a shareholder in a pooled investment vehicle, the Fund
will bear its ratable share of that vehicle's expenses, and would remain subject
to payment of the Fund's advisory and administrative fees with respect to assets
so invested. Shareholders would therefore be subject to duplicative expenses to
the extent the Fund invests in other pooled investment vehicles. In addition,
the Fund will incur brokerage costs when purchasing and selling shares of
exchange-traded funds or other exchange-traded pooled investment vehicles.
Securities of other pooled investment vehicles may be leveraged, in which case
the value and/or yield of such securities will tend to be more volatile than
securities of unleveraged vehicles.
REGULATORY CHANGE RISK. The regulation of the United States futures and Forex
markets has undergone substantial change in recent years, and such change is
expected to continue for the foreseeable future. In addition, there are
indications of substantial regulatory changes pending in certain foreign
markets. The effect of regulatory change on the Fund, while impossible to
predict, could be substantial and adverse.
REGULATORY RISK. The CFTC has adopted amendments to CFTC Rule 4.5, which subject
the Fund and the Subsidiary to regulation by the CFTC and impose additional
disclosure, reporting and recordkeeping rules on the Fund and the Subsidiary.
Compliance with these additional rules may increase the Fund's expenses. In
addition, certain exchanges may limit the maximum net long or net short
speculative positions that a party may hold or control in any particular futures
or options contracts, and it is possible that other regulatory authorities may
adopt similar limits. Position limits are currently the subject of disputes
being resolved in the U.S. court system. The Fund's investment decisions may
need to be modified, and commodity contract positions held by the Fund may have
to be liquidated at disadvantageous times or prices, to avoid exceeding any
applicable position limits, potentially subjecting the Fund to substantial
losses. The regulation of commodity transactions in the United States is a
rapidly changing area of law and is subject to ongoing modification by
government, self-regulatory and judicial action. The effect of any future
regulatory change on the Fund is impossible to predict, but could be substantial
and adverse to the Fund. Suspension or termination of the Advisor's registration
as a commodity pool operator would prevent it, until such time (if any) as such
registration was reinstated, from managing the Fund, and might result in the
termination of the Fund.
12
Also, the Fund may have limited recourse to non-registered CFTC entities. An
investor in the Fund should be aware that a non-registered entity may be subject
to a level of regulatory oversight that could limit the Fund's ability to select
a proper venue if a dispute should arise.
REPURCHASE AGREEMENT RISK. The Fund will enter into repurchase agreements only
with counterparties that are deemed to present acceptable credit risks, and the
collateral securing the repurchase agreements generally will be limited to U.S.
government securities and cash. If the market value of the underlying
obligations of a repurchase agreement declines, the counterparty must provide
additional collateral so that at all times the value of the collateral is
greater than the repurchase price of the underlying obligations. Nonetheless,
should a counterparty become insolvent or otherwise default, there could be a
delay before the Fund is able to liquidate the collateral, which would subject
the collateral and the Fund to market risk during that period.
SHORT SALES RISK. The Fund may engage in "short sale" transactions. A short sale
involves the sale by the Fund of an instrument or security that it does not own
with the hope of purchasing the same security at a later date at a lower price.
Short sales are designed to profit from a decline in the price of a security or
instrument. The Fund will lose value if the security or instrument that is the
subject of a short sale increases in value. This is the opposite of traditional
"long" investments where the value of the Subsidiary increases as the value of a
portfolio security or instrument increases. The Fund also may enter into a short
derivative position through a futures contract. If the price of the security or
derivative that is the subject of a short sale increases, then the Fund will
incur a loss equal to the increase in price from the time that the short sale
was entered into plus any premiums and interest paid to a third party in
connection with the short sale. Therefore, short sales involve the risk that
losses may be exaggerated, potentially losing more money than the actual cost of
the investment. Also, there is the risk that the third party to the short sale
may fail to honor its contract terms, causing a loss to the Fund.
SUBSIDIARY INVESTMENT RISK. The Subsidiary is not registered under the 1940 Act
and is not subject to all of the investor protections of the 1940 Act. Thus, the
Fund, as an investor in the Subsidiary, will not have all of the protections
offered to investors in registered investment companies. In addition, changes in
the laws of the United States and/or the Cayman Islands, under which the Fund
and the Subsidiary is organized, respectively, could result in the inability of
the Fund and/or the Subsidiary to operate as intended and could negatively
affect the Fund and its shareholders.
VOLATILITY RISK. The Fund is designed to capture the long-term economic benefits
of rising or declining market trends. Frequent or significant short-term price
movements could adversely impact the performance of the Fund. "Whipsaw" markets
(as opposed to choppy or stable markets), in which significant price movements
develop but then repeatedly reverse, could cause substantial losses due to
prices moving against the Fund's long or short positions (which are based on
prior trends) and generally are not adjusted on an intra-quarter basis.
NON-PRINCIPAL RISKS
BROKERAGE FIRMS RISK. Even given proper segregation, in the event of the
insolvency of a FCM, the Fund may be subject to a risk of loss of its funds and
would be able to recover only a pro rata share, specifically traceable to the
Fund's account. In commodity broker insolvencies customers have, in fact, been
unable to recover from the broker's estate the full amount of their "customer"
funds. In addition, under certain circumstances, such as the inability of
another client of the FCM or the FCM itself to satisfy substantial deficiencies
in such other client's account, the Fund may be subject to a risk of loss of its
funds on deposit with its FCM, even if such funds are properly segregated. In
the case of any such bankruptcy or client loss, the Fund might recover, even in
respect of property specifically traceable to the client, only a pro rata share
of all property available for distribution to all of the FCM's clients. The
financial failure of the parties with which the Fund trades in the securities or
cash or forward markets could also result in substantial losses for the Fund, as
the Fund deals with such persons as principals, and, furthermore, there is no
requirement that such parties segregate funds of the Fund held by them in
respect of such trading.
CALL RISK. Many bonds may be redeemed at the option of the issuer, or "called,"
before their stated maturity date. In general, an issuer will call its bonds if
they can be refinanced by issuing new bonds which bear a lower interest rate.
The Fund is subject to the possibility that during periods of falling interest
rates, a bond issuer will call its high-yielding bonds. The Fund would then be
forced to invest the unanticipated proceeds at lower interest rates, resulting
in a decline in the Fund's income.
INFLATION RISK. Inflation risk is the risk that the value of assets or income
from investments will be less in the future as inflation decreases the value of
money. As inflation increases, the value of the Fund's assets can decline as can
the value of the Fund's distributions.
13
ISSUER SPECIFIC CHANGES RISK. Changes in the financial condition of an issuer or
counterparty, changes in specific economic or political conditions that affect a
particular type of security or issuer, and changes in general economic or
political conditions can affect a security's or instrument's value. The value of
securities of smaller, less well-known issuers can be more volatile than that of
larger issuers. Issuer specific events can have a negative impact on the value
of the Fund.
MARKET MAKER RISK. If the Fund has lower average daily trading volumes, it may
rely on a small number of third-party market makers to provide a market for the
purchase and sale of shares. Any trading halt or other problem relating to the
trading activity of these market makers could result in a dramatic change in the
spread between the Fund's net asset value and the price at which the Fund's
shares are trading on NASDAQ(R), which could result in a decrease in value of
the Fund's shares.
TRADING ISSUES
Although shares of the Fund are listed for trading on NASDAQ(R), there can be no
assurance that an active trading market for such shares will develop or be
maintained. Trading in shares on NASDAQ(R) may be halted due to market
conditions or for reasons that, in the view of NASDAQ(R), make trading in shares
inadvisable. In addition, trading in shares on NASDAQ(R) is subject to trading
halts caused by extraordinary market volatility pursuant to NASDAQ(R) "circuit
breaker" rules. There can be no assurance that the requirements of NASDAQ(R)
necessary to maintain the listing of the Fund will continue to be met or will
remain unchanged.
FLUCTUATION OF NET ASSET VALUE
The net asset value of shares of the Fund will generally fluctuate with changes
in the market value of the Fund's holdings. The market prices of shares will
generally fluctuate in accordance with changes in net asset value as well as the
relative supply of and demand for shares on NASDAQ(R). The Fund cannot predict
whether shares will trade below, at or above their net asset value. Price
differences may be due, in large part, to the fact that supply and demand forces
at work in the secondary trading market for shares will be closely related to,
but not identical to, the same forces influencing the prices of the holdings of
the Fund trading individually or in the aggregate at any point in time. However,
given that shares can be purchased and redeemed either in-kind or for cash in
Creation Units (unlike shares of closed-end funds, which frequently trade at
appreciable discounts from, and sometimes at premiums to, their net asset
value), the Fund believes that large discounts or premiums to the net asset
value of shares should not be sustained.
FUND ORGANIZATION
The Fund is a series of the Trust, an investment company registered under the
1940 Act. The Fund is treated as a separate fund with its own investment
objective and policies. The Trust is organized as a Massachusetts business
trust. The Trust's Board is responsible for the overall management and direction
of the Trust. The Board elects the Trust's officers and approves all significant
agreements, including those with the investment advisor, custodian and fund
administrative and accounting agent.
MANAGEMENT OF THE FUND
First Trust Advisors L.P., 120 East Liberty Drive, Wheaton, Illinois 60187, is
the investment advisor, commodity pool operator and commodity trading advisor to
the Fund. In this capacity, First Trust is responsible for the selection and
ongoing monitoring of the securities in the Fund's portfolio and certain other
services necessary for the management of the portfolio.
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. Grace Partners of
DuPage L.P. is a limited partnership with one general partner, The Charger
Corporation, and a number of limited partners. The Charger Corporation is an
Illinois corporation controlled by James A. Bowen, the Chief Executive Officer
of First Trust, a Trustee of the Trust, and sole Director of the Subsidiary.
First Trust discharges its responsibilities subject to the policies of the
Board. First Trust is registered as a commodity pool operator and also is a
member of the National Futures Association.
First Trust serves as advisor or sub-advisor to five mutual fund portfolios,
nine exchange-traded funds consisting of 94 series and 15 closed-end funds. It
is also the portfolio supervisor of certain unit investment trusts sponsored by
First Trust Portfolios L.P. ("FTP"), an affiliate of First Trust, 120 East
Liberty Drive, Wheaton, Illinois 60187. FTP specializes in the underwriting,
trading and distribution of unit investment trusts and other securities. FTP is
the principal underwriter of the shares of the Fund.
14
There is no one individual primarily responsible for portfolio management
decisions for the Fund. Investments are made under the direction of the
Investment Committee with daily decisions being primarily made by John Gambla
and Rob A. Guttschow. The Investment Committee consists of John Gambla, Rob A.
Guttschow, Daniel J. Lindquist, Jon C. Erickson, David G. McGarel and Roger F.
Testin.
o Mr. Gambla, CFA, FRM, PRM, is a senior portfolio manager for the
Alternatives Investment Team at First Trust. Prior to joining First
Trust in July 2011, Mr. Gambla was co-Chief Investment Officer at the
Nuveen HydePark Group LLC where he started in 2007. While at Nuveen
HydePark Group LLC, Mr. Gambla co-directed investment activities
including research, product development, trading, portfolio management
and performance attribution. Mr. Gambla also led the research systems
and infrastructure development for Nuveen HydePark Group LLC.
Previously, Mr. Gambla was a Senior Trader and Quantitative specialist
at Nuveen Asset Management. While there, he was responsible for trading
all derivatives for the 120+ municipal mutual funds with Nuveen Asset
Management. Mr. Gambla has served in a variety of roles throughout his
career including: portfolio management, research, business development
and strategy development.
o Mr. Guttschow, CFA, is a senior portfolio manager for the Alternatives
Investment Team at First Trust. Prior to joining First Trust in July
2011, Mr. Guttschow was co-Chief Investment Officer at the Nuveen
HydePark Group LLC where he started in 2007. While at Nuveen HydePark
Group LLC, Mr. Guttschow co-directed investment activities including
research, product development, trading, portfolio management and
performance attribution. Previously, Mr. Guttschow was an Overlay
Manager and Senior Portfolio Manager at Nuveen Asset Management. While
there, he developed Nuveen's buy-side derivative desk for fixed income
and equity portfolio hedging.
o Mr. Lindquist is Chairman of the Investment Committee and presides over
Investment Committee meetings. Mr. Lindquist is responsible for
overseeing the implementation of the Fund's investment strategy. Mr.
Lindquist joined First Trust as a Vice President in April 2004 and was
a Senior Vice President of First Trust and FTP from September 2005 to
July 2012. Mr. Lindquist has been a Managing Director of First Trust
and FTP since 2012.
o Mr. Erickson has been a Senior Vice President of First Trust and FTP
since 2001. As the head of First Trust's Equity Research Group, Mr.
Erickson is responsible for determining the securities to be purchased
and sold by funds that do not utilize quantitative investment
strategies.
o Mr. McGarel has been Chief Investment Officer and Managing Director
since 2012. From 2004 to 2012, he was a Senior Vice President of First
Trust and FTP. As First Trust's Chief Investment Officer, Mr. McGarel
consults with the Investment Committee on market conditions and First
Trust's general investment philosophy.
o Mr. Testin has been a Senior Vice President of First Trust and FTP
since 2003. Mr. Testin is the head of First Trust's Portfolio
Management Group.
For additional information concerning First Trust, including a description of
the services provided to the Fund, see the SAI. Additional information about the
compensation of Investment Committee members, other accounts managed by members
of the Investment Committee and ownership by members of the Investment Committee
of shares of the Fund is provided in the SAI.
MANAGEMENT OF THE SUBSIDIARY
The Subsidiary is a wholly-owned subsidiary of the Fund. The Subsidiary is
organized under the laws of the Cayman Islands and overseen by its own board of
directors. The Fund is the sole shareholder of the Subsidiary, and it is
currently expected that shares of the Subsidiary will not be sold or offered to
other investors. The Fund and the Subsidiary in the aggregate are managed to
comply with the compliance policies and procedures of the Fund. As a result, in
managing the Fund's and the Subsidiary's portfolios, First Trust will comply
with the investment policies and restrictions that apply to the management of
the Fund and the Subsidiary (on a consolidated basis), and, in particular, to
the requirements relating to leverage, liquidity, brokerage and the timing and
method of the valuation of the Fund's and the Subsidiary's portfolio
investments. The Trust's Chief Compliance Officer oversees implementation of the
Subsidiary's policies and procedures and makes periodic reports to the Trust's
Board of Trustees regarding the Subsidiary's compliance with its policies and
procedures. First Trust serves as the investment advisor of the Subsidiary and
manages the investment of the Subsidiary's assets on a discretionary basis. The
Subsidiary does not pay First Trust a management fee for its services. The
Subsidiary has also entered into separate contracts for the provision of
custody, transfer agency and audit services.
15
MANAGEMENT FEE
Pursuant to the Investment Management Agreement, First Trust manages the
investment of the Fund's assets and will be responsible for the Fund's and the
Subsidiary's expenses, including the cost of transfer agency, custody, fund
administration, legal, audit and other services, but excluding fee payments
under the Investment Management Agreement, interest, taxes, brokerage
commissions and other expenses connected with the execution of portfolio
transactions, distribution and service fees payable pursuant to a 12b-1 plan, if
any, and extraordinary expenses.
The Fund has agreed to pay First Trust an annual management fee of 0.95% of its
average daily net assets. A discussion regarding the Board's approval of the
Investment Management Agreement for the Fund is available in the Fund's Annual
Report to Shareholders for the period ended December 31, 2013.
HOW TO BUY AND SELL SHARES
Most investors will buy and sell shares of the Fund in secondary market
transactions through brokers. Shares of the Fund are expected to be listed for
trading on the secondary market on NASDAQ(R). Shares can be bought and sold
throughout the trading day like other publicly traded shares. There is no
minimum investment when buying shares on NASDAQ(R). Although shares are
generally purchased and sold in "round lots" of 100 shares, brokerage firms
typically permit investors to purchase or sell shares in smaller "odd lots," at
no per-share price differential. When buying or selling shares through a broker,
investors should expect to incur customary brokerage commissions, investors may
receive less than the net asset value of the shares because shares are bought
and sold at market prices rather than net asset value, and investors may pay
some or all of the spread between the bid and the offer price in the secondary
market on each leg of a round trip (purchase and sale) transaction. Share prices
are reported in dollars and cents per share.
For purposes of the 1940 Act, the Fund is treated as a registered investment
company, and the acquisition of shares by other registered investment companies
is subject to the restrictions of Section 12(d)(1) of the 1940 Act. The Trust,
on behalf of the Fund, has received an exemptive order from the Securities and
Exchange Commission that permits certain registered investment companies to
invest in the Fund beyond the limits set forth in Section 12(d)(1), subject to
certain terms and conditions, including that any such investment companies enter
into an agreement with the Fund regarding the terms of any investment. In
addition, the Fund may invest in the securities of exchange-traded funds in
excess of the limits imposed under the 1940 Act pursuant to exemptive orders
obtained by other exchange-traded funds and their sponsors from the Securities
and Exchange Commission.
BOOK ENTRY
Shares are held in book-entry form, which means that no share certificates are
issued. The Depository Trust Company ("DTC") or its nominee is the record owner
of all outstanding shares of the Fund and is recognized as the owner of all
shares for all purposes.
Investors owning shares are beneficial owners as shown on the records of DTC or
its participants. DTC serves as the securities depository for all shares.
Participants in DTC include securities brokers and dealers, banks, trust
companies, clearing corporations and other institutions that directly or
indirectly maintain a custodial relationship with DTC. As a beneficial owner of
shares, you are not entitled to receive physical delivery of share certificates
or to have shares registered in your name, and you are not considered a
registered owner of shares. Therefore, to exercise any right as an owner of
shares, you must rely upon the procedures of DTC and its participants. These
procedures are the same as those that apply to any other stocks that you hold in
book-entry or "street name" form.
SHARE TRADING PRICES
The trading price of shares of the Fund on NASDAQ(R) is based on market price
and may differ from the Fund's daily net asset value and can be affected by
market forces of supply and demand, economic conditions and other factors.
Information regarding the intra-day value of the shares of the Fund, also
referred to as the "indicative optimized portfolio value" ("IOPV"), is
disseminated every 15 seconds throughout the Fund's trading day by the national
securities exchange on which the shares are listed or by market data vendors or
other information providers. The IOPV should not be viewed as a "real-time"
update of the net asset value per share of the Fund because the IOPV may not be
calculated in the same manner as the net asset value, which is computed once a
day, generally at the end of the business day. The price of a non-U.S. security
that is primarily traded on a non-U.S. exchange will be updated, using the last
sale price, every 15 seconds throughout the trading day, provided, that upon the
closing of such non-U.S. exchange, the closing price of the security, after
being converted to U.S. dollars, will be used. Furthermore, in calculating the
IOPV of the Fund's shares, exchange rates may be used throughout the day (9:00
a.m. to 4:15 p.m., Eastern Time) that may differ from those used to calculate
the net asset value per share of the Fund and consequently may result in
differences between the net asset value and the IOPV. The Fund is not involved
16
in, or responsible for, the calculation or dissemination of the IOPV of shares
of the Fund and the Fund does not make any warranty as to its accuracy.
FREQUENT PURCHASES AND REDEMPTIONS OF THE FUND'S SHARES
The Fund imposes no restrictions on the frequency of purchases and redemptions
("market timing"). In determining not to approve a written, established policy,
the Board evaluated the risks of market timing activities by the Fund's
shareholders. The Board considered that the Fund's shares can only be purchased
and redeemed directly from the Fund in Creation Units by broker-dealers and
large institutional investors that have entered into participation agreements
(i.e., authorized participants ("APs")) and that the vast majority of trading in
the Fund's shares occurs on the secondary market. Because the secondary market
trades do not involve the Fund directly, it is unlikely those trades would cause
many of the harmful effects of market timing, including dilution, disruption of
portfolio management, increases in the Fund's trading costs and the realization
of capital gains. With respect to trades directly with the Fund, to the extent
effected in-kind (i.e., for securities), those trades do not cause any of the
harmful effects that may result from frequent cash trades. As the Fund may
effect the purchase or redemption of Creation Units in exchange wholly or
partially for cash, the Board noted that such trades could result in dilution to
the Fund and increased transaction costs, which could negatively impact the
Fund's ability to achieve its investment objective. However, the Board noted
that direct trading by APs is critical to ensuring that the shares trade at or
close to net asset value. In addition, the Fund imposes fixed and variable
transaction fees on purchases and redemptions of Creation Units to cover the
custodial and other costs incurred by the Fund in effecting trades. Finally, the
Advisor monitors orders from APs for patterns of abusive trading and the Fund
reserves the right to not accept creation orders from APs that the Advisor has
determined may be disruptive to the management of the Fund, or otherwise not in
the Fund's best interests.
DIVIDENDS, DISTRIBUTIONS AND TAXES
Dividends from net investment income of the Fund, if any, are declared and paid
quarterly by the Fund. The Fund distributes its net realized capital gains, if
any, to shareholders at least annually.
Distributions in cash may be reinvested automatically in additional whole shares
only if the broker through whom you purchased shares makes such option
available. Such shares will generally be reinvested by the broker based upon the
market price of those shares and investors may be subject to customary brokerage
commissions charged by the broker.
FEDERAL TAX MATTERS
This section summarizes some of the main U.S. federal income tax consequences of
owning shares of the Fund. This section is current as of the date of this
prospectus. Tax laws and interpretations change frequently, and these summaries
do not describe all of the tax consequences to all taxpayers. For example, these
summaries generally do not describe your situation if you are a corporation, a
non-U.S. person, a broker-dealer or other investor with special circumstances.
In addition, this section does not describe your state, local or non-U.S. tax
consequences.
This federal income tax summary is based in part on the advice of counsel to the
Fund. The Internal Revenue Service could disagree with any conclusions set forth
in this section. In addition, counsel to the Fund was not asked to review, and
has not reached a conclusion with respect to, the federal income tax treatment
of the assets to be included in the Fund. This may not be sufficient for you to
use for the purpose of avoiding penalties under federal tax law.
As with any investment, you should seek advice based on your individual
circumstances from your own tax advisor.
FUND STATUS
The Fund intends to continue to qualify as a "regulated investment company"
under the federal tax laws. If the Fund qualifies as a regulated investment
company and distributes its income as required by the tax law, the Fund
generally will not pay federal income taxes.
For federal income tax purposes, you are treated as the owner of Fund shares and
not of the assets held by the Fund. Taxability issues are taken into account at
the Fund level. Your federal income tax treatment of income from the Fund is
based on the distributions paid by the Fund.
Subject to certain reasonable cause and de minimis exceptions, to qualify for
the favorable U.S. federal income tax treatment generally accorded to regulated
investment companies, the Fund must, among other things, (i) derive in each
taxable year at least 90% of its gross income from dividends, interest, payments
with respect to securities loans and gains from the sale or other disposition of
stock, securities or foreign currencies, other income derived with respect to
its business of investing in such stock, securities or currencies or net income
derived from interests in certain publicly traded partnerships; (ii) diversify
17
its holdings so that, at the end of each quarter of the taxable year, (a) at
least 50% of the value of the Fund's total assets is represented by cash and
cash items (including receivables), U.S. government securities, the securities
of other regulated investment companies and other securities, with such other
securities of any one issuer generally limited for the purposes of this
calculation to an amount not greater than 5% of the value of the Fund's total
assets and not greater than 10% of the outstanding voting securities of such
issuer, and (b) not more than 25% of the value of its total assets is invested
in the securities (other than U.S. government securities or the securities of
other regulated investment companies) of any one issuer, the securities (other
than the securities of other regulated investment companies) of two or more
issuers which the Fund controls (i.e., owns 20% or more of the total combined
voting power of all classes of stock entitled to vote) and which are engaged in
the same, similar or related trades or businesses or the securities of one or
more certain publicly traded partnerships; and (iii) distribute at least 90% of
its investment company taxable income (determined without regard to capital gain
dividends and exempt interest dividends) and at least 90% of its net tax-exempt
interest income each taxable year.
Income from commodities is generally not qualifying income for RICs. The Fund
intends to treat any income it may derive from commodity-linked derivatives
(other than derivatives described in Revenue Rulings 2006-1 and 2006-31)
received from the Subsidiary as "qualifying income" for RICs, based on a tax
opinion from special tax counsel which was based, in part, on numerous PLRs
provided to third parties not associated with the Fund or its affiliates (which
only those parties may cite as precedent). Shareholders and potential investors
should be aware, however, that, in July 2011, the Internal Revenue Service
suspended the issuance of such PLRs pending its re-examination of the policies
underlying them, which was still ongoing at the date of this prospectus. If, at
the end of that re-examination, the Internal Revenue Service changes its
position with respect to the conclusions reached in those PLRs, then the Fund
may be required to restructure its investments to satisfy the qualifying income
requirement or might cease to qualify as a RIC.
The Fund has undertaken to not hold more than 25% of its assets in the
Subsidiary at the end of any quarter. If the Fund fails to limit itself to the
25% ceiling and fails to correct the issue within 30 days after the end of the
quarter, the Fund may fail the RIC diversification tests described above.
Subject to certain reasonable cause and de minimis exceptions, if the Fund fails
to qualify as a RIC or fails to satisfy the 90% distribution requirement in any
taxable year, the Fund will be taxed as an ordinary corporation on its taxable
income (even if such income were distributed to its shareholders) and all
distributions out of earnings and profits will be taxed to you as dividend
income, which, in general and subject to limitations under the Internal Revenue
Code of 1986, as amended, under current law will constitute qualified dividend
income in the case of individual shareholders and would be eligible for
corporate dividends received deduction. In such event, in order to re-qualify
for taxation as a RIC, the Fund might be required to recognize unrealized gains,
pay substantial taxes and interest and make certain distributions. This would
cause investors to incur higher tax liabilities than they otherwise would have
incurred and would have a negative impact on Fund returns. In such event, the
Fund's Board of Trustees may determine to reorganize or close the Fund or
materially change the Fund's investment objective and strategies.
DISTRIBUTIONS
The Fund's distributions are generally taxable. After the end of each year, you
will receive a tax statement that separates the distributions of the Fund into
two categories, ordinary income distributions and capital gain dividends.
Ordinary income distributions are generally taxed at your ordinary tax rate,
however, as further discussed below, certain ordinary income distributions
received from the Fund may be taxed at the capital gains tax rates. Generally,
you will treat all capital gain dividends as long-term capital gains regardless
of how long you have owned your shares. To determine your actual tax liability
for your capital gain dividends, you must calculate your total net capital gain
or loss for the tax year after considering all of your other taxable
transactions, as described below. In addition, the Fund may make distributions
that represent a return of capital for tax purposes. These return of capital
distributions are generally not immediately taxable to you; however, such
distributions may reduce your tax basis in your shares, which could result in
you having to pay higher taxes in the future when shares are sold, even if you
sell the shares at a loss from your original investment. The tax status of your
distributions from the Fund is not affected by whether you reinvest your
distributions in additional shares or receive them in cash. The income from the
Fund that you must take into account for federal income tax purposes is not
reduced by amounts used to pay a deferred sales fee, if any. The tax laws may
require you to treat distributions made to you in January as if you had received
them on December 31 of the previous year.
Income from the Fund may also be subject to a 3.8% "Medicare tax." This tax will
generally apply to your net investment income if your adjusted gross income
exceeds certain threshold amounts, which are $250,000 in the case of married
couples filing joint returns and $200,000 in the case of single individuals.
18
DIVIDENDS RECEIVED DEDUCTION
A corporation that owns shares generally will not be entitled to the dividends
received deduction with respect to many dividends received from the Fund because
the dividends received deduction is generally not available for distributions
from regulated investment companies. However, certain ordinary income dividends
on shares that are attributable to qualifying dividends received by the Fund
from certain corporations may be reported by the Fund as being eligible for the
dividends received deduction.
CAPITAL GAINS AND LOSSES AND CERTAIN ORDINARY INCOME DIVIDENDS
If you are an individual, the maximum marginal stated federal tax rate for net
capital gain is generally 20% for taxpayers in the 39.6% tax bracket, 15% for
taxpayers in the 25%, 28%, 33% and 35% tax brackets and 0% for taxpayers in the
10% and 15% tax brackets. Some portion of your capital gain dividends may be
taxed at a higher maximum stated tax rate. Capital gains may also be subject to
the Medicare tax described above.
Net capital gain equals net long-term capital gain minus net short-term capital
loss for the taxable year. Capital gain or loss is long-term if the holding
period for the asset is more than one year and is short-term if the holding
period for the asset is one year or less. You must exclude the date you purchase
your shares to determine your holding period. However, if you receive a capital
gain dividend from the Fund and sell your shares at a loss after holding them
for six months or less, the loss will be recharacterized as long-term capital
loss to the extent of the capital gain dividend received. The tax rates for
capital gains realized from assets held for one year or less are generally the
same as for ordinary income. The Internal Revenue Code of 1986, as amended,
treats certain capital gains as ordinary income in special situations.
Ordinary income dividends received by an individual shareholder from a regulated
investment company such as the Fund are generally taxed at the same rates that
apply to net capital gain (as discussed above), provided certain holding period
requirements are satisfied and provided the dividends are attributable to
qualifying dividends received by the Fund itself. Dividends from foreign
corporations are qualifying dividends only in limited circumstances. The Fund
will provide notice to its shareholders of the amount of any distribution which
may be taken into account as a dividend which is eligible for the capital gains
tax rates.
SALE OF SHARES
If you sell or redeem your shares, you will generally recognize a taxable gain
or loss. To determine the amount of this gain or loss, you must subtract your
tax basis in your shares from the amount you receive in the transaction. Your
tax basis in your shares is generally equal to the cost of your shares,
generally including sales charges. In some cases, however, you may have to
adjust your tax basis after you purchase your shares.
TAXES ON PURCHASE AND REDEMPTION OF CREATION UNITS
If you exchange securities for Creation Units, you will generally recognize a
gain or a loss. The gain or loss will be equal to the difference between the
market value of the Creation Units at the time and your aggregate basis in the
securities surrendered and the cash component paid. If you exchange Creation
Units for securities, you will generally recognize a gain or loss equal to the
difference between your basis in the Creation Units and the aggregate market
value of the securities received and the cash redemption amount. The Internal
Revenue Service, however, may assert that a loss realized upon an exchange of
securities for Creation Units or Creation Units for securities cannot be
deducted currently under the rules governing "wash sales," or on the basis that
there has been no significant change in economic position.
DEDUCTIBILITY OF FUND EXPENSES
Expenses incurred and deducted by the Fund will generally not be treated as
income taxable to you. In some cases, however, you may be required to treat your
portion of these Fund expenses as income. In these cases you may be able to take
a deduction for these expenses. However, certain miscellaneous itemized
deductions, such as investment expenses, may be deducted by individuals only to
the extent that all of these deductions exceed 2% of the individual's adjusted
gross income. Some individuals may also be subject to further limitations on the
amount of their itemized deductions, depending on their income.
NON-U.S. TAX CREDIT
Because the Fund invests in non-U.S. securities, the tax statement that you
receive may include an item showing non-U.S. taxes the Fund paid to other
countries. In this case, dividends taxed to you will include your share of the
taxes the Fund paid to other countries. You may be able to deduct or receive a
tax credit for your share of these taxes.
NON-U.S. INVESTORS
If you are a non-U.S. investor (i.e., an investor other than a U.S. citizen or
resident or a U.S. corporation, partnership, estate or trust), you should be
aware that, generally, subject to applicable tax treaties, distributions from
19
the Fund will be characterized as dividends for federal income tax purposes
(other than dividends which the Fund properly reports as capital gain dividends)
and will be subject to U.S. federal income taxes, including withholding taxes,
subject to certain exceptions described below. However, distributions received
by a non-U.S. investor from the Fund that are properly reported by the Fund as
capital gain dividends may not be subject to U.S. federal income taxes,
including withholding taxes, provided that the Fund makes certain elections and
certain other conditions are met.
Distributions may be subject to a U.S. withholding tax of 30% in the case of
distributions to (i) certain non-U.S. financial institutions that have not
entered into an agreement with the U.S. Treasury to collect and disclose certain
information and are not resident in a jurisdiction that has entered into such an
agreement with the U.S. Treasury and (ii) certain other non-U.S. entities that
do not provide certain certifications and information about the entity's U.S.
owners. Dispositions of shares by such persons may be subject to such
withholding after December 31, 2016.
INVESTMENTS IN CERTAIN NON-U.S. CORPORATIONS
If the Fund holds an equity interest in any passive foreign investment companies
("PFICs"), which are generally certain non-U.S. corporations that receive at
least 75% of their annual gross income from passive sources (such as interest,
dividends, certain rents and royalties or capital gains) or that hold at least
50% of their assets in investments producing such passive income, the Fund could
be subject to U.S. federal income tax and additional interest charges on gains
and certain distributions with respect to those equity interests, even if all
the income or gain is timely distributed to its shareholders. The Fund will not
be able to pass through to its shareholders any credit or deduction for such
taxes. The Fund may be able to make an election that could ameliorate these
adverse tax consequences. In this case, the Fund would recognize as ordinary
income any increase in the value of such PFIC shares, and as ordinary loss any
decrease in such value to the extent it did not exceed prior increases included
in income. Under this election, the Fund might be required to recognize in a
year income in excess of its distributions from PFICs and its proceeds from
dispositions of PFIC stock during that year, and such income would nevertheless
be subject to the distribution requirement and would be taken into account for
purposes of the 4% excise tax. Dividends paid by PFICs are not treated as
qualified dividend income.
INVESTMENT IN THE SUBSIDIARY
One of the requirements for qualification as a RIC is that the Fund must derive
at least 90% of its gross income for each taxable year from "qualifying income."
Qualifying income includes dividends, interest, payments with respect to certain
securities loans, and gains from the sale or other disposition of stock,
securities or foreign currencies or other income derived with respect to its
business of investing in such stock, securities or currencies. The Internal
Revenue Service has issued a revenue ruling which concludes that income derived
from certain commodity-linked swaps is not qualifying income under Subchapter M
of the Internal Revenue Code of 1986, as amended.
However, the Internal Revenue Service has in recent years issued PLRs to other
RICs in which it concluded that income from certain commodity index-linked notes
is qualifying income and that income derived from subsidiaries similar to the
Subsidiary will be qualifying income whether received in the form of current
distributions or as undistributed subpart F income. There is no authority
directly addressing some of the issues of the law considered in these rulings.
There can be no assurance that the Internal Revenue Service will not change its
position with respect to some or all of these issues or, if the Internal Revenue
Service did so, that a court would not sustain, such contrary positions. If the
Internal Revenue Service were to change its position on some or all of these
issues, and if such contrary positions were upheld, the Fund might cease to
qualify as a RIC. A PLR may only be relied upon by the taxpayer to whom it was
provided. The Fund does not plan to seek a PLR. The Fund has obtained an opinion
from special tax counsel that if the Subsidiary distributes income in the same
year that Fund must include the Subsidiary's income in the Fund's income, the
income from the Subsidiary will be qualifying income for the Fund, and, if the
Subsidiary does not make such distributions, the income from the Subsidiary
should be qualifying income for the Fund. However, such an opinion is not
binding on the Internal Revenue Service. Therefore, to the extent the Fund
invests directly in commodity-index-linked derivative instruments or in the
Subsidiary, the Internal Revenue Service may contest the Fund's characterization
of the income produced by such assets as qualifying income which, if successful,
could cause the Fund to fail to qualify as a RIC. Shareholders and potential
investors should be aware that, in July 2011, the Internal Revenue Service
suspended the issuance of such PLRs pending its re-examination of the policies
underlying them, which was still ongoing at the date of this prospectus. If, at
the end of that re-examination, the Internal Revenue Service changes its
position with respect to the conclusions reached in those PLRs, then the Fund
may be required to restructure its investments to satisfy the qualifying income
requirement or might cease to qualify as a RIC. The Fund and the Advisor plan to
direct investments of the Fund's assets in conformance with Revenue Ruling
2006-31, Internal Revenue Service guidance, and the advice of counsel.
If the Fund did not qualify as a RIC for any taxable year and certain relief
provisions were not available, the Fund's taxable income would be subject to tax
at the Fund level and to a further tax at the shareholder level when such income
is distributed. In such event, in order to re-qualify for taxation as a RIC, the
Fund might be required to recognize unrealized gains, pay substantial taxes and
interest and make certain distributions. This would cause investors to incur
higher tax liabilities than they otherwise would have incurred and would have a
20
negative impact on Fund returns. In such event, the Fund's Board of Trustees may
determine to reorganize or close the Fund or materially change the Fund's
investment objective and strategies.
The Subsidiary intends to conduct its affairs in a manner such that it will not
be subject to U.S. federal income tax. It will, however, be considered a
controlled foreign corporation, and the Fund will be required to include as
income annually amounts earned by the Subsidiary during that year, whether or
not distributed by the Subsidiary. Furthermore, the Fund will be subject to the
RIC qualification distribution requirements with respect to the Subsidiary's
income, whether or not the Subsidiary makes a distribution to the Fund during
the taxable year and thus the Fund may not have sufficient cash on hand to make
such distribution.
Changes in the laws of the United States and/or the Cayman Islands, under which
the Fund and the Subsidiary is organized, respectively, could result in the
inability of the Fund and/or the Subsidiary to operate as described in this
prospectus and could negatively affect the Fund and its shareholders. For
example, Cayman Islands law does not currently impose any income, corporate or
capital gains tax, estate duty, inheritance tax, gift tax or withholding tax on
the Subsidiary. If Cayman Islands law changes such that the Subsidiary must pay
Cayman Islands governmental authority taxes, the Fund's shareholders would
likely suffer decreased investment returns. There remains a risk that the tax
treatment of swap agreements and other derivative instruments, such as
commodity-linked notes, swap agreements, commodity options, futures and options
on futures, may be affected by future regulatory or legislative changes that
could affect the character, timing and/or amount of the Fund's taxable income or
gains and distributions.
DISTRIBUTION PLAN
FTP serves as the distributor of Creation Units for the Fund on an agency basis.
FTP does not maintain a secondary market in shares.
The Board has adopted a Distribution and Service Plan pursuant to Rule 12b-1
under the 1940 Act. In accordance with its Rule 12b-1 plan, the Fund is
authorized to pay an amount up to 0.25% of its average daily net assets each
year to reimburse FTP for amounts expended to finance activities primarily
intended to result in the sale of Creation Units or the provision of investor
services. FTP may also use this amount to compensate securities dealers or other
persons that are APs for providing distribution assistance, including
broker-dealer and shareholder support and educational and promotional services.
The Fund does not currently pay 12b-1 fees, and pursuant to a contractual
arrangement, the Fund will not pay 12b-1 fees any time before April 30, 2016.
However, in the event 12b-1 fees are charged in the future, because these fees
are paid out of the Fund's assets, over time these fees will increase the cost
of your investment and may cost you more than certain other types of sales
charges.
NET ASSET VALUE
The Fund's net asset value is determined as of the close of trading (normally
4:00 p.m., Eastern Time) on each day the New York Stock Exchange is open for
business. Net asset value is calculated for the Fund by taking the market price
of the Fund's total assets, including interest or dividends accrued but not yet
collected, less all liabilities, and dividing such amount by the total number of
shares outstanding. The result, rounded to the nearest cent, is the net asset
value per share. All valuations are subject to review by the Board or its
delegate.
The Fund's investments are valued daily in accordance with valuation procedures
adopted by the Board, and in accordance with provisions of the 1940 Act. Certain
securities in which the Fund may invest are not listed on any securities
exchange or board of trade. Such securities are typically bought and sold by
institutional investors in individually negotiated private transactions that
function in many respects like an over-the-counter secondary market, although
typically no formal market makers exist. Certain securities, particularly debt
securities, have few or no trades, or trade infrequently, and information
regarding a specific security may not be widely available or may be incomplete.
Accordingly, determinations of the fair value of debt securities may be based on
infrequent and dated information. Because there is less reliable, objective data
available, elements of judgment may play a greater role in valuation of debt
securities than for other types of securities. Typically, debt securities are
valued using information provided by a third-party pricing service. The
third-party pricing service primarily uses broker quotes to value the
securities.
The Fund's investments are valued at market value or, in the absence of market
value with respect to any portfolio securities, at fair value, in accordance
with valuation procedures adopted by the Board and in accordance with the 1940
Act. Portfolio securities listed on any exchange other than NASDAQ(R) and the
London Stock Exchange Alternative Investment Market ("AIM") are valued at the
21
last sale price on the business day as of which such value is being determined.
Securities listed on NASDAQ(R) or the AIM are valued at the official closing
price on the business day as of which such value is being determined. If there
has been no sale on such day, or no official closing price in the case of
securities traded on NASDAQ(R) or the AIM, the securities are fair valued at the
mean of the most recent bid and ask prices on such day. Portfolio securities
traded on more than one securities exchange are valued at the last sale price or
official closing price, as applicable, on the business day as of which such
value is being determined at the close of the exchange representing the
principal market for such securities. Portfolio securities traded in the
over-the-counter market, but excluding securities trading on NASDAQ(R) or the
AIM, are fair valued at the mean of the most recent bid and asked price, if
available, and otherwise at the closing bid price. Short-term investments that
mature in less than 60 days when purchased are fair valued at cost adjusted for
amortization of premiums and accretion of discount, provided the Advisor's
Pricing Committee has determined that the use of amortized cost is an
appropriate reflection of fair value given market and issuer-specific conditions
existing at the time of the determination. Net asset value may change on days
when investors may not sell or redeem Fund shares.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Board or its delegate, the
Advisor's Pricing Committee, at fair value. The use of fair value pricing by the
Fund is governed by valuation procedures adopted by the Board and in accordance
with the provisions of the 1940 Act. These securities generally include, but are
not limited to, certain restricted securities (securities which may not be
publicly sold without registration under the Securities Act) for which a pricing
service is unable to provide a market price; securities whose trading has been
formally suspended; a security whose market or fair value price is not available
from a pre-established pricing source; a security with respect to which an event
has occurred that is likely to materially affect the value of the security after
the market has closed but before the calculation of the Fund's net asset value
or make it difficult or impossible to obtain a reliable market quotation; and a
security whose price, as provided by the pricing service, does not reflect the
security's fair value. As a general principle, the current fair value of a
security would appear to be the amount which the owner might reasonably expect
to receive for the security upon its current sale. When fair value prices are
used, generally they will differ from the current market quotations or official
closing prices on the applicable exchange. A variety of factors may be
considered in determining the fair value of such securities. The Subsidiary's
holdings will be valued in the same manner as the Fund's holdings. See the
Fund's SAI for details.
Because foreign securities exchanges may be open on different days than the days
during which an investor may purchase or sell shares of the Fund, the value of
the Fund's securities may change on days when investors are not able to purchase
or sell shares of the Fund. The value of securities denominated in foreign
currencies is converted into U.S. dollars at the exchange rates in effect at the
time of valuation.
Exchange-traded futures contracts will be valued at the closing price in the
market where such contracts are principally traded. If no closing price is
available, exchange-traded futures contracts will be fair valued at the mean of
the last bid and asked prices, if available, and otherwise at the closing bid
price.
FUND SERVICE PROVIDERS
Brown Brothers Harriman & Co., 50 Post Office Square, Boston, Massachusetts
02110, acts as the administrator, accounting agent, custodian and transfer agent
to the Fund. Chapman and Cutler LLP, 111 West Monroe Street, Chicago, Illinois
60603, serves as legal counsel to the Fund. First Trust serves as the fund
reporting agent for the Fund.
PREMIUM/DISCOUNT INFORMATION
The table that follows presents information about the differences between the
Fund's daily market price on NASDAQ(R) and its net asset value. The "Market
Price" of the Fund generally is determined using the midpoint between the
highest bid and lowest offer on NASDAQ(R), as of the time the Fund's net asset
value is calculated. The Fund's Market Price may be at, above or below its net
asset value. The net asset value of the Fund will fluctuate with changes in the
market value of its portfolio holdings. The Market Price of the Fund will
fluctuate in accordance with changes in its net asset value, as well as market
supply and demand.
Premiums or discounts are the differences (generally expressed as a percentage)
between the net asset value and Market Price of the Fund on a given day,
generally at the time net asset value is calculated. A premium is the amount
that the Fund is trading above the reported net asset value. A discount is the
amount that the Fund is trading below the reported net asset value.
The following information shows the frequency distribution of premiums and
discounts of the daily bid/ask price of the Fund against its net asset value.
The information shown is for the period indicated. Shareholders may pay more
than net asset value when they buy Fund shares and receive less than net asset
value when they sell those shares because shares are bought and sold at current
market price. All data presented here represents past performance, which cannot
22
be used to predict future results. Information about the premiums and discounts
at which the Fund's shares have traded is available on the Fund's website at
www.ftportfolios.com.
FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC)
BID/ASK MIDPOINT VS. NET ASSET VALUE
NUMBER OF DAYS BID/ASK MIDPOINT AT/ABOVE NET ASSET VALUE
0.00% - 0.49% 0.50% - 0.99% 1.00% - 1.99% >= 2.00%
1/1/2014 - 12/31/2014 188 5 1 0
3 Months Ended 3/31/2015 40 2 1 0
NUMBER OF DAYS BID/ASK MIDPOINT BELOW NET ASSET VALUE
0.00% - 0.49% 0.50% - 0.99% 1.00% - 1.99% >= 2.00%
1/1/2014 - 12/31/2014 57 1 0 0
3 Months Ended 3/31/2015 18 0 0 0
TOTAL RETURN INFORMATION
The table below compares the total return of the Fund to the Fund's benchmark
index. The information presented for the Fund is for the period indicated.
"Average annual total returns" represent the average annual change in the value
of an investment over the period indicated. "Cumulative total returns" represent
the total change in value of an investment over the period indicated. The net
asset value per share of the Fund is the value of one share of the Fund and is
computed by dividing the value of all assets of the Fund (including accrued
interest and dividends), less liabilities (including accrued expenses and
dividends declared but unpaid), by the total number of outstanding shares. The
net asset value return is based on the net asset value per share of the Fund,
and the market return is based on the market price per share of the Fund. The
price used to calculate market return ("Market Price") generally is determined
by using the midpoint between the highest bid and the lowest offer on NASDAQ(R)
on which the shares of the Fund are listed for trading, as of the time that the
Fund's net asset value is calculated. Since the shares of the Fund typically do
not trade in the secondary market until several days after the Fund's inception,
for the period from inception to the first day of secondary market trading in
shares of the Fund, the net asset value of the Fund is used as a proxy for the
secondary market trading price to calculate market returns. Market and net asset
value returns assume that dividends and capital gain distributions have been
reinvested in the Fund at Market Price and net asset value, respectively. An
index is a statistical composite that tracks a specified financial market or
sector. Unlike the Fund, an index does not actually hold a portfolio of
securities and therefore does not incur the expenses incurred by the Fund. These
expenses negatively impact the performance of the Fund. Also, market returns do
not include brokerage commissions that may be payable on secondary market
transactions. If brokerage commissions were included, market returns would be
lower. The total returns reflect the reinvestment of dividends on securities in
the Indices. The returns shown in the table below do not reflect the deduction
of taxes that a shareholder would pay on Fund distributions or the redemption or
sale of shares of the Fund. The investment return and principal value of shares
of the Fund will vary with changes in market conditions. Shares of the Fund may
be worth more or less than their original cost when they are redeemed or sold in
the market. The Fund's past performance is no guarantee of future results.
FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC)
AVERAGE ANNUAL CUMULATIVE
TOTAL RETURNS TOTAL RETURNS
1 YEAR INCEPTION INCEPTION
ENDED (10/22/2013) (10/22/2013)
12/31/2014 TO 12/31/2014 TO 12/31/2014
FUND PERFORMANCE
Net Asset Value -11.89% -10.60% -12.50%
Market Price -11.65% -10.37% -12.24%
INDEX PERFORMANCE
Bloomberg Commodity Index(1) -17.01% -15.80% -18.53%
S&P GSCI(R) Total Return Index -33.06% -28.89% -33.39%
S&P 500(R) Index 13.69% 16.76% 20.28%
(1) The Bloomberg Commodity Index is the Fund's benchmark. The benchmark's name
changed from Dow Jones-UBS Commodity Index to Bloomberg Commodity Index as
of July 1, 2014.
23
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand the Fund's
financial performance for the periods shown. Certain information reflects
financial results for a single share of the Fund. The total returns represent
the rate that an investor would have earned (or lost) on an investment in the
Fund (assuming reinvestment of all dividends and distributions). The information
for the periods indicated has been derived from financial statements audited by
Deloitte & Touche LLP whose report, along with the Fund's financial statements,
is included in the Annual Report to Shareholders dated December 31, 2014 and is
incorporated by reference in the Fund's SAI, which is available upon request.
FINANCIAL HIGHLIGHTS
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD
FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND (FTGC)
FOR THE PERIOD
FOR THE YEAR 10/22/2013 (a)
ENDED THROUGH
12/31/2014 12/31/2013
------------- ---------------
Net asset value, beginning of period $ 29.78 $ 29.99
---------- ----------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) (0.38) (0.05)
Net realized and unrealized gain (loss) (3.16) (0.16)
---------- ----------
Total from investment operations (3.54) (0.21)
---------- ----------
Net asset value, end of period $ 26.24 $ 29.78
========== ==========
TOTAL RETURN (b) (11.89)% (0.70)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) $ 175,910 $ 3,077
RATIOS TO AVERAGE NET ASSETS:
Ratio of total expenses to average net assets 0.95% 0.95%(c)
Ratio of net investment income (loss) to
average net assets (0.92)% (0.92)%(c)
Portfolio turnover rate (d) 0% 0%
(a) Inception date is consistent with the commencement of investment
operations. First Trust Portfolios L.P. seeded the Fund on September 9,
2013 in order to provide initial capital required by Securities and
Exchange Commission rules.
(b) Total return is calculated assuming an initial investment made at the net
asset value at the beginning of the period, reinvestment of all dividend
distributions at net asset value during the period, and redemption at net
asset value on the last day of the period. The returns presented do not
reflect the deduction of taxes that a shareholder would pay on Fund
distributions or the redemption or sale of Fund shares. Total return is
calculated for the time period presented and is not annualized for periods
of less than a year.
(c) Annualized.
(d) Portfolio turnover is calculated for the time period presented and is not
annualized for periods of less than a year and does not include securities
received or delivered from processing creations or redemptions,
derivatives and in-kind transactions.
24
OTHER INFORMATION
CONTINUOUS OFFERING
The Fund issues, on a continuous offering basis, its shares in one or more
groups of a fixed number of Fund shares (each such group of such specified
number of individual Fund shares, a "Creation Unit Aggregation"). The method by
which Creation Unit Aggregations of Fund shares are created and traded may raise
certain issues under applicable securities laws. Because new Creation Unit
Aggregations of shares are issued and sold by the Fund on an ongoing basis, a
"distribution," as such term is used in the Securities Act, may occur at any
point. Broker-dealers and other persons are cautioned that some activities on
their part may, depending on the circumstances, result in their being deemed
participants in a distribution in a manner which could render them statutory
underwriters and subject them to the prospectus delivery requirement and
liability provisions of the Securities Act.
For example, a broker-dealer firm or its client may be deemed a statutory
underwriter if it takes Creation Unit Aggregations after placing an order with
FTP, breaks them down into constituent shares and sells such shares directly to
customers, or if it chooses to couple the creation of a supply of new shares
with an active selling effort involving solicitation of secondary market demand
for shares. A determination of whether one is an underwriter for purposes of the
Securities Act must take into account all the facts and circumstances pertaining
to the activities of the broker-dealer or its client in the particular case, and
the examples mentioned above should not be considered a complete description of
all the activities that could lead to a characterization as an underwriter.
Broker-dealer firms should also note that dealers who are not "underwriters" but
are effecting transactions in shares, whether or not participating in the
distribution of shares, are generally required to deliver a prospectus. This is
because the prospectus delivery exemption in Section 4(a)(3) of the Securities
Act is not available in respect of such transactions as a result of Section
24(d) of the 1940 Act. The Trust, on behalf of the Fund, however, has received
from the Securities and Exchange Commission an exemption from the prospectus
delivery obligation in ordinary secondary market transactions under certain
circumstances, on the condition that purchasers are provided with a product
description of the shares. As a result, broker-dealer firms should note that
dealers who are not underwriters but are participating in a distribution (as
contrasted with ordinary secondary market transactions) and thus dealing with
the shares that are part of an overallotment within the meaning of Section
4(a)(3)(C) of the Securities Act would be unable to take advantage of the
prospectus delivery exemption provided by Section 4(a)(3) of the Securities Act.
Firms that incur a prospectus delivery obligation with respect to shares are
reminded that, under the Securities Act Rule 153, a prospectus delivery
obligation under Section 5(b)(2) of the Securities Act owed to a broker-dealer
in connection with a sale on NASDAQ(R) is satisfied by the fact that the
prospectus is available from NASDAQ(R) upon request. The prospectus delivery
mechanism provided in Rule 153 is available with respect to transactions on a
national securities exchange, a trading facility or an alternative trading
system.
25
First Trust First Trust Exchange-Traded Fund VII
--------------------------------------------------------------------------------
First Trust Global Tactical Commodity Strategy Fund
FOR MORE INFORMATION
For more detailed information on the Fund, several additional sources of
information are available to you. The SAI, incorporated by reference into this
prospectus, contains detailed information on the Fund's policies and operation.
Additional information about the Fund's investments is available in the annual
and semi-annual reports to shareholders. In the Fund's annual report, you will
find a discussion of the market conditions and investment strategies that
significantly impacted the Fund's performance during the last fiscal year. The
Fund's most recent SAI, annual or semi-annual reports and certain other
information are available free of charge by calling the Fund at (800) 621-1675,
on the Fund's website at www.ftportfolios.com or through your financial advisor.
Shareholders may call the toll-free number above with any inquiries.
You may obtain this and other information regarding the Fund, including the SAI
and Codes of Ethics adopted by First Trust, FTP and the Trust, directly from the
Securities and Exchange Commission (the "SEC"). Information on the SEC's website
is free of charge. Visit the SEC's on-line EDGAR database at http://www.sec.gov
or in person at the SEC's Public Reference Room in Washington, D.C., or call the
SEC at (202) 551-8090 for information on the Public Reference Room. You may also
request information regarding the Fund by sending a request (along with a
duplication fee) to the SEC's Public Reference Section, 100 F Street, N.E.,
Washington, D.C. 20549-1520 or by sending an electronic request to
publicinfo@sec.gov.
First Trust Advisors L.P.
120 East Liberty Drive, Suite 400
Wheaton, Illinois 60187
(800) 621-1675 SEC File #: 333-184918
www.ftportfolios.com 811-22767
STATEMENT OF ADDITIONAL INFORMATION
INVESTMENT COMPANY ACT FILE NO. 811-22767
FIRST TRUST EXCHANGE-TRADED FUND VII
TICKER
FUND NAME SYMBOL EXCHANGE
FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND FTGC NASDAQ(R)
DATED MAY 1, 2015
This Statement of Additional Information ("SAI") is not a prospectus. It
should be read in conjunction with the prospectus dated May 1, 2015, as it may
be revised from time to time (the "Prospectus") for First Trust Global Tactical
Commodity Strategy Fund (the "Fund"), a series of the First Trust
Exchange-Traded Fund VII (the "Trust"). Capitalized terms used herein that are
not defined have the same meaning as in the Prospectus, unless otherwise noted.
A copy of the Prospectus may be obtained without charge by writing to the
Trust's distributor, First Trust Portfolios L.P., 120 East Liberty Drive, Suite
400, Wheaton, Illinois 60187, or by calling toll free at (800) 621-1675.
TABLE OF CONTENTS
GENERAL DESCRIPTION OF THE TRUST AND THE FUND..................................1
EXCHANGE LISTING AND TRADING...................................................3
INVESTMENT OBJECTIVE AND POLICIES..............................................4
INVESTMENT STRATEGIES..........................................................5
INVESTMENT RISKS..............................................................15
ADDITIONAL PROVISIONS CONCERNING THE FUND'S AND THE SUBSIDIARY'S
INVESTMENTS..............................................................18
MANAGEMENT OF THE FUND........................................................19
ACCOUNTS MANAGED BY INVESTMENT COMMITTEE......................................33
BROKERAGE ALLOCATIONS.........................................................33
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT..................35
ADDITIONAL PAYMENTS TO FINANCIAL INTERMEDIARIES...............................37
ADDITIONAL INFORMATION........................................................39
PROXY VOTING POLICIES AND PROCEDURES..........................................41
CREATION AND REDEMPTION OF CREATION UNIT AGGREGATIONS.........................42
REGULAR HOLIDAYS..............................................................49
FEDERAL TAX MATTERS...........................................................53
DETERMINATION OF NET ASSET VALUE..............................................60
DIVIDENDS AND DISTRIBUTIONS...................................................62
MISCELLANEOUS INFORMATION.....................................................63
FINANCIAL STATEMENTS..........................................................63
EXHIBIT A - PRINCIPAL HOLDERS TABLE..........................................A-1
EXHIBIT B - PROXY VOTING GUIDELINES..........................................B-1
EXHIBIT C - CREDIT RATING DEFINITIONS........................................C-1
The audited financial statements for the Fund's most recent fiscal period
appears in the Fund's Annual Report to Shareholders dated December 31, 2014,
which was filed with the Securities and Exchange Commission (the "SEC") on
February 27, 2015. The financial statements from such Annual Report are
incorporated herein by reference. The Annual Report is available without charge
by calling (800) 621-1675 or by visiting the SEC's website at
http://www.sec.gov.
- ii -
GENERAL DESCRIPTION OF THE TRUST AND THE FUND
The Trust was organized as a Massachusetts business trust on November 6,
2012 and is authorized to issue an unlimited number of shares in one or more
series or "Funds." The Trust is an open-end management investment company,
registered under the Investment Company Act of 1940, as amended (the "1940
Act"). The Trust currently offers shares in one series, the Fund, which is a
non-diversified series.
This SAI relates to the Fund. The Fund, as a series of the Trust,
represents a beneficial interest in a separate portfolio of securities and other
assets, with its own objective and policies.
The Board of Trustees of the Trust (the "Board of Trustees" or the
"Trustees") has the right to establish additional series in the future, to
determine the preferences, voting powers, rights and privileges thereof and to
modify such preferences, voting powers, rights and privileges without
shareholder approval. Shares of any series may also be divided into one or more
classes at the discretion of the Trustees.
The Trust or any series or class thereof may be terminated at any time by
the Board of Trustees upon written notice to the shareholders.
Each share has one vote with respect to matters upon which a shareholder
vote is required consistent with the requirements of the 1940 Act and the rules
promulgated thereunder. Shares of all series of the Trust vote together as a
single class except as otherwise required by the 1940 Act, or if the matter
being voted on affects only a particular series, and, if a matter affects a
particular series differently from other series, the shares of that series will
vote separately on such matter.
The Trust's Declaration of Trust (the "Declaration") requires a
shareholder vote only on those matters where the 1940 Act requires a vote of
shareholders and otherwise permits the Trustees to take actions without seeking
the consent of shareholders. For example, the Declaration gives the Trustees
broad authority to approve reorganizations between the Fund and another entity,
such as another exchange-traded fund, or the sale of all or substantially all of
the Fund's assets, or the termination of the Trust or the Fund without
shareholder approval if the 1940 Act would not require such approval.
The Declaration provides that by becoming a shareholder of the Fund, each
shareholder shall be expressly held to have agreed to be bound by the provisions
of the Declaration. The Declaration may, except in limited circumstances, be
amended by the Trustees in any respect without a shareholder vote. The
Declaration provides that the Trustees may establish the number of Trustees and
that vacancies on the Board of Trustees may be filled by the remaining Trustees,
except when election of Trustees by the shareholders is required under the 1940
Act. Trustees are then elected by a plurality of votes cast by shareholders at a
meeting at which a quorum is present. The Declaration also provides that
Trustees may be removed, with or without cause, by a vote of shareholders
holding at least two-thirds of the voting power of the Trust, or by a vote of
two-thirds of the remaining Trustees. The provisions of the Declaration relating
to the election and removal of Trustees may not be amended without the approval
of two-thirds of the Trustees.
The holders of Fund shares are required to disclose information on direct
or indirect ownership of Fund shares as may be required to comply with various
laws applicable to the Fund or as the Trustees may determine, and ownership of
Fund shares may be disclosed by the Fund if so required by law or regulation. In
addition, pursuant to the Declaration, the Trustees may, in their discretion,
require the Trust to redeem shares held by any shareholder for any reason under
terms set by the Trustees. The Declaration provides a detailed process for the
bringing of derivative actions by shareholders in order to permit legitimate
inquiries and claims while avoiding the time, expense, distraction and other
harm that can be caused to the Fund or its shareholders as a result of spurious
shareholder demands and derivative actions. Prior to bringing a derivative
action, a demand must first be made on the Trustees. The Declaration details
various information, certifications, undertakings and acknowledgements that must
be included in the demand. Following receipt of the demand, the Trustees have a
period of 90 days, which may be extended by an additional 60 days, to consider
the demand. If a majority of the Trustees who are considered independent for the
purposes of considering the demand determine that maintaining the suit would not
be in the best interests of the Fund, the Trustees are required to reject the
demand and the complaining shareholder may not proceed with the derivative
action unless the shareholder is able to sustain the burden of proof to a court
that the decision of the Trustees not to pursue the requested action was not a
good faith exercise of their business judgment on behalf of the Fund. In making
such a determination, a Trustee is not considered to have a personal financial
interest by virtue of being compensated for his or her services as a Trustee. If
a demand is rejected, the complaining shareholder will be responsible for the
costs and expenses (including attorneys' fees) incurred by the Fund in
connection with the consideration of the demand under a number of circumstances.
If a derivative action is brought in violation of the Declaration, the
shareholder bringing the action may be responsible for the Fund's costs,
including attorneys' fees. The Declaration also provides that any shareholder
bringing an action against the Fund waives the right to trial by jury to the
fullest extent permitted by law.
The Trust is not required to and does not intend to hold annual meetings
of shareholders.
Under Massachusetts law applicable to Massachusetts business trusts,
shareholders of such a trust may, under certain circumstances, be held
personally liable as partners for its obligations. However, the Declaration
contains an express disclaimer of shareholder liability for acts or obligations
of the Trust and requires that notice of this disclaimer be given in each
agreement, obligation or instrument entered into or executed by the Trust or the
Trustees. The Declaration further provides for indemnification out of the assets
and property of the Trust for all losses and expenses of any shareholder held
personally liable for the obligations of the Trust. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which both inadequate insurance existed and the
Trust or the Fund itself was unable to meet its obligations.
The Declaration further provides that a Trustee acting in his or her
capacity as Trustee is not personally liable to any person other than the Trust
or its shareholders, for any act, omission, or obligation of the Trust. The
Declaration requires the Trust to indemnify any persons who are or who have been
Trustees, officers or employees of the Trust for any liability for actions or
failure to act except to the extent prohibited by applicable federal law. In
making any determination as to whether any person is entitled to the advancement
- 2 -
of expenses in connection with a claim for which indemnification is sought, such
person is entitled to a rebuttable presumption that he or she did not engage in
conduct for which indemnification is not available. The Declaration provides
that any Trustee who serves as chair of the Board of Trustees or of a committee
of the Board of Trustees, as lead independent Trustee or as audit committee
financial expert, or in any other similar capacity will not be subject to any
greater standard of care or liability because of such position.
The Fund is advised by First Trust Advisors L.P. (the "Advisor" or "First
Trust").
The shares of the Fund list and principally trade on The NASDAQ Stock
Market(R) ("NASDAQ(R)" or the "Exchange"). The shares will trade on the Exchange
at market prices that may be below, at or above net asset value. The Fund offers
and issues shares at net asset value only in aggregations of a specified number
of shares (each a "Creation Unit" or a "Creation Unit Aggregation"), generally
in exchange for a basket of securities and other instruments (the "Deposit
Securities"), together with the deposit of a specified cash payment (the "Cash
Component"), or for cash as specified in the Prospectus. Creation Units are
aggregations of 50,000 shares of the Fund.
The Trust reserves the right to permit creations and redemptions of Fund
shares to be made in whole or in part on a cash basis under certain
circumstances. Fund shares may be issued in advance of receipt of Deposit
Securities subject to various conditions including a requirement to maintain on
deposit with the Fund cash at least equal to 115% of the market value of the
missing Deposit Securities. See the section entitled "Creation and Redemption of
Creation Unit Aggregations." In each instance of such cash creations or
redemptions, transaction fees may be imposed that will be higher than the
transaction fees associated with in-kind creations or redemptions. In all cases,
such fees will be limited in accordance with the requirements of the SEC
applicable to management investment companies offering redeemable securities.
EXCHANGE LISTING AND TRADING
There can be no assurance that the requirements of the Exchange necessary
to maintain the listing of shares of the Fund will continue to be met. The
Exchange may, but is not required to, remove the shares of the Fund from listing
if (i) following the initial 12-month period beginning at the commencement of
trading of the Fund, there are fewer than 50 beneficial owners of the shares of
the Fund for 30 or more consecutive trading days or (ii) such other event shall
occur or condition exist that, in the opinion of the Exchange, makes further
dealings on the Exchange inadvisable. The Exchange will remove the shares of the
Fund from listing and trading upon termination of the Fund.
As in the case of other stocks traded on the Exchange, brokers'
commissions on transactions will be based on negotiated commission rates at
customary levels.
The Fund reserves the right to adjust the price levels of shares in the
future to help maintain convenient trading ranges for investors. Any adjustments
- 3 -
would be accomplished through stock splits or reverse stock splits, which would
have no effect on the net assets of the Fund.
INVESTMENT OBJECTIVE AND POLICIES
The Prospectus describes the investment objective and certain policies of
the Fund. The following supplements the information contained in the Prospectus
concerning the investment objective and policies of the Fund.
The Fund is subject to the following fundamental policies, which may not
be changed without approval of the holders of a majority of the outstanding
voting securities (as such term is defined in the 1940 Act) of the Fund:
(1) The Fund may not issue senior securities, except as permitted
under the 1940 Act.
(2) The Fund may not borrow money, except that the Fund may (i)
borrow money from banks for temporary or emergency purposes (but not for
leverage or the purchase of investments) and (ii) engage in other
transactions permissible under the 1940 Act that may involve a borrowing
(such as obtaining short-term credits as are necessary for the clearance
of transactions, engaging in delayed-delivery transactions, or purchasing
certain futures), provided that the combination of (i) and (ii) shall not
exceed 33-1/3% of the value of the Fund's total assets (including the
amount borrowed), less the Fund's liabilities (other than borrowings).
(3) The Fund will not underwrite the securities of other issuers
except to the extent the Fund may be considered an underwriter under the
Securities Act of 1933, as amended (the "1933 Act"), in connection with
the purchase and sale of portfolio securities.
(4) The Fund will not purchase or sell real estate or interests
therein, unless acquired as a result of ownership of securities or other
instruments (but this shall not prohibit the Fund from purchasing or
selling securities or other instruments backed by real estate or of
issuers engaged in real estate activities).
(5) The Fund may not make loans to other persons, except through
(i) the purchase of debt securities permissible under the Fund's
investment policies, (ii) repurchase agreements, or (iii) the lending of
portfolio securities, provided that no such loan of portfolio securities
may be made by the Fund if, as a result, the aggregate of such loans would
exceed 33-1/3% of the value of the Fund's total assets.
(6) The Fund may only purchase or sell physical commodities through
its wholly owned subsidiary, FT Cayman Subsidiary II (the "Subsidiary").
(7) The Fund may not invest 25% or more of the value of its total
assets in securities of issuers in any one industry or group of
- 4 -
industries. This restriction does not apply to obligations issued or
guaranteed by the U.S. government, its agencies or instrumentalities.
For purposes of applying restriction (1) above, under the 1940 Act as
currently in effect, the Fund is not permitted to issue senior securities,
except that the Fund may borrow from any bank if immediately after such
borrowing the value of the Fund's total assets is at least 300% of the principal
amount of all of the Fund's borrowings (i.e., the principal amount of the
borrowings may not exceed 33 1/3% of the Fund's total assets). In the event that
such asset coverage shall at any time fall below 300% the Fund shall, within
three days thereafter (not including Sundays and holidays), reduce the amount of
its borrowings to an extent that the asset coverage of such borrowings shall be
at least 300%. The fundamental investment limitations set forth above limit the
Fund's ability to engage in certain investment practices and purchase securities
or other instruments to the extent permitted by, or consistent with, applicable
law. As such, these limitations will change as the statute, rules, regulations
or orders (or, if applicable, interpretations) change, and no shareholder vote
will be required or sought.
Except for restriction (2), if a percentage restriction is adhered to at
the time of investment, a later increase in percentage resulting from a change
in market value of the investment or the total assets will not constitute a
violation of that restriction. With respect to restriction (2), if the
limitations are exceeded as a result of a change in market value then the Fund
will reduce the amount of borrowings within three days thereafter to the extent
necessary to comply with the limitations (not including Sundays and holidays).
The foregoing fundamental policies of the Fund may not be changed without
the affirmative vote of the majority of the outstanding voting securities of the
Fund. The 1940 Act defines a majority vote as the vote of the lesser of (i) 67%
or more of the voting securities represented at a meeting at which more than 50%
of the outstanding securities are represented; or (ii) more than 50% of the
outstanding voting securities. With respect to the submission of a change in an
investment policy to the holders of outstanding voting securities of the Fund,
such matter shall be deemed to have been effectively acted upon with respect to
the Fund if a majority of the outstanding voting securities of the Fund vote for
the approval of such matter, notwithstanding that such matter has not been
approved by the holders of a majority of the outstanding voting securities of
any other series of the Trust affected by such matter.
In addition to the foregoing fundamental policies, the Fund is also
subject to strategies and policies discussed herein which, unless otherwise
noted, are non-fundamental restrictions and policies and may be changed by the
Board of Trustees.
INVESTMENT STRATEGIES
Under normal market conditions, the Fund through the Subsidiary, invests
principally in exchange-traded commodity futures contracts and exchange-traded
commodity linked instruments ("Commodities Instruments"), along with short-term
investment grade fixed income securities that include U.S. government and agency
securities; sovereign debt obligations of non-U.S. countries and repurchase
agreements; money market instruments; ETFs and other investment companies
registered under the 1940 Act; and cash and other cash equivalents.
- 5 -
TYPES OF INVESTMENTS
Cayman Subsidiary: The Fund may invest up to 25% of its total assets in
the Subsidiary. The Subsidiary may invest in Commodities Instruments, as
described under "Commodities Instruments" below. Because the Fund may invest a
substantial portion of its assets in the Subsidiary, which may hold certain of
the investments described in the Prospectus and this SAI, the Fund may be
considered to be investing indirectly in those investments through the
Subsidiary. Therefore, except as otherwise noted, for purposes of this
disclosure, references to the Fund's investments may also be deemed to include
the Fund's indirect investments through the Subsidiary.
The Subsidiary is not registered under the 1940 Act and is not directly
subject to its investor protections, except as noted in the Prospectus or this
SAI. However, the Subsidiary is wholly-owned and controlled by the Fund and is
advised by First Trust. The Trust's Board of Trustees has oversight
responsibility for the investment activities of the Fund, including its
investment in the Subsidiary, and the Fund's role as the sole shareholder of the
Subsidiary. First Trust receives no additional compensation for managing the
assets of the Subsidiary. The Subsidiary will also enter into separate contracts
for the provision of custody, transfer agency and accounting agent services with
the same service providers or with affiliates of the same service providers that
provide those services to the Fund.
Changes in the laws of the United States (where the Fund is organized)
and/or the Cayman Islands (where the Subsidiary is incorporated) could prevent
the Fund and/or the Subsidiary from operating as described in the Prospectus and
this SAI and could negatively affect the Fund and its shareholders. For example,
the Cayman Islands currently does not impose certain taxes on the Subsidiary,
including income and capital gains tax, among others. If Cayman Islands laws
were changed to require the Subsidiary to pay Cayman Islands taxes, the
investment returns of the Fund would likely decrease.
The financial statements of the Subsidiary will be consolidated with the
Fund's financial statements in the Fund's Annual and Semi-Annual Reports.
Commodities Instruments: The Fund gains exposure to Commodities
Instruments through the Subsidiary. Additional information on the Subsidiary is
set forth under "Cayman Subsidiary" above. Additional information regarding
specific Commodities Instruments is set forth below. The Fund, either directly
or through the Subsidiary, may also gain exposure to Commodities Instruments
through investment in certain investment companies, including exchange-traded
funds ("ETFs"), and other pooled investment vehicles that invest primarily in
commodities or commodity-related instruments, and in exchange-traded notes
("ETNs") linked to the value of commodities.
The Fund may invest up to 25% of its total assets in the Subsidiary, which
will be committed as "initial" and "variation" margin to secure the Subsidiary's
positions in Commodities Instruments. These assets are placed in accounts
maintained by the Subsidiary at the Subsidiary's clearing broker, and are held
in cash or invested in U.S. Treasury bills and other direct or guaranteed debt
- 6 -
obligations of the U.S. government maturing within less than one year at the
time of investment.
Historically, the correlation between the quarterly investment returns of
managed commodities strategies and the quarterly investment returns of
traditional financial assets such as stocks generally was negative. This inverse
relationship occurred generally because managed commodities strategies have
historically tended to increase and decrease in value during different parts of
the business cycle than financial assets. Nevertheless, at various times,
commodities prices may move in tandem with the prices of financial assets and
thus may not provide overall portfolio diversification benefits. The reverse may
be true during "bull markets," when investments in traditional securities such
as stocks may outperform the Subsidiary's commodity-related investments.
However, over the long term, the returns on the Subsidiary's commodity-related
investments are expected to exhibit low or negative correlation with stocks and
bonds.
The Subsidiary will utilize futures contracts. The use of futures is
subject to applicable regulations of the SEC, the several exchanges upon which
they are traded, the Commodity Futures Trading Commission (the "CFTC") and
various state regulatory authorities.
Exchange-Traded Notes: ETNs are a type of senior, unsecured,
unsubordinated debt security issued by financial institutions that combine
aspects of both bonds and ETFs. An ETN's returns are based on the performance of
a market index minus fees and expenses. Similar to ETFs, ETNs are listed on an
exchange and traded in the secondary market. However, unlike an ETF, an ETN can
be held until the ETN's maturity, at which time the issuer will pay a return
linked to the performance of the market index to which the ETN is linked minus
certain fees.
Futures Contracts
The Fund, through the Subsidiary, may purchase and sell futures contracts.
The Subsidiary invests in commodity futures contracts. Commodity futures
contracts are generally based upon commodities within the six principal
commodity groups: energy, industrial metals, agriculture, precious metals, foods
and fibers, and livestock. The price of a commodity futures contract will
reflect the storage costs of purchasing the physical commodity. These storage
costs include the time value of money invested in the physical commodity plus
the actual costs of storing the commodity less any benefits from ownership of
the physical commodity that are not obtained by the holder of a futures contract
(this is sometimes referred to as the "convenience yield"). To the extent that
these storage costs change for an underlying commodity while the Fund is in a
long position on that commodity, the value of the futures contract may change
proportionately.
Commodity futures contracts are traded on futures exchanges. These futures
exchanges offer a central marketplace in which to transact futures contracts, a
clearing corporation to process trades, a standardization of expiration dates
and contract sizes, and the availability of a secondary market. Futures markets
also specify the terms and conditions of delivery as well as the maximum
permissible price movement during a trading session. Additionally, the commodity
futures exchanges may have position limit rules that limit the amount of futures
- 7 -
contracts that any one party may hold in a particular commodity at any point in
time. These position limit rules are designed to prevent any one participant
from controlling a significant portion of the market. In the commodity futures
markets, the exchange clearing corporation takes the other side in all
transactions, either buying or selling directly to the market participants. The
clearinghouse acts as the counterparty to all exchange-traded futures contracts,
that is, the Subsidiary's obligation is to the clearinghouse, and the Subsidiary
will look to the clearinghouse to satisfy the Subsidiary's rights under a
commodity futures contract.
Transaction costs are incurred when a futures contract is bought or sold
and margin deposits must be maintained. A futures contract may be satisfied by
delivery or purchase, as the case may be, of the instrument or by payment of the
change in the cash value of the index. More commonly, futures contracts are
closed out prior to delivery by entering into an offsetting transaction in a
matching futures contract. Although the value of an index might be a function of
the value of certain specified securities, no physical delivery of those
securities is made. If the offsetting purchase price is less than the original
sale price, a gain will be realized; if it is more, a loss will be realized.
Conversely, if the offsetting sale price is more than the original purchase
price, a gain will be realized; if it is less, a loss will be realized. The
transaction costs must also be included in these calculations. There can be no
assurance, however, that the Fund will be able to enter into an offsetting
transaction with respect to a particular futures contract at a particular time.
If the Subsidiary is not able to enter into an offsetting transaction, the
Subsidiary will continue to be required to maintain the margin deposits on the
futures contract.
Margin is the amount of funds that must be deposited by the Fund with its
custodian in a segregated account in the name of the futures commission merchant
in order to initiate futures trading and to maintain the Subsidiary's open
positions in futures contracts. A margin deposit is intended to ensure the
Subsidiary's performance of the futures contract. The margin required for a
particular futures contract is set by the exchange on which the futures contract
is traded and may be significantly modified from time to time by the exchange
during the term of the futures contract. Futures contracts are customarily
purchased and sold on margins that may range upward from less than 5% of the
value of the futures contract being traded.
If the price of an open futures contract changes (by increase in the case
of a sale or by decrease in the case of a purchase) so that the loss on the
futures contract reaches a point at which the margin on deposit does not satisfy
margin requirements, the broker will require an increase in the margin. However,
if the value of a position increases because of favorable price changes in the
futures contract so that the margin deposit exceeds the required margin, the
broker will pay the excess to the Subsidiary. In computing daily net asset
value, the Subsidiary will mark to market the current value of its open futures
contracts. The Subsidiary expects to earn interest income on its margin
deposits.
Because of the low margin deposits required, futures trading involves an
extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the futures contract is deposited as margin, a subsequent 10%
decrease in the value of the futures contract would result in a total loss of
the margin deposit, before any deduction for the transaction costs, if the
account were then closed out. A 15% decrease would result in a loss equal to
- 8 -
150% of the original margin deposit, if the futures contract were closed out.
Thus, a purchase or sale of a futures contract may result in losses in excess of
the amount initially invested in the futures contract. However, the Subsidiary
would presumably have sustained comparable losses if, instead of investing in
the futures contract, it had invested in the underlying financial instrument and
sold it after the decline.
Most U.S. futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The day limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of a trading session.
Once the daily limit has been reached in a particular type of futures contract,
no trades may be made on that day at a price beyond that limit. The daily limit
governs only price movement during a particular trading day and therefore does
not limit potential losses, because the limit may prevent the liquidation of
unfavorable positions. Futures contract prices have occasionally moved to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of futures positions and subjecting some
futures traders to substantial losses. Despite the daily price limits on various
futures exchanges, the price volatility of commodity futures contracts has been
historically greater than that for traditional securities such as stocks and
bonds. To the extent that the Subsidiary invests in commodity futures contracts,
the assets of the Fund and the Subsidiary, and therefore the prices of Fund
shares, may be subject to greater volatility.
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a futures contract. The Subsidiary would continue to
be required to meet margin requirements until the position is closed, possibly
resulting in a decline in the Fund's net asset value. In addition, many of the
contracts discussed above are relatively new instruments without a significant
trading history. As a result, there can be no assurance that an active secondary
market will develop or continue to exist.
Regulatory Aspects of Investments in Futures
First Trust has registered as a "commodity pool operator" with the CFTC.
First Trust's investment decisions may need to be modified, and commodity
contract positions held by the Fund and/or the Subsidiary may have to be
liquidated at disadvantageous times or prices, to avoid exceeding position
limits established by the CFTC, potentially subjecting the Fund to substantial
losses. The regulation of commodity transactions in the United States is a
rapidly changing area of the law and is subject to ongoing modification by
government, self-regulatory and judicial action. The effect of any future
regulatory change on the Fund is impossible to predict, but could be substantial
and adverse to the Fund.
Asset Coverage for Futures Positions
The Fund and Subsidiary will comply with SEC guidance with respect to
coverage of futures positions by registered investment companies. SEC guidance
may require the Fund, in certain circumstances, to segregate cash or liquid
securities on its books and records, or engage in other appropriate measures to
"cover" its obligations under certain futures or derivative contracts. For
example, with respect futures that are not cash settled, the Fund is required to
segregate liquid assets equal to the full notional value of the futures
contract. For futures contracts that are cash settled, the Fund is required to
- 9 -
segregate liquid assets in an amount equal to the Fund's daily mark-to-market
(net) obligation (i.e., the Fund's daily net liability) under the contract.
Securities earmarked or held in a segregated account cannot be sold while the
Fund's futures position is outstanding, unless replaced with other permissible
assets (or otherwise covered), and will be marked-to-market daily. As an
alternative to segregating assets, for any futures contract held by the Fund,
the Fund could purchase a put option on that same futures contract with a strike
price as high or higher than the price of the contract held. The Subsidiary may
not enter into futures positions if such positions will require the Fund to set
aside or earmark more than 100% of its net assets.
Federal Income Tax Treatment of Exchange-Listed Commodity Futures and
Investments in the Subsidiary
The Subsidiary's transactions in exchange-listed commodity futures
contracts will be subject to special provisions of the Internal Revenue Code of
1986, as amended (the "Code"), that, among other things, may affect the
character of gains and losses realized by the Subsidiary (i.e., may affect
whether gains or losses are ordinary or capital, or short-term or long-term),
may accelerate recognition of income to the Subsidiary and may defer Subsidiary
losses. Because the Subsidiary is a controlled foreign corporation for U.S.
federal income tax purposes, this treatment of the Subsidiary's income will
affect the income the Fund must recognize. These rules could, therefore, affect
the character, amount and timing of distributions to shareholders. These
provisions also (a) will require the Subsidiary to mark-to-market certain types
of the positions in its portfolio (i.e., treat them as if they were closed out),
and (b) may cause the Subsidiary and the Fund to recognize income without the
Fund receiving cash with which to make distributions in amounts necessary to
satisfy the 90% distribution requirement for qualifying to be taxed as a
regulated investment company and the distribution requirement for avoiding
excise taxes.
The Fund intends to treat any income it may derive from Commodities
Instruments (other than derivatives described in Revenue Rulings 2006 1 and 2006
31) received by the Subsidiary as "qualifying income" under the provisions of
the Code applicable to "regulated investment companies" ("RICs"), based on a tax
opinion received from Fund counsel that was based, in part, on numerous private
letter rulings ("PLRs") provided to third parties not associated with the Fund
or its affiliates (which only those parties may cite as precedent). Shareholders
and potential investors should be aware, however, that, in July 2011, the
Internal Revenue Service ("IRS") suspended the issuance of such PLRs pending its
re-examination of the policies underlying them, which was still ongoing at the
date of this SAI. If, at the end of that re-examination, the IRS changes its
position with respect to the conclusions reached in those PLRs, then the Fund
may be required to restructure its investments to satisfy the qualifying income
requirement or it might cease to qualify as a RIC.
Fixed Income Investments and Cash Equivalents: Normally, the Fund invests
substantially all of its assets to meet its investment objective and
consequently invests significantly in fixed income securities. However, in
certain instances, for temporary or defensive purposes, the Fund may also invest
- 10 -
in other cash equivalents in order to provide income, liquidity, preserve
capital and serve as collateral for the Subsidiary's investments in Commodities
Instruments.
Fixed income investments and cash equivalents held by the Fund may
include, without limitation, the types of investments set forth below:
(1) The Fund may invest in U.S. government securities, including
bills, notes and bonds differing as to maturity and rates of interest,
which are either issued or guaranteed by the U.S. Treasury or by U.S.
government agencies or instrumentalities. U.S. government securities
include securities that are issued or guaranteed by the United States
Treasury, by various agencies of the U.S. government, or by various
instrumentalities that have been established or sponsored by the U.S.
government. U.S. Treasury securities are backed by the "full faith and
credit" of the United States. Securities issued or guaranteed by federal
agencies and U.S. government-sponsored instrumentalities may or may not be
backed by the full faith and credit of the United States. Some of the U.S.
government agencies that issue or guarantee securities include the
Export-Import Bank of the United States, the Farmers Home Administration,
the Federal Housing Administration, the Maritime Administration, the Small
Business Administration and the Tennessee Valley Authority. An
instrumentality of the U.S. government is a government agency organized
under federal charter with government supervision. Instrumentalities
issuing or guaranteeing securities include, among others, the Federal Home
Loan Banks, the Federal Land Banks, the Central Bank for Cooperatives,
Federal Intermediate Credit Banks and the Federal National Mortgage
Association ("Fannie Mae"). In the case of those U.S. government
securities not backed by the full faith and credit of the United States,
the investor must look principally to the agency or instrumentality
issuing or guaranteeing the security for ultimate repayment and may not be
able to assert a claim against the United States itself in the event that
the agency or instrumentality does not meet its commitment. The U.S.
government, its agencies and instrumentalities do not guarantee the market
value of their securities, and consequently, the value of such securities
may fluctuate. In addition, the Fund may invest in sovereign debt
obligations of non-U.S. countries. A sovereign debtor's willingness or
ability to repay principal and interest in a timely manner may be affected
by a number of factors, including its cash flow situation, the extent of
its non-U.S. reserves, the availability of sufficient non-U.S. exchange on
the date a payment is due, the relative size of the debt service burden to
the economy as a whole, the sovereign debtor's policy toward principal
international lenders and the political constraints to which it may be
subject.
(2) The Fund may invest in certificates of deposit issued against
funds deposited in a bank or savings and loan association. Such
certificates are for a definite period of time, earn a specified rate of
return and are normally negotiable. If such certificates of deposit are
non-negotiable, they will be considered illiquid securities and be subject
to the Fund's 15% restriction on investments in illiquid securities.
Pursuant to the certificate of deposit, the issuer agrees to pay the
amount deposited plus interest to the bearer of the certificate on the
date specified thereon. Under current FDIC regulations, the maximum
insurance payable as to any one certificate of deposit is $250,000;
- 11 -
therefore, certificates of deposit purchased by the Fund may not be fully
insured. The Fund may only invest in certificates of deposit issued by
U.S. banks with at least $1 billion in assets.
(3) The Fund may invest in bankers' acceptances, which are
short-term credit instruments used to finance commercial transactions.
Generally, an acceptance is a time draft drawn on a bank by an exporter or
an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by a bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
asset or it may be sold in the secondary market at the going rate of
interest for a specific maturity.
(4) The Fund may invest in repurchase agreements, which involve
purchases of debt securities with counterparties that are deemed by the
Advisor to present acceptable credit risks. In such an action, at the time
the Fund purchases the security, it simultaneously agrees to resell and
redeliver the security to the seller, who also simultaneously agrees to
buy back the security at a fixed price and time. This assures a
predetermined yield for the Fund during its holding period since the
resale price is always greater than the purchase price and reflects an
agreed-upon market rate. Such actions afford an opportunity for the Fund
to invest temporarily available cash. The Fund may enter into repurchase
agreements only with respect to obligations of the U.S. government or its
agencies or instrumentalities, certificates of deposit or bankers'
acceptances in which the Fund may invest. Repurchase agreements may be
considered loans to the seller, collateralized by the underlying
securities. The risk to the Fund is limited to the ability of the seller
to pay the agreed-upon sum on the repurchase date; in the event of
default, the repurchase agreement provides that the Fund is entitled to
sell the underlying collateral. If the value of the collateral declines
after the agreement is entered into, however, and if the seller defaults
under a repurchase agreement when the value of the underlying collateral
is less than the repurchase price, the Fund could incur a loss of both
principal and interest. The portfolio managers monitor the value of the
collateral at the time the action is entered into and at all times during
the term of the repurchase agreement. The portfolio managers do so in an
effort to determine that the value of the collateral always equals or
exceeds the agreed-upon repurchase price to be paid to the Fund. If the
seller were to be subject to a federal bankruptcy proceeding, the ability
of the Fund to liquidate the collateral could be delayed or impaired
because of certain provisions of the bankruptcy laws.
(5) The Fund may invest in bank time deposits, which are monies
kept on deposit with banks or savings and loan associations for a stated
period of time at a fixed rate of interest. There may be penalties for the
early withdrawal of such time deposits, in which case the yields of these
investments will be reduced.
(6) The Fund may invest in commercial paper, which are short-term
unsecured promissory notes, including variable rate master demand notes
issued by corporations to finance their current operations. Master demand
notes are direct lending arrangements between the Fund and a corporation.
- 12 -
There is no secondary market for the notes. However, they are redeemable
by the Fund at any time. The Fund's portfolio managers will consider the
financial condition of the corporation (e.g., earning power, cash flow and
other liquidity ratios) and will continuously monitor the corporation's
ability to meet all of its financial obligations, because the Fund's
liquidity might be impaired if the corporation were unable to pay
principal and interest on demand. The Fund may invest in commercial paper
only if it has received the highest rating from at least one nationally
recognized statistical rating organization or, if unrated, judged by First
Trust to be of comparable quality.
(7) The Fund may invest in shares of money market funds, as
consistent with its investment objective and policies. Shares of money
market funds are subject to management fees and other expenses of those
funds. Therefore, investments in money market funds will cause the Fund to
bear proportionately the costs incurred by the money market funds'
operations. At the same time, the Fund will continue to pay its own
management fees and expenses with respect to all of its assets, including
any portion invested in the shares of other investment companies. Although
money market funds that operate in accordance with Rule 2a-7 under the
1940 Act seek to preserve a $1.00 share price (until October 2016, when
amended Rule 2a-7 will require share prices of non-government money market
funds to be valued at their floating net asset value), it is possible for
the Fund to lose money by investing in money market funds.
Illiquid Securities: The Fund may invest in illiquid securities (i.e.,
securities that are not readily marketable). For purposes of this restriction,
illiquid securities include, but are not limited to, certain restricted
securities (securities the disposition of which is restricted under the federal
securities laws), securities that may only be resold pursuant to Rule 144A under
the 1933 Act that are deemed to be illiquid; and repurchase agreements with
maturities in excess of seven days. However, the Fund will not acquire illiquid
securities if, as a result, such securities would comprise more than 15% of the
value of the Fund's net assets. The Board of Trustees or its delegate has the
ultimate authority to determine, to the extent permissible under the federal
securities laws, which securities are liquid or illiquid for purposes of this
15% limitation. The Board of Trustees has delegated to First Trust the
day-to-day determination of the illiquidity of any equity or fixed-income
security, although it has retained oversight for such determinations. With
respect to Rule 144A securities, First Trust considers factors such as (i) the
nature of the market for a security (including the institutional private resale
market, the frequency of trades and quotes for the security, the number of
dealers willing to purchase or sell the security, the amount of time normally
needed to dispose of the security, the method of soliciting offers and the
mechanics of transfer); (ii) the terms of certain securities or other
instruments allowing for the disposition to a third party or the issuer thereof
(e.g., certain repurchase obligations and demand instruments); and (iii) other
permissible relevant factors.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the 1933 Act. Where registration is required, the
Fund may be obligated to pay all or part of the registration expenses and a
considerable period may elapse between the time of the decision to sell and the
time the Fund may be permitted to sell a security under an effective
registration statement. If, during such a period, adverse market conditions were
to develop, the Fund might obtain a less favorable price than that which
- 13 -
prevailed when it decided to sell. Illiquid securities will be priced at fair
value as determined in good faith under procedures adopted by the Board of
Trustees. If, through the appreciation of illiquid securities or the
depreciation of liquid securities, the Fund should be in a position where more
than 15% of the value of its net assets are invested in illiquid securities,
including restricted securities which are not readily marketable, the Fund will
take such steps as is deemed advisable, if any, to protect liquidity.
Other Investment Companies and Pooled Investment Vehicles: The Fund may
invest in securities of other investment companies, including registered
investment companies that are ETFs. ETFs trade on a securities exchange and
their shares may, at times, trade at a premium or discount to their net asset
value. Most ETFs hold a portfolio of common stocks or bonds designed to track
the performance of a securities index, including industry, sector, country and
region indexes, but an ETF may not replicate exactly the performance of the
index it seeks to track for a number of reasons, including transaction costs
incurred by the ETF.
The Fund may also invest a portion of its assets in pooled investment
vehicles other than registered investment companies. For example, some vehicles
which are commonly referred to as "exchanged traded funds" may not be registered
investment companies because of the nature of their underlying investments. As a
stockholder in an investment company or other pooled vehicle, the Fund will bear
its ratable share of that investment company's or vehicle's expenses, and would
remain subject to payment of the fund's or vehicle's advisory and administrative
fees with respect to assets so invested. Shareholders would therefore be subject
to duplicative expenses to the extent the Fund invests in other investment
companies or vehicles. In addition, the securities of other investment companies
or pooled vehicles may be leveraged and will therefore be subject to leverage
risks (in addition to other risks of the investment company's or pooled
vehicle's strategy). The Fund will also incur brokerage costs when purchasing
and selling shares of ETFs and other pooled vehicles.
An investment in the shares of another fund is subject to the risks
associated with that fund's portfolio securities. To the extent the Fund invests
in shares of another fund, Fund shareholders would indirectly pay a portion of
that fund's expenses, including advisory fees, brokerage and other distribution
expenses. These fees and expenses are in addition to the direct expenses of the
Fund's own operations.
PORTFOLIO TURNOVER
The Fund buys and sells portfolio securities in the normal course of its
investment activities. The proportion of the Fund's investment portfolio that is
bought and sold during a year is known as the Fund's portfolio turnover rate. A
turnover rate of 100% would occur, for example, if the Fund bought and sold
securities valued at 100% of its net assets within one year. A high portfolio
turnover rate could result in the payment by the Fund of increased brokerage
costs, expenses and taxes. The portfolio turnover rates for the Fund for the
fiscal period ended December 31, 2013 and the fiscal year ended December 31,
2014 were 0% and 0%, respectively.
- 14 -
INVESTMENT RISKS
The following information supplements the discussion of the Fund's
investment risks that appears in the Prospectus.
RISKS AND SPECIAL CONSIDERATIONS CONCERNING COMMODITIES INSTRUMENTS
In addition to the risks set forth in the Prospectus, investing in
Commodities Instruments involves certain general risks and considerations as
described below.
(1) Market Risk. Market risk is the risk that the value of the
underlying assets may go up or down. Adverse movements in the value of an
underlying asset can expose the Fund to losses. Market risk is the primary
risk associated with derivative transactions. Commodities Instruments may
include elements of leverage and, accordingly, fluctuations in the value
of the Commodities Instruments may be magnified. The successful use of
Commodities Instruments depends upon a variety of factors, particularly
the portfolio manager's ability to predict movements of the securities,
currencies and commodities markets, which may require different skills
than predicting changes in the prices of individual securities. There can
be no assurance that any particular strategy adopted will succeed. A
decision to engage in a commodity transaction will reflect the portfolio
manager's judgment that the commodity transaction will provide value to
the Subsidiary and to the Fund's shareholders and is consistent with the
Fund and the Subsidiary's objectives, investment limitations, and
operating policies. In making such a judgment, the portfolio managers will
analyze the benefits and risks of the Commodities Instruments and weigh
them in the context of the Subsidiary's overall investments and investment
objective. The prices of the Commodities Instruments may move in different
directions than investments in traditional equity and debt securities. For
example, during periods of rising inflation, historically debt securities
have tended to decline in value due to the general increase in prevailing
interest rates. Conversely, during those same periods of rising inflation,
historically the prices of certain commodities, such as oil and metals,
have tended to increase. Of course, there cannot be any guarantee that
these investments will perform in that manner in the future, and at
certain times the price movements of commodity-linked investments have
been parallel to debt and equity securities.
(2) Credit Risk/Counterparty Risk. Credit risk is the risk that a
loss may be sustained as a result of the failure of a counterparty to
comply with the terms of a derivative instrument In all transactions, the
Fund will bear the risk that the counterparty will default, and this could
result in a loss of the expected benefit of the Commodities Instruments
transactions and possibly other losses to the Fund. The Subsidiary will
enter into transactions in Commodities Instruments only with
counterparties that the Advisor reasonably believes are capable of
performing under the contract.
(3) Correlation Risk. Correlation risk is the risk that there might
be an imperfect correlation, or even no correlation, between price
movements of a Commodities Instrument and price movements of investments
being hedged. When a commodity transaction is used to completely hedge
- 15 -
another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from an
imperfect correlation between the price movements of the two instruments.
With a perfect hedge, the value of the combined position remains unchanged
with any change in the price of the underlying asset. With an imperfect
hedge, the value of the Commodities Instrument and its hedge are not
perfectly correlated. For example, if the value of a Commodities
Instrument used in a short hedge (such as selling a futures contract)
increased by less than the decline in value of the hedged investments, the
hedge would not be perfectly correlated. This might occur due to factors
unrelated to the value of the investments being hedged, such as
speculative or other pressures on the markets in which these instruments
are traded. The effectiveness of hedges using instruments on indices will
depend, in part, on the degree of correlation between price movements in
the index and the price movements in the investments being hedged.
(4) Liquidity Risk. Liquidity risk is the risk that a Commodities
Instrument cannot be sold, closed out, or replaced quickly at or very
close to its fundamental value. Generally, exchange contracts are very
liquid because the exchange clearinghouse is the counterparty of every
contract. The Fund and the Subsidiary might be required by applicable
regulatory requirements to maintain assets as "cover," maintain segregated
accounts, and/or make margin payments when it takes positions in
derivative instruments involving obligations to third parties (i.e.,
instruments other than purchase options). If the Subsidiary is unable to
close out its positions in such instruments, it might be required to
continue to maintain such assets or accounts or make such payments until
the position expires, matures, or is closed out. These requirements might
impair the Subsidiary's ability to sell a security or make an investment
at a time when it would otherwise be favorable to do so, or require that
the Fund sell a portfolio security at a disadvantageous time. The
Subsidiary's ability to sell or close out a position in an instrument
prior to expiration or maturity depends upon the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the counterparty to enter into a transaction closing out
the position. Due to liquidity risk, there is no assurance that any
Commodities Instruments position can be sold or closed out at a time and
price that is favorable to the Subsidiary.
(5) Legal Risk. Legal risk is the risk of loss caused by the
unenforceability of a party's obligations under the derivative. While a
party seeking price certainty agrees to surrender the potential upside in
exchange for downside protection, the party taking the risk is looking for
a positive payoff. Despite this voluntary assumption of risk, a
counterparty that has lost money in a Commodities Instruments transaction
may try to avoid payment by exploiting various legal uncertainties about
certain derivative products.
(6) Systemic or "Interconnection" Risk. Systemic or interconnection
risk is the risk that a disruption in the financial markets will cause
difficulties for all market participants. In other words, a disruption in
one market will spill over into other markets, perhaps creating a chain
reaction.
- 16 -
(7) Leverage Risk. Leverage risk is the risk that the Subsidiary
may be more volatile than if it had not been leveraged due to leverage's
tendency to exaggerate the effect of any increase or decrease in the value
of the Subsidiary's portfolio. The use of leverage may also cause the
Subsidiary to liquidate portfolio positions when it may not be
advantageous to do so to satisfy its obligations or to meet segregation
requirements.
(8) Regulatory Risk. The Dodd-Frank Act Wall Street Reform and
Consumer Protection Act (the "Dodd-Frank Act") has initiated a dramatic
revision of the U.S. financial regulatory framework and covers a broad
range of topics, including (among many others) a reorganization of federal
financial regulators; a process intended to improve financial systemic
stability and the resolution of potentially insolvent financial firms; and
new rules for derivatives trading. Instruments in which the Fund may
invest, or the issuers of such instruments, may be affected by the
legislation and regulation in ways that are unforeseeable. Many of the
implementing regulations have not yet been finalized. Accordingly, the
ultimate impact of the Dodd-Frank Act, including on the Commodities
Instruments in which the Fund may invest through the Subsidiary, is not
yet certain.
(9) Tax Risk. The Fund intends to treat any income it may derive
from Commodities Instruments (other than derivatives described in Revenue
Rulings 2006-1 and 2006-31) received from the Subsidiary as "qualifying
income" under the provisions of the Code applicable to RICs, based on a
tax opinion from Fund counsel that was based, in part, on numerous PLRs
provided to third parties not associated with the Fund or its affiliates
(which only those parties may cite as precedent). Shareholders and
potential investors should be aware, however, that, in July 2011, the IRS
suspended the issuance of such PLRs pending its re-examination of the
policies underlying them, which was still ongoing at the date of this SAI.
If, at the end of that re-examination, the IRS changes its position with
respect to the conclusions reached in those PLRs, then the Fund may be
required to restructure its investments to satisfy the qualifying income
requirement or might cease to qualify as a RIC.
ADDITIONAL RISKS OF INVESTING IN THE FUND
Credit Risk
Credit risk is the risk that an issuer of a debt instrument, Commodity
Instrument, derivative or other instrument may be unable or unwilling to make
dividend, interest and/or principal payments when due and the related risk that
the value of an instrument may decline because of concerns about the issuer's
ability or unwillingness to make such payments.
Currency Risk
Changes in currency exchange rates may affect the Fund's net asset value,
the value of dividends and interest earned, and gains and losses realized on the
sale of securities.
- 17 -
Cyber Security Risk
As the use of Internet technology has become more prevalent in the course
of business, the Fund has become more susceptible to potential operational risks
through breaches in cyber security. A breach in cyber security refers to both
intentional and unintentional events that may cause the Fund to lose proprietary
information, suffer data corruption or lose operational capacity. Such events
could cause the Fund to incur regulatory penalties, reputational damage,
additional compliance costs associated with corrective measures and/or financial
loss. Cyber security breaches may involve unauthorized access to the Fund's
digital information systems through "hacking" or malicious software coding, but
may also result from outside attacks such as denial-of-service attacks through
efforts to make network services unavailable to intended users. In addition,
cyber security breaches of the Fund's third party service providers, such as its
administrator, transfer agent, custodian or sub-advisor, as applicable, or
issuers in which the Fund invests, can also subject the Fund to many of the same
risks associated with direct cyber security breaches. The Fund has established
risk management systems designed to reduce the risks associated with cyber
security. However, there is no guarantee that such efforts will succeed,
especially because the Fund does not directly control the cyber security systems
of issuers or third party service providers.
Liquidity Risk
Whether or not the assets in the Fund are listed on an exchange, the
principal trading market for certain of the assets in the Fund may be in the
over-the-counter ("OTC") market. As a result, the existence of a liquid trading
market for the assets may depend on whether dealers will make a market in the
assets. There can be no assurance that a market will be made for any of the
assets, that any market for the assets will be maintained or that there will be
sufficient liquidity of the assets in any markets made. The price at which the
assets are held in the Fund will be adversely affected if trading markets for
the assets are limited or absent.
ADDITIONAL PROVISIONS CONCERNING THE FUND'S AND THE SUBSIDIARY'S INVESTMENTS
To permit the Fund to list and trade its shares on the Exchange under
NASDAQ(R) Rule 5735, the SEC has issued an order granting approval of a proposed
rule change (the "Proposed Rule Change"). The Proposed Rule Change includes, in
addition to various investment-related provisions that apply to the Fund and the
Subsidiary that are set forth in the Prospectus and elsewhere in this SAI,
certain other investment-related provisions, including those summarized below.
The Fund may hold up to an aggregate amount of 15% of its net assets in
illiquid securities (calculated at the time of investment), including Rule 144A
securities and master demand notes. The Fund will monitor its portfolio
liquidity on an ongoing basis to determine whether, in light of current
circumstances, an adequate level of liquidity is being maintained, and will
consider taking appropriate steps in order to maintain adequate liquidity if,
through a change in values, net assets, or other circumstances, more than 15% of
the Fund's net assets are held in illiquid securities. Illiquid securities
include securities subject to contractual or other restrictions on resale and
- 18 -
other instruments that lack readily available markets as determined in
accordance with SEC staff guidance.
The Fund's and the Subsidiary's investments will be consistent with the
Fund's investment objective and will not be used to enhance leverage.
The Subsidiary's shares will be offered only to the Fund, and the Fund
will not sell shares of the Subsidiary to other investors. The Fund will not
invest in any non-U.S. equity securities (other than shares of the Subsidiary),
and the Subsidiary will not invest in any non-U.S. equity securities.
The Fund will not invest directly in options contracts, futures contracts
or swap agreements; however, this restriction will not apply to the Subsidiary.
With respect to futures contracts in which the Subsidiary invests, not
more than 10% of the weight of such futures contracts in the aggregate shall
consist of futures contracts whose principal trading market (a) is not a member
of the Intermarket Surveillance Group ("ISG") or (b) is a market with which the
Exchange does not have a comprehensive surveillance sharing agreement.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The general supervision of the duties performed for the Fund under the
investment management agreement is the responsibility of the Board of Trustees.
There are five Trustees of the Trust, one of whom is an "interested person" (as
the term is defined in the 1940 Act) and four of whom are Trustees who are not
officers or employees of First Trust or any of its affiliates ("Independent
Trustees"). The Trustees set broad policies for the Fund, choose the Trust's
officers and hire the Trust's investment advisor. The officers of the Trust
manage its day-to-day operations and are responsible to the Trust's Board of
Trustees. The following is a list of the Trustees and executive officers of the
Trust and a statement of their present positions and principal occupations
during the past five years, the number of portfolios each Trustee oversees and
the other directorships they have held during the past five years, if
applicable. Each Trustee has been elected for an indefinite term. The officers
of the Trust serve indefinite terms. Each Trustee, except for James A. Bowen, is
an Independent Trustee. Mr. Bowen is deemed an "interested person" (as that term
is defined in the 1940 Act) ("Interested Trustee") of the Trust due to his
position as Chief Executive Officer of First Trust, investment advisor to the
Fund.
- 19 -
NUMBER OF
PORTFOLIOS OTHER
IN THE FIRST TRUSTEESHIPS OR
TERM OF OFFICE TRUST FUND DIRECTORSHIPS
AND YEAR FIRST COMPLEX HELD BY TRUSTEE
NAME, ADDRESS POSITION AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING THE PAST
AND DATE OF BIRTH OFFICES WITH TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
Trustee Who Is an Interested
Person of the Trust
----------------------------
James A. Bowen(1) Chairman of the o Indefinite term Chief Executive Officer 114 Portfolios None
120 East Liberty Drive, Board and Trustee (December 2010 to
Suite 400 present), President
Wheaton, IL 60187 o Since inception (until December 2010),
D.O.B.: 09/55 First Trust Advisors
L.P. and First Trust
Portfolios L.P.;
Chairman of the Board
of Directors, BondWave
LLC (Software
Development Company/
Investment Advisor) and
Stonebridge Advisors
LLC (Investment Advisor)
Independent Trustees
----------------------------
Richard E. Erickson Trustee o Indefinite term Physician; President, 114 Portfolios None
c/o First Trust Advisors Wheaton Orthopedics;
L.P. Limited Partner,
120 East Liberty Drive, o Since inception Gundersen Real Estate
Suite 400 Limited Partnership;
Wheaton, IL 60187 Member, Sportsmed LLC
D.O.B.: 04/51
Thomas R. Kadlec Trustee o Indefinite term President (March 2010 114 Portfolios Director of
c/o First Trust Advisors to present), Senior ADM Investor
L.P. o Since inception Vice President and Services,
120 East Liberty Drive, Chief Financial Officer Inc., ADM
Suite 400 (May 2007 to March Investor
Wheaton, IL 60187 2010), ADM Investor Services
D.O.B.: 11/57 Services, Inc. (Futures International
Commission Merchant) and Futures
Industry
Association
Robert F. Keith Trustee o Indefinite term President (2003 to 114 Portfolios Director of
c/o First Trust Advisors present), Hibs Trust Company
L.P. o Since inception Enterprises (Financial of Illinois
120 East Liberty Drive, and Management
Suite 400 Consulting)
Wheaton, IL 60187
D.O.B.: 11/56
- 20 -
NUMBER OF
PORTFOLIOS OTHER
IN THE FIRST TRUSTEESHIPS OR
TERM OF OFFICE TRUST FUND DIRECTORSHIPS
AND YEAR FIRST COMPLEX HELD BY TRUSTEE
NAME, ADDRESS POSITION AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING THE PAST
AND DATE OF BIRTH OFFICES WITH TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
Niel B. Nielson Trustee o Indefinite term Managing Director and 114 Portfolios Director of
c/o First Trust Advisors Chief Operating Officer Covenant
L.P. o Since inception (January 2015 to Transport Inc.
120 East Liberty Drive, present), Pelita (May 2003 to
Suite 400 Harapan Educational May 2014)
Wheaton, IL 60187 Foundation (Educational
D.O.B.: 03/54 Products and Services);
President and Chief
Executive Officer (June
2012 to September
2014), Servant
Interactive LLC
(Educational Products
and Services);
President and Chief
Executive Officer (June
2012 to September
2014), Dew Learning LLC
(Educational Products
and Services); President
(June 2002 to June 2012),
Covenant College
Officers of the Trust
----------------------------
Mark R. Bradley President and Chief o Indefinite term Chief Financial N/A N/A
120 East Liberty Drive, Executive Officer Officer, Chief
Suite 400 Operating Officer
Wheaton, IL 60187 o Since inception (December 2010 to
D.O.B.: 11/57 present), First Trust
Advisors L.P. and First
Trust Portfolios L.P.;
Chief Financial
Officer, BondWave LLC
(Software Development
Company/Investment
Advisor) and
Stonebridge Advisors
LLC (Investment
Advisor)
James M. Dykas Treasurer, Chief o Indefinite term Controller (January N/A N/A
120 East Liberty Drive, Financial Officer 2011 to present),
Suite 400 and Chief o Since inception Senior Vice President
Wheaton, IL 60187 Accounting Officer (April 2007 to
D.O.B.: 01/66 present), First Trust
Advisors L.P. and First
Trust Portfolios L.P.
W. Scott Jardine Secretary and Chief o Indefinite term General Counsel, First N/A N/A
120 East Liberty Drive, Legal Officer Trust Advisors L.P. and
Suite 400 o Since inception First Trust Portfolios
Wheaton, IL 60187 L.P.; Secretary and
D.O.B.: 05/60 General Counsel,
BondWave LLC (Software
Development Company/
Investment Advisor) and
Secretary, Stonebridge
Advisors LLC
(Investment Advisor)
- 21 -
NUMBER OF
PORTFOLIOS OTHER
IN THE FIRST TRUSTEESHIPS OR
TERM OF OFFICE TRUST FUND DIRECTORSHIPS
AND YEAR FIRST COMPLEX HELD BY TRUSTEE
NAME, ADDRESS POSITION AND ELECTED OR PRINCIPAL OCCUPATIONS OVERSEEN BY DURING THE PAST
AND DATE OF BIRTH OFFICES WITH TRUST APPOINTED DURING PAST 5 YEARS TRUSTEE 5 YEARS
Daniel J. Lindquist Vice President o Indefinite term Managing Director (July N/A N/A
120 East Liberty Drive, 2012 to present),
Suite 400 o Since inception Senior Vice President
Wheaton, IL 60187 (September 2005 to
D.O.B.: 02/70 July 2012), First
Trust Advisors L.P. and
First Trust Portfolios
L.P.
Kristi A. Maher Chief Compliance o Indefinite term Deputy General Counsel, N/A N/A
120 East Liberty Drive, Officer and First Trust Advisors
Suite 400 Assistant Secretary o Since inception L.P. and First Trust
Wheaton, IL 60187 Portfolios L.P.
D.O.B.: 12/66
Roger F. Testin Vice President o Indefinite term Senior Vice President N/A N/A
120 East Liberty Drive, (November 2003 to
Suite 400 o Since inception present), First Trust
Wheaton, IL 60187 Advisors L.P. and First
D.O.B.: 06/66 Trust Portfolios L.P.
Stan Ueland Vice President o Indefinite term Senior Vice President N/A N/A
120 East Liberty Drive, (September 2012 to
Suite 400 o Since inception present), Vice
Wheaton, IL 60187 President (August 2005
D.O.B.: 11/70 to September 2012)
First Trust Advisors
L.P. and First Trust
Portfolios L.P.
--------------------
(1) Mr. Bowen is deemed an "interested person" of the Trust due to his
position as Chief Executive Officer of First Trust, investment advisor
of the Fund.
UNITARY BOARD LEADERSHIP STRUCTURE
Each Trustee serves as a trustee of all open-end and closed-end funds in
the First Trust Fund Complex (as defined below), which is known as a "unitary"
board leadership structure. Each Trustee currently serves as a trustee of First
Trust Series Fund and First Trust Variable Insurance Trust, open-end funds with
five portfolios advised by First Trust; First Trust Senior Floating Rate Income
Fund II, Macquarie/First Trust Global Infrastructure/Utilities Dividend & Income
Fund, First Trust Energy Income and Growth Fund, First Trust Enhanced Equity
Income Fund, First Trust/Aberdeen Global Opportunity Income Fund, First Trust
Mortgage Income Fund, First Trust Strategic High Income Fund II, First
Trust/Aberdeen Emerging Opportunity Fund, First Trust Specialty Finance and
Financial Opportunities Fund, First Trust Dividend and Income Fund, First Trust
High Income Long/Short Fund, First Trust Energy Infrastructure Fund, First Trust
MLP and Energy Income Fund, First Trust Intermediate Duration Preferred & Income
Fund and First Trust New Opportunities MLP & Energy Fund, closed-end funds
advised by First Trust; and the Trust, First Trust Exchange-Traded Fund, First
Trust Exchange-Traded Fund II, First Trust Exchange-Traded Fund III, First Trust
Exchange-Traded Fund IV, First Trust Exchange-Traded Fund V, First Trust
Exchange-Traded Fund VI, First Trust Exchange-Traded AlphaDEX(R) Fund and First
- 22 -
Trust Exchange Traded AlphaDEX(R) Fund II, exchange-traded funds with 94
portfolios advised by First Trust (each a "First Trust Fund" and collectively,
the "First Trust Fund Complex"). None of the Trustees who are not "interested
persons" of the Trust, nor any of their immediate family members, has ever been
a director, officer or employee of, or consultant to, First Trust, First Trust
Portfolios L.P. or their affiliates.
The management of the Fund, including general supervision of the duties
performed for the Fund under the investment management agreement between the
Trust, on behalf of the Fund, and the Advisor, is the responsibility of the
Board of Trustees. The Trustees of the Trust set broad policies for the Fund,
choose the Trust's officers, and hire the Fund's investment advisor and other
service providers. The officers of the Trust manage the day-to-day operations
and are responsible to the Trust's Board. The Trust's Board is composed of four
Independent Trustees and one Interested Trustee. The Interested Trustee, James
A. Bowen, serves as the Chairman of the Board for each fund in the First Trust
Fund Complex.
The same five persons serve as Trustees on the Trust's Board and on the
Boards of all other First Trust Funds. The unitary board structure was adopted
for the First Trust Funds because of the efficiencies it achieves with respect
to the governance and oversight of the First Trust Funds. Each First Trust Fund
is subject to the rules and regulations of the 1940 Act (and other applicable
securities laws), which means that many of the First Trust Funds face similar
issues with respect to certain of their fundamental activities, including risk
management, portfolio liquidity, portfolio valuation and financial reporting.
Because of the similar and often overlapping issues facing the First Trust
Funds, including among the First Trust exchange-traded funds, the Board of the
First Trust Funds believes that maintaining a unitary board structure promotes
efficiency and consistency in the governance and oversight of all First Trust
Funds and reduces the costs, administrative burdens and possible conflicts that
may result from having multiple boards. In adopting a unitary board structure,
the Trustees seek to provide effective governance through establishing a board
the overall composition of which will, as a body, possess the appropriate
skills, diversity, independence and experience to oversee the Fund's business.
Annually, the Board reviews its governance structure and the committee
structures, their performance and functions and it reviews any processes that
would enhance Board governance over the Fund's business. The Board has
determined that its leadership structure, including the unitary board and
committee structure, is appropriate based on the characteristics of the funds it
serves and the characteristics of the First Trust Fund Complex as a whole.
In order to streamline communication between the Advisor and the
Independent Trustees and create certain efficiencies, the Board has a Lead
Independent Trustee who is responsible for: (i) coordinating activities of the
Independent Trustees; (ii) working with the Advisor, Fund counsel and the
independent legal counsel to the Independent Trustees to determine the agenda
for Board meetings; (iii) serving as the principal contact for and facilitating
communication between the Independent Trustees and the Fund's service providers,
particularly the Advisor; and (iv) any other duties that the Independent
Trustees may delegate to the Lead Independent Trustee. The Lead Independent
Trustee is selected by the Independent Trustees and serves a three year term or
until his or her successor is selected.
- 23 -
The Board has established four standing committees (as described below)
and has delegated certain of its responsibilities to those committees. The Board
and its committees meet frequently throughout the year to oversee the Fund's
activities, review contractual arrangements with and performance of service
providers, oversee compliance with regulatory requirements and review Fund
performance. The Independent Trustees are represented by independent legal
counsel at all Board and committee meetings (other than meetings of the
Executive Committee). Generally, the Board acts by majority vote of all the
Trustees, including a majority vote of the Independent Trustees if required by
applicable law.
The three Committee Chairmen and the Lead Independent Trustee rotate every
three years in serving as Chairman of the Audit Committee, the Nominating and
Governance Committee or the Valuation Committee, or as Lead Independent Trustee.
The Lead Independent Trustee and immediate past Lead Independent Trustee also
serve on the Executive Committee with the Interested Trustee.
The four standing committees of the First Trust Fund Complex are: the
Executive Committee (and Pricing and Dividend Committee), the Nominating and
Governance Committee, the Valuation Committee and the Audit Committee. The
Executive Committee, which meets between Board meetings, is authorized to
exercise all powers of and to act in the place of the Board of Trustees to the
extent permitted by the Trust's Declaration of Trust and By Laws. Such Committee
is also responsible for the declaration and setting of dividends. Mr. Kadlec,
Mr. Bowen and Mr. Keith are members of the Executive Committee. During the last
fiscal year, the Executive Committee held four meetings.
The Nominating and Governance Committee is responsible for appointing and
nominating non-interested persons to the Trust's Board of Trustees. Messrs.
Erickson, Kadlec, Keith and Nielson are members of the Nominating and Governance
Committee. If there is no vacancy on the Board of Trustees, the Board will not
actively seek recommendations from other parties, including shareholders. The
Board of Trustees adopted a mandatory retirement age of 75 for Trustees, beyond
which age Trustees are ineligible to serve. The Committee will not consider new
trustee candidates who are 72 years of age or older. When a vacancy on the Board
of Trustees occurs and nominations are sought to fill such vacancy, the
Nominating and Governance Committee may seek nominations from those sources it
deems appropriate in its discretion, including shareholders of the Fund. To
submit a recommendation for nomination as a candidate for a position on the
Board of Trustees, shareholders of the Fund should mail such recommendation to
W. Scott Jardine, Secretary, at the Trust's address, 120 East Liberty Drive,
Suite 400, Wheaton, Illinois 60187. Such recommendation shall include the
following information: (i) evidence of Fund ownership of the person or entity
recommending the candidate (if a Fund shareholder); (ii) a full description of
the proposed candidate's background, including education, experience, current
employment and date of birth; (iii) names and addresses of at least three
professional references for the candidate; (iv) information as to whether the
candidate is an "interested person" in relation to the Fund, as such term is
defined in the 1940 Act, and such other information that may be considered to
impair the candidate's independence; and (v) any other information that may be
helpful to the Committee in evaluating the candidate. If a recommendation is
received with satisfactorily completed information regarding a candidate during
a time when a vacancy exists on the Board or during such other time as the
- 24 -
Nominating and Governance Committee is accepting recommendations, the
recommendation will be forwarded to the Chairman of the Nominating and
Governance Committee and the counsel to the Independent Trustees.
Recommendations received at any other time will be kept on file until such time
as the Nominating and Governance Committee is accepting recommendations, at
which point they may be considered for nomination. During the last fiscal year,
the Nominating and Governance Committee held four meetings.
The Valuation Committee is responsible for the oversight of the valuation
procedures of the Fund (the "Valuation Procedures"), for determining the fair
value of the Fund's securities or other assets under certain circumstances as
described in the Valuation Procedures and for evaluating the performance of any
pricing service for that Fund. Messrs. Erickson, Kadlec, Keith and Nielson are
members of the Valuation Committee. During the last fiscal year, the Valuation
Committee held four meetings.
The Audit Committee is responsible for overseeing the Fund's accounting
and financial reporting process, the system of internal controls and audit
process and evaluating and appointing independent auditors (subject also to
Board approval). Messrs. Erickson, Kadlec, Keith and Nielson serve on the Audit
Committee. During the last fiscal year, the Audit Committee held eight meetings.
EXECUTIVE OFFICERS
The executive officers of the Trust hold the same positions with each fund
in the First Trust Fund Complex (representing 114 portfolios) as they hold with
the Trust.
RISK OVERSIGHT
As part of the general oversight of the Fund, the Board is involved in the
risk oversight of the Fund. The Board has adopted and periodically reviews
policies and procedures designed to address the Fund's risks. Oversight of
investment and compliance risk is performed primarily at the Board level in
conjunction with the Advisor's investment oversight group and the Trust's Chief
Compliance Officer ("CCO"). Oversight of other risks also occurs at the
committee level. The Advisor's investment oversight group reports to the Board
at quarterly meetings regarding, among other things, Fund performance and the
various drivers of such performance. The Board reviews reports on the Fund's and
the service providers' compliance policies and procedures at each quarterly
Board meeting and receives an annual report from the CCO regarding the
operations of the Fund's and the service providers' compliance program. In
addition, the Independent Trustees meet privately each quarter with the CCO. The
Audit Committee reviews with the Advisor the Fund's major financial risk
exposures and the steps the Advisor has taken to monitor and control these
exposures, including the Fund's risk assessment and risk management policies and
guidelines. The Audit Committee also, as appropriate, reviews in a general
manner the processes other Board committees have in place with respect to risk
assessment and risk management. The Nominating and Governance Committee monitors
all matters related to the corporate governance of the Trust. The Valuation
Committee monitors valuation risk and compliance with the Fund's Valuation
Procedures and oversees the pricing services and actions by the Advisor's
Pricing Committee with respect to the valuation of portfolio securities.
- 25 -
Not all risks that may affect the Fund can be identified nor can controls
be developed to eliminate or mitigate their occurrence or effects. It may not be
practical or cost effective to eliminate or mitigate certain risks, the
processes and controls employed to address certain risks may be limited in their
effectiveness, and some risks are simply beyond the reasonable control of the
Fund or the Advisor or other service providers. For instance, as the use of
Internet technology has become more prevalent, the Fund and its service
providers have become more susceptible to potential operational risks through
breaches in cyber security (generally, intentional and unintentional events that
may cause the Fund or a service provider to lose proprietary information, suffer
data corruption or lose operational capacity). There can be no guarantee that
any risk management systems established by the Fund, its service providers, or
issuers of the securities in which the Fund invests to reduce cyber security
risks will succeed, and the Fund cannot control such systems put in place by
service providers, issuers or other third parties whose operations may affect
the Fund and/or its shareholders. Moreover, it is necessary to bear certain
risks (such as investment related risks) to achieve the Fund's goals. As a
result of the foregoing and other factors, the Fund's ability to manage risk is
subject to substantial limitations.
BOARD DIVERSIFICATION AND TRUSTEE QUALIFICATIONS
As described above, the Nominating and Governance Committee of the Board
oversees matters related to the nomination of Trustees. The Nominating and
Governance Committee seeks to establish an effective Board with an appropriate
range of skills and diversity, including, as appropriate, differences in
background, professional experience, education, vocation, and other individual
characteristics and traits in the aggregate. Each Trustee must meet certain
basic requirements, including relevant skills and experience, time availability
and, if qualifying as an Independent Trustee, independence from the Advisor and
any sub-advisors, underwriters or other service providers, including any
affiliates of these entities.
Listed below for each current Trustee are the experiences, qualifications
and attributes that led to the conclusion, as of the date of this SAI, that each
current Trustee should serve as a Trustee in light of the Trust's business and
structure.
Richard E. Erickson, M.D., is an orthopedic surgeon and President of
Wheaton Orthopedics. He also has been a co-owner and director of a fitness
center and a limited partner of two real estate companies. Dr. Erickson has
served as a Trustee of each First Trust Fund since its inception. Dr. Erickson
has also served as the Lead Independent Trustee and on the Executive Committee
(2008 - 2009), Chairman of the Nominating and Governance Committee (2003 -
2007), Chairman of the Audit Committee (2012 - 2013) and Chairman of the
Valuation Committee (June 2006 - 2007 and 2010 - 2011) of the First Trust Funds.
He currently serves as Chairman of the Nominating and Governance Committee
(since January 1, 2014) of the First Trust Funds.
Thomas R. Kadlec is President of ADM Investor Services Inc. ("ADMIS"), a
futures commission merchant and wholly-owned subsidiary of the Archer Daniels
Midland Company ("ADM"). Mr. Kadlec has been employed by ADMIS and its
affiliates since 1990 in various accounting, financial, operations and risk
management capacities. Mr. Kadlec serves on the boards of several international
- 26 -
affiliates of ADMIS and is a member of ADM's Integrated Risk Committee, which is
tasked with the duty of implementing and communicating enterprise-wide risk
management. In 2014, Mr. Kadlec was elected to the board of the Futures Industry
Association. Mr. Kadlec has served as a Trustee of each First Trust Fund since
its inception. Mr. Kadlec also served on the Executive Committee from the
organization of the first First Trust closed-end fund in 2003 until he was
elected as the first Lead Independent Trustee in December 2005, serving as such
through 2007. He also served as Chairman of the Valuation Committee (2008 -
2009), Chairman of the Audit Committee (2010 - 2011) and Chairman of the
Nominating and Governance Committee (2012 - 2013). He currently serves as Lead
Independent Trustee and on the Executive Committee (since January 1, 2014) of
the First Trust Funds.
Robert F. Keith is President of Hibs Enterprises, a financial and
management consulting firm. Mr. Keith has been with Hibs Enterprises since 2003.
Prior thereto, Mr. Keith spent 18 years with ServiceMaster and Aramark,
including three years as President and COO of ServiceMaster Consumer Services,
where he led the initial expansion of certain products overseas; five years as
President and COO of ServiceMaster Management Services; and two years as
President of Aramark ServiceMaster Management Services. Mr. Keith is a certified
public accountant and also has held the positions of Treasurer and Chief
Financial Officer of ServiceMaster, at which time he oversaw the financial
aspects of ServiceMaster's expansion of its Management Services division into
Europe, the Middle East and Asia. Mr. Keith has served as a Trustee of the First
Trust Funds since June 2006. Mr. Keith has also served as the Chairman of the
Audit Committee (2008 - 2009) and Chairman of the Nominating and Governance
Committee (2010 - 2011) of the First Trust Funds. He served as Lead Independent
Trustee and on the Executive Committee (2012 - 2013) and currently serves as
Chairman of the Valuation Committee (since January 1, 2014) and on the Executive
Committee (since January 31, 2014) of the First Trust Funds.
Niel B. Nielson, Ph.D., has been the Managing Director and Chief Operating
Officer of Pelita Harapan Educational Foundation, a global provider of
educational products and services since January 2015. Mr. Nielson formerly
served as the President and Chief Executive Officer of Dew Learning LLC from
June 2012 through September 2014, President of Covenant College (2002 - 2012),
and as a partner and trader (of options and futures contracts for hedging
options) for Ritchie Capital Markets Group (1996 - 1997), where he held an
administrative management position at this proprietary derivatives trading
company. He also held prior positions in new business development for
ServiceMaster Management Services Company and in personnel and human resources
for NationsBank of North Carolina, N.A. and Chicago Research and Trading Group,
Ltd. ("CRT"). His international experience includes serving as a director of CRT
Europe, Inc. for two years, directing out of London all aspects of business
conducted by the U.K. and European subsidiary of CRT. Prior to that, Mr. Nielson
was a trader and manager at CRT in Chicago. Mr. Nielson has served as a Trustee
of each First Trust Fund since its inception and of the First Trust Funds since
1999. Mr. Nielson has also served as the Chairman of the Audit Committee (2003 -
2006), Chairman of the Valuation Committee (2007 - 2008), Chairman of the
Nominating and Governance Committee (2008 - 2009) and Lead Independent Trustee
and a member of the Executive Committee (2010 - 2011). He currently serves as
Chairman of the Audit Committee (since January 1, 2014) of the First Trust
Funds.
- 27 -
James A. Bowen is Chief Executive Officer of First Trust Advisors L.P. and
First Trust Portfolios L.P. Mr. Bowen is involved in the day-to-day management
of the First Trust Funds and serves on the Executive Committee. He has over 26
years of experience in the investment company business in sales, sales
management and executive management. Mr. Bowen has served as a Trustee of each
First Trust Fund since its inception and of the First Trust Funds since 1999.
Each Independent Trustee is paid a fixed annual retainer of $125,000 per
year and an annual per-fund fee of $4,000 for each closed-end fund or other
actively managed fund and $1,000 for each index fund in the First Trust Fund
Complex. The fixed annual retainer is allocated pro rata among each fund in the
First Trust Fund Complex based on net assets. Additionally, the Lead Independent
Trustee is paid $15,000 annually, the Chairman of the Audit Committee is paid
$10,000 annually, and each of the Chairmen of the Nominating and Governance
Committee and the Valuation Committee is paid $5,000 annually to serve in such
capacities, with such compensation allocated pro rata among each fund in the
First Trust Fund Complex based on net assets. Trustees are also reimbursed by
the investment companies in the First Trust Fund Complex for travel and
out-of-pocket expenses incurred in connection with all meetings.
The following table sets forth the compensation (including reimbursement
for travel and out-of-pocket expenses) paid by the Fund and the First Trust Fund
Complex to each of the Independent Trustees for the fiscal year and the calendar
year ended December 31, 2014. The Trust has no retirement or pension plans. The
officers and Trustee who are "interested persons" as designated above serve
without any compensation from the Trust. The Trust has no employees. Its
officers are compensated by First Trust.
COMPENSATION FROM TOTAL COMPENSATION FROM
NAME OF TRUSTEE THE FUND(1) THE FIRST TRUST FUND COMPLEX(2)
Richard E. Erickson $4,575 $331,237
Thomas R. Kadlec $4,610 $339,500
Robert F. Keith $4,584 $332,800
Niel B. Nielson $4,610 $340,356
--------------------
(1) The compensation paid by the Fund to the Independent Trustees for the
fiscal year ended December 31, 2014 for services to the Fund.
(2) The total compensation paid to the Independent Trustees for the
calendar year ended December 31, 2014 for services to the 122
portfolios existing in 2014, consisted of 13 open-end mutual funds, 15
closed-end funds and 94 exchange-traded funds.
- 28 -
The following table sets forth the dollar range of equity securities
beneficially owned by the Trustees in the Fund and in other funds overseen by
the Trustees in the First Trust Fund Complex as of December 31, 2014:
AGGREGATE DOLLAR RANGE OF
EQUITY SECURITIES IN
ALL REGISTERED INVESTMENT COMPANIES
DOLLAR RANGE OF OVERSEEN BY TRUSTEE IN THE FIRST
EQUITY SECURITIES TRUST
TRUSTEE IN THE FUND FUND COMPLEX
Interested Trustee
James A. Bowen None $10,001-$50,000
Independent Trustees
Richard E. Erickson None Over $100,000
Thomas R. Kadlec None Over $100,000
Robert F. Keith None Over $100,000
Niel B. Nielson None Over $100,000
As of December 31, 2014, the Independent Trustees of the Trust and their
immediate family members did not own beneficially or of record any class of
securities of an investment advisor or principal underwriter of the Fund or any
person directly or indirectly controlling, controlled by, or under common
control with an investment advisor or principal underwriter of the Fund.
As of December 31, 2014, the officers and Trustees, in the aggregate,
owned less than 1% of the shares of the Fund.
As of December 31, 2014, the Advisor did not own any shares of the Fund.
The table set forth as Exhibit A shows the percentage ownership of each
person or "group" (as that term is used in Section 13(d) of the Securities
Exchange Act of 1934, as amended (the "1934 Act")) who, as of March 31, 2015,
owned of record, or is known by the Trust to have owned of record or
beneficially, 5% or more of the shares of the Fund (the "Principal Holders"). A
control person is one who owns, either directly or indirectly, more than 25% of
the voting securities of the Fund or acknowledges the existence of control. A
party that controls the Fund may be able to significantly influence the outcome
of any item presented to shareholders for approval.
Information as to the Principal Holders is based on the securities
position listing reports as of March 31, 2015. The Fund does not have any
knowledge of who the ultimate beneficiaries are of the shares.
Investment Advisor. The Board of Trustees of the Trust, including the
Independent Trustees, approved an investment management agreement (the
"Investment Management Agreement") for the Fund. A discussion regarding the
Board's approval of the Investment Management Agreement for the Fund is
available in the Fund's Annual Report to Shareholders for the period ended
- 29 -
December 31, 2013. The Board of Trustees determined that the Investment
Management Agreement is in the best interests of the Fund in light of the extent
and quality of the services expected to be provided, and such other matters as
the Board of Trustees considered to be relevant in the exercise of its
reasonable business judgment.
Pursuant to the Investment Management Agreement between First Trust and
the Trust, First Trust manages the investment of the Fund's assets and is
responsible for paying all expenses of the Fund and the Subsidiary, excluding
the fee payments under the Investment Management Agreement, interest, taxes,
brokerage commissions and other expenses connected with the execution of
portfolio transactions, distribution and service fees payable pursuant to a Rule
12b-1 plan, if any, and extraordinary expenses. The Fund has agreed to pay First
Trust an annual management fee equal to 0.95% of its average daily net assets.
First Trust provides fund reporting services to the Fund for a flat annual fee
in the amount of $9,250, which is covered under the annual management fee.
First Trust, 120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187,
is the investment advisor to the Fund. First Trust is a limited partnership with
one limited partner, Grace Partners of DuPage L.P., and one general partner, The
Charger Corporation. Grace Partners of DuPage L.P. is a limited partnership with
one general partner, The Charger Corporation, and a number of limited partners.
The Charger Corporation is an Illinois corporation controlled by James A. Bowen,
the Chief Executive Officer of First Trust. First Trust discharges its
responsibilities to the Fund subject to the policies of the Board of Trustees.
First Trust provides investment tools and portfolios for advisors and
investors. First Trust is committed to theoretically sound portfolio
construction and empirically verifiable investment management approaches. Its
asset management philosophy and investment discipline are deeply rooted in the
application of intuitive factor analysis and model implementation to enhance
investment decisions.
First Trust acts as investment advisor for and manages the investment and
reinvestment of the assets of the Fund. First Trust also administers the Trust's
business affairs, provides office facilities and equipment and certain clerical,
bookkeeping and administrative services, and permits any of its officers or
employees to serve without compensation as Trustees or officers of the Trust if
elected to such positions.
Under the Investment Management Agreement, First Trust shall not be liable
for any loss sustained by reason of the purchase, sale or retention of any
security, whether or not such purchase, sale or retention shall have been based
upon the investigation and research made by any other individual, firm or
corporation, if such recommendation shall have been selected with due care and
in good faith, except loss resulting from willful misfeasance, bad faith, or
gross negligence on the part of First Trust in the performance of its
obligations and duties, or by reason of its reckless disregard of its
obligations and duties. The Investment Management Agreement continues until two
years after the initial issuance of Fund shares, and thereafter only if approved
annually by the Board of Trustees, including a majority of the Independent
Trustees. The Investment Management Agreement terminates automatically upon
assignment and is terminable at any time without penalty as to the Fund by the
Board of Trustees, including a majority of the Independent Trustees, or by vote
- 30 -
of the holders of a majority of the Fund's outstanding voting securities on 60
days' written notice to First Trust, or by First Trust on 60 days' written
notice to the Fund. The following table sets forth the management fees received
by First Trust for the specified periods. The Fund experienced significant
differences in the management fees paid to First Trust for the fiscal year ended
December 31, 2014 due to significant variances in the aggregate amount of assets
under management in the Fund from the prior fiscal year.
AMOUNT OF MANAGEMENT FEES
FISCAL PERIOD OCTOBER 22, 2013 FISCAL YEAR ENDED
THROUGH DECEMBER 31, 2013 DECEMBER 31, 2014
$5,564 $1,347,547
Portfolio Managers. The following persons serve as the portfolio managers of the
Fund.
POSITION WITH LENGTH OF SERVICE PRINCIPAL OCCUPATION
NAME FIRST TRUST WITH FIRST TRUST DURING PAST FIVE YEARS
John Gambla Senior Portfolio Manager Since 2011 Senior Portfolio Manager,
First Trust Advisors L.P.; Co
Chief Investment Officer,
Nuveen HydePark Group LLC
Rob A. Guttschow Senior Portfolio Manager Since 2011 Senior Portfolio Manager,
First Trust Advisors L.P.; Co
Chief Investment Officer,
Nuveen HydePark Group LLC
Daniel J. Lindquist Managing Director Since 2004 Managing Director (July 2012
to present), Senior Vice
President (September 2005 to
July 2012).
Jon C. Erickson Senior Vice President Since 1997 Senior Vice President, First
Trust Advisors L.P. and First
Trust Portfolios L.P.
David G. McGarel Chief Investment Officer Since 1997 Chief Investment Officer (June
and Managing Director 2012 to present), Managing
Director (July 2012 to
present), Senior Vice
President (September 2005 to
July 2012), First Trust
Advisors L.P. and First Trust
Portfolios L.P.
Roger F. Testin Senior Vice President Since 2001 Senior Vice President, First
Trust Advisors L.P. and First
Trust Portfolios L.P.
- 31 -
John Gambla: Mr. Gambla is a senior portfolio manager for the Alternatives
Investment Team at First Trust.
Rob A. Guttschow: Mr. Guttschow is a senior portfolio manager for the
Alternatives Investment Team at First Trust.
Daniel J. Lindquist: Mr. Lindquist is Chairman of the Investment Committee
and presides over Investment Committee meetings. Mr. Lindquist is also
responsible for overseeing the implementation of the Fund's investment
strategies.
David G. McGarel: As First Trust's Chief Investment Officer, Mr. McGarel
consults with the Investment Committee on market conditions and First Trust's
general investment philosophy.
Jon C. Erickson: As the head of First Trust's Equity Research Group, Mr.
Erickson is responsible for determining the securities to be purchased and sold
by funds that do not utilize quantitative investment strategies.
Roger F. Testin: As head of First Trust's Portfolio Management Group, Mr.
Testin is responsible for executing the instructions of the Strategy Research
Group and Equity Research Group in the Fund's portfolio.
As of December 31, 2014, none of the portfolio managers beneficially
owned any shares of the Fund, with the exception of Mr. Lindquist, who
beneficially owned shares of the Fund in the $10,001-$50,000 range.
Compensation. The portfolio managers are compensated with an industry
competitive salary and a year-end discretionary bonus based on client service,
asset growth and the performance of the Fund. Each portfolio manager's
performance is formally evaluated annually based on a variety of factors. Bonus
compensation is primarily a function of the firm's overall annual profitability
and the individual portfolio manager's contribution as measured by the overall
investment performance of client portfolios in the strategy the portfolio
manager manages relative to the strategy's general benchmark.
Other Accounts Managed. In addition to the Fund, as of December 31, 2014,
the Investment Committee members are also primarily responsible for the
day-to-day portfolio management of the following accounts:
- 32 -
ACCOUNTS MANAGED BY INVESTMENT COMMITTEE
REGISTERED INVESTMENT OTHER POOLED
COMPANIES INVESTMENT VEHICLES
NUMBER OF ACCOUNTS NUMBER OF ACCOUNTS OTHER ACCOUNTS NUMBER OF
INVESTMENT COMMITTEE MEMBER ($ ASSETS) ($ ASSETS) ACCOUNTS ($ ASSETS)
John Gambla 6 ($46,842,264) 4 ($89,603,266) N/A
Rob A. Guttschow 6 ($46,842,264) 4 ($89,603,266) N/A
Roger F. Testin 88 ($31,418,856,024) 22 ($295,265,123) 2,382 ($792,774,929)
Jon C. Erickson 88 ($31,418,856,024) 22 ($295,265,123) 2,382 ($792,774,929)
David G. McGarel 88 ($31,418,856,024) 22 ($295,265,123) 2,382 ($792,774,929)
Daniel J. Lindquist 88 ($31,418,856,024) 22 ($295,265,123) 2,382 ($792,774,929)
--------------------
Conflicts. None of the accounts managed by the Investment Committee pay an
advisory fee that is based upon the performance of the account. In addition,
First Trust believes that there are no material conflicts of interest that may
arise in connection with the Investment Committee's management of the Fund's
investments and the investments of the other accounts managed by the Investment
Committee. However, because the investment strategy of the Fund and the
investment strategies of many of the other accounts managed by the Investment
Committee are based on fairly mechanical investment processes, the Investment
Committee may recommend that certain clients sell and other clients buy a given
security at the same time. In addition, because the investment strategies of the
Fund and other accounts managed by the Investment Committee generally result in
the clients investing in readily available securities, First Trust believes that
there should not be material conflicts in the allocation of investment
opportunities between the Fund and other accounts managed by the Investment
Committee.
BROKERAGE ALLOCATIONS
First Trust is responsible for decisions to buy and sell securities for
the Fund and for the placement of the Fund's securities business, the
negotiation of the commissions to be paid on brokered transactions, the prices
for principal trades in securities, and the allocation of portfolio brokerage
and principal business. It is the policy of First Trust to seek the best
execution at the best security price available with respect to each transaction,
and with respect to brokered transactions in light of the overall quality of
brokerage and research services provided to First Trust and its clients. The
best price to the Fund means the best net price without regard to the mix
between purchase or sale price and commission, if any. Purchases may be made
from underwriters, dealers, and, on occasion, the issuers. Commissions will be
- 33 -
paid on the Fund's futures and options transactions, if any. The purchase price
of portfolio securities purchased from an underwriter or dealer may include
underwriting commissions and dealer spreads. The Fund may pay markups on
principal transactions. In selecting broker/dealers and in negotiating
commissions, First Trust considers, among other things, the firm's reliability,
the quality of its execution services on a continuing basis and its financial
condition. Fund portfolio transactions may be effected with broker/dealers who
have assisted investors in the purchase of shares.
Section 28(e) of the 1934 Act permits an investment advisor, under certain
circumstances, to cause an account to pay a broker or dealer who supplies
brokerage and research services a commission for effecting a transaction in
excess of the amount of commission another broker or dealer would have charged
for effecting the transaction. Brokerage and research services include (a)
furnishing advice as to the value of securities, the advisability of investing,
purchasing or selling securities, and the availability of securities or
purchasers or sellers of securities; (b) furnishing analyses and reports
concerning issuers, industries, securities, economic factors and trends,
portfolio strategy, and the performance of accounts; and (c) effecting
securities transactions and performing functions incidental thereto (such as
clearance, settlement, and custody). Such brokerage and research services are
often referred to as "soft dollars." First Trust has advised the Board of
Trustees that it does not currently intend to use soft dollars.
Notwithstanding the foregoing, in selecting brokers, First Trust may in
the future consider investment and market information and other research, such
as economic, securities and performance measurement research, provided by such
brokers, and the quality and reliability of brokerage services, including
execution capability, performance, and financial responsibility. Accordingly,
the commissions charged by any such broker may be greater than the amount
another firm might charge if First Trust determines in good faith that the
amount of such commissions is reasonable in relation to the value of the
research information and brokerage services provided by such broker to First
Trust or the Trust. In addition, First Trust must determine that the research
information received in this manner provides the Fund with benefits by
supplementing the research otherwise available to the Fund. The Investment
Management Agreement provides that such higher commissions will not be paid by
the Fund unless the Advisor determines in good faith that the amount is
reasonable in relation to the services provided. The investment advisory fees
paid by the Fund to First Trust under the Investment Management Agreement would
not be reduced as a result of receipt by First Trust of research services.
First Trust places portfolio transactions for other advisory accounts
advised by it, and research services furnished by firms through which the Fund
effects its securities transactions may be used by First Trust in servicing all
of its accounts; not all of such services may be used by First Trust in
connection with the Fund. First Trust believes it is not possible to measure
separately the benefits from research services to each of the accounts
(including the Fund) advised by it. Because the volume and nature of the trading
activities of the accounts are not uniform, the amount of commissions in excess
of those charged by another broker paid by each account for brokerage and
research services will vary. However, First Trust believes such costs to the
Fund will not be disproportionate to the benefits received by the Fund on a
continuing basis. First Trust seeks to allocate portfolio transactions equitably
- 34 -
whenever concurrent decisions are made to purchase or sell securities by the
Fund and another advisory account. In some cases, this procedure could have an
adverse effect on the price or the amount of securities available to the Fund.
In making such allocations between the Fund and other advisory accounts, the
main factors considered by First Trust are the respective investment objective,
the relative size of portfolio holding of the same or comparable securities, the
availability of cash for investment and the size of investment commitments
generally held.
BROKERAGE COMMISSIONS
The following table sets forth the aggregate amount of brokerage
commissions paid by the Fund for the specified period.
AGGREGATE AMOUNT OF BROKERAGE COMMISSIONS
FISCAL PERIOD OCTOBER 22, 2013 THROUGH FISCAL YEAR ENDED
DECEMBER 31, 2013 DECEMBER 31, 2014
$0 $0
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT
Custodian, Administrator, Fund Accountant and Transfer Agent. Brown
Brothers Harriman & Co. ("BBH"), as custodian for the Fund pursuant to a
Custodian Agreement, holds the Fund's assets. Also, pursuant to an
Administrative Agency Agreement, BBH provides certain administrative and
accounting services to the Fund, including maintaining the Fund's books of
account, records of the Fund's securities transactions and certain other books
and records; acting as liaison with the Fund's independent registered public
accounting firm by providing such accountant with various audit-related
information with respect to the Fund; and providing other continuous accounting
and administrative services. BBH also serves as the Fund's transfer agent
pursuant to an Administrative Agency Agreement. BBH is located at 50 Post Office
Square, Boston, Massachusetts 02110.
Pursuant to the Administrative Agency Agreement, the Trust on behalf of
the Fund has agreed to indemnify the Administrator for certain liabilities,
including certain liabilities arising under the federal securities laws, unless
such loss or liability results from negligence or willful misconduct in the
performance of its duties.
Pursuant to the Fund Administration and Accounting Agreement between BBH
and the Trust, the Fund has agreed to pay such compensation as is mutually
agreed from time to time and such out-of-pocket expenses as incurred by BBH in
the performance of its duties.
Distributor. First Trust Portfolios L.P., an affiliate of First Trust, is
the distributor ("FTP" or the "Distributor") and principal underwriter of the
shares of the Fund. Its principal address is 120 East Liberty Drive, Suite 400,
Wheaton, Illinois 60187. The Distributor has entered into a Distribution
- 35 -
Agreement with the Trust pursuant to which it distributes Fund shares. Shares
are continuously offered for sale by the Fund through the Distributor only in
Creation Unit Aggregations, as described in the Prospectus and below under the
heading "Creation and Redemption of Creation Unit Aggregations."
Since the inception of the Fund, there have been no underwriting
commissions with respect to the sale of Fund shares, and FTP did not receive
compensation on redemptions for the Fund for that period.
12b-1 Plan. The Trust has adopted a Plan of Distribution pursuant to Rule
12b-1 under the 1940 Act (the "Plan") pursuant to which the Fund may reimburse
the Distributor up to a maximum annual rate of 0.25% of its average daily net
assets.
Under the Plan and as required by Rule 12b-1, the Trustees will receive
and review after the end of each calendar quarter a written report provided by
the Distributor of the amounts expended under the Plan and the purpose for which
such expenditures were made. With the exception of the Distributor and its
affiliates, no "interested person" of the Trust (as that term is defined in the
1940 Act) and no Trustee of the Trust has a direct or indirect financial
interest in the operation of the Plan or any related agreement.
No fee is currently paid by the Fund under the Plan, and pursuant to a
contractual agreement, the Fund will not pay 12b-1 fees any time before April
30, 2016.
Aggregations. Fund shares in less than Creation Unit Aggregations are not
distributed by the Distributor. The Distributor will deliver the Prospectus and,
upon request, this SAI to persons purchasing Creation Unit Aggregations and will
maintain records of both orders placed with it and confirmations of acceptance
furnished by it. The Distributor is a broker-dealer registered under the 1934
Act and a member of the Financial Industry Regulatory Authority ("FINRA").
The Distribution Agreement provides that it may be terminated at any time,
without the payment of any penalty, on at least 60 days' written notice by the
Trust to the Distributor (i) by vote of a majority of the Independent Trustees
or (ii) by vote of a majority of the outstanding voting securities (as defined
in the 1940 Act) of the Fund. The Distribution Agreement will terminate
automatically in the event of its assignment (as defined in the 1940 Act).
The Distributor may also enter into agreements with participants that
utilize the facilities of the Depository Trust Company (the "DTC Participants"),
which have international, operational, capabilities and place orders for
Creation Unit Aggregations of Fund shares. Participating Parties (which are
participants in the Continuous Net Settlement System of the National Securities
Clearing Corporation) shall be DTC Participants.
Exchange. The only relationship that the Exchange has with First Trust or
the Distributor of the Fund in connection with the Fund is that the Exchange
lists the shares of the Fund and disseminates the intra-day portfolio values
that are calculated by the IPV Calculator pursuant to its listing agreement with
the Trust. The Exchange is not responsible for and has not participated in the
- 36 -
determination of pricing or the timing of the issuance or sale of the shares of
the Fund or in the determination or calculation of the asset value of the Fund.
The Exchange has no obligation or liability in connection with the
administration, marketing or trading of the Fund.
ADDITIONAL PAYMENTS TO FINANCIAL INTERMEDIARIES
First Trust or its affiliates may from time to time make payments, out of
their own resources, to certain financial intermediaries that sell shares of
First Trust mutual funds and ETFs ("First Trust Funds") to promote the sales and
retention of Fund shares by those firms and their customers. The amounts of
these payments vary by intermediary. The level of payments that First Trust is
willing to provide to a particular intermediary may be affected by, among other
factors, (i) the firm's total assets or Fund shares held in and recent net
investments into First Trust Funds, (ii) the value of the assets invested in the
First Trust Funds by the intermediary's customers, (iii) redemption rates, (iv)
its ability to attract and retain assets, (v) the intermediary's reputation in
the industry, (vi) the level and/or type of marketing assistance and educational
activities provided by the intermediary, (vii) the firm's level of participation
in First Trust Funds' sales and marketing programs, (viii) the firm's
compensation program for its registered representatives who sell Fund shares and
provide services to Fund shareholders, and (ix) the asset class of the First
Trust Funds for which these payments are provided. Such payments are generally
asset-based but also may include the payment of a lump sum.
First Trust may also make payments to certain intermediaries for certain
administrative services and shareholder processing services, including record
keeping and sub-accounting of shareholder accounts pursuant to a sub-transfer
agency, omnibus account service or sub-accounting agreement. All fees payable by
First Trust under this category of services may be charged back to the Fund,
subject to approval by the Board.
First Trust and/or its affiliates may make payments, out of its own
assets, to those firms as compensation and/or reimbursement for marketing
support and/or program servicing to selected intermediaries that are registered
as holders or dealers of record for accounts invested in one or more of the
First Trust Funds or that make First Trust Fund shares available through certain
selected Fund no-transaction fee institutional platforms and fee-based wrap
programs at certain financial intermediaries. Program servicing payments
typically apply to employee benefit plans, such as retirement plans, or
fee-based advisory programs but may apply to retail sales and assets in certain
situations. The payments are based on such factors as the type and nature of
services or support furnished by the intermediary and are generally asset-based.
Services for which an intermediary receives marketing support payments may
include, but are not limited to, business planning assistance, advertising,
educating the intermediary's personnel about First Trust Funds in connection
with shareholder financial planning needs, placement on the intermediary's
preferred or recommended fund list, and access to sales meetings, sales
representatives and management representatives of the intermediary. In addition,
intermediaries may be compensated for enabling representatives of First Trust
and/or its affiliates to participate in and/or present at conferences or
seminars, sales or training programs for invited registered representatives and
other employees, client and investor events and other events sponsored by the
intermediary. Services for which an intermediary receives program servicing
payments typically include, but are not limited to, record keeping, reporting or
- 37 -
transaction processing and shareholder communications and other account
administration services, but may also include services rendered in connection
with Fund/investment selection and monitoring, employee enrollment and
education, plan balance rollover or separation, or other similar services. An
intermediary may perform program services itself or may arrange with a third
party to perform program services. These payments are in addition to the service
fee and any applicable omnibus sub-accounting fees paid to these firms with
respect to these services by the First Trust Funds out of Fund assets.
From time to time, First Trust and/or its affiliates, at its expense, may
provide other compensation to intermediaries that sell or arrange for the sale
of shares of the First Trust Funds, which may be in addition to marketing
support and program servicing payments described above. For example, First Trust
and/or its affiliates may: (i) compensate intermediaries for National Securities
Clearing Corporation networking system services (e.g., shareholder
communication, account statements, trade confirmations, and tax reporting) on an
asset-based or per account basis; (ii) compensate intermediaries for providing
Fund shareholder trading information; (iii) make onetime or periodic payments to
reimburse selected intermediaries for items such as ticket charges (i.e., fees
that an intermediary charges its representatives for effecting transactions in
Fund shares) or exchange order, operational charges (e.g., fees that an
intermediary charges for establishing the Fund on its trading system), and
literature printing and/or distribution costs; (iv) at the direction of a
retirement plan's sponsor, reimburse or pay direct expenses of an employee
benefit plan that would otherwise be payable by the plan; and (v) provide
payments to broker-dealers to help defray their technology or infrastructure
costs.
When not provided for in a marketing support or program servicing
agreement, First Trust and/or its affiliates may also pay intermediaries for
enabling First Trust and/or its affiliates to participate in and/or present at
conferences or seminars, sales or training programs for invited registered
representatives and other intermediary employees, client and investor events and
other intermediary-sponsored events, and for travel expenses, including lodging
incurred by registered representatives and other employees in connection with
prospecting, asset retention and due diligence trips. These payments may vary
depending upon the nature of the event. First Trust and/or its affiliates make
payments for such events as it deems appropriate, subject to its internal
guidelines and applicable law.
First Trust and/or its affiliates occasionally sponsor due diligence
meetings for registered representatives during which they receive updates on
various First Trust Funds and are afforded the opportunity to speak with
portfolio managers. Although invitations to these meetings are not conditioned
on selling a specific number of shares, those who have shown an interest in
First Trust Funds are more likely to be considered. To the extent permitted by
their firm's policies and procedures, all or a portion of registered
representatives' expenses in attending these meetings may be covered by First
Trust and/or its affiliates.
The amounts of payments referenced above made by First Trust and/or its
affiliates could be significant and may create an incentive for an intermediary
or its representatives to recommend or offer shares of the First Trust Funds to
its customers. The intermediary may elevate the prominence or profile of the
First Trust Funds within the intermediary's organization by, for example,
placing the First Trust Funds on a list of preferred or recommended funds and/or
- 38 -
granting First Trust and/or its affiliates preferential or enhanced
opportunities to promote the First Trust Funds in various ways within the
intermediary's organization. These payments are made pursuant to negotiated
agreements with intermediaries. The payments do not change the price paid by
investors for the purchase of a share or the amount the Fund will receive as
proceeds from such sales. Furthermore, many of these payments are not reflected
in the fees and expenses listed in the fee table section of the Fund's
Prospectus because they are not paid by the Fund. The types of payments
described herein are not mutually exclusive, and a single intermediary may
receive some or all types of payments as described.
Other compensation may be offered to the extent not prohibited by state
laws or any self-regulatory agency, such as FINRA. Investors can ask their
intermediaries for information about any payments they receive from First Trust
and/or its affiliates and the services it provides for those payments. Investors
may wish to take intermediary payment arrangements into account when considering
and evaluating any recommendations relating to Fund shares.
ADDITIONAL INFORMATION
Book Entry Only System. The following information supplements and should
be read in conjunction with the Prospectus.
DTC Acts as Securities Depository for Fund Shares. Shares of the Fund are
represented by securities registered in the name of The Depository Trust Company
("DTC") or its nominee, Cede & Co., and deposited with, or on behalf of, DTC.
DTC, a limited-purpose trust company, was created to hold securities of
its participants and to facilitate the clearance and settlement of securities
transactions among the DTC Participants in such securities through electronic
book-entry changes in accounts of the DTC Participants, thereby eliminating the
need for physical movement of securities or certificates. DTC Participants
include securities brokers and dealers, banks, trust companies, clearing
corporations and certain other organizations, some of whom (and/or their
representatives) own DTC. More specifically, DTC is owned by a number of its DTC
Participants and by the New York Stock Exchange (the "NYSE") and FINRA. Access
to the DTC system is also available to others such as banks, brokers, dealers
and trust companies that clear through or maintain a custodial relationship with
a DTC Participant, either directly or indirectly (the "Indirect Participants").
Beneficial ownership of shares is limited to DTC Participants, Indirect
Participants and persons holding interests through DTC Participants and Indirect
Participants. Ownership of beneficial interests in shares (owners of such
beneficial interests are referred to herein as "Beneficial Owners") is shown on,
and the transfer of ownership is effected only through, records maintained by
DTC (with respect to DTC Participants) and on the records of DTC Participants
(with respect to Indirect Participants and Beneficial Owners that are not DTC
Participants). Beneficial Owners will receive from or through the DTC
Participant a written confirmation relating to their purchase and sale of
shares.
- 39 -
Conveyance of all notices, statements and other communications to
Beneficial Owners is effected as follows. Pursuant to a letter agreement between
DTC and the Trust, DTC is required to make available to the Trust upon request
and for a fee to be charged to the Trust a listing of the shares of the Fund
held by each DTC Participant. The Trust shall inquire of each such DTC
Participant as to the number of Beneficial Owners holding shares, directly or
indirectly, through such DTC Participant. The Trust shall provide each such DTC
Participant with copies of such notice, statement or other communication, in
such form, number and at such place as such DTC Participant may reasonably
request, in order that such notice, statement or communication may be
transmitted by such DTC Participant, directly or indirectly, to such Beneficial
Owners. In addition, the Trust shall pay to each such DTC Participants a fair
and reasonable amount as reimbursement for the expenses attendant to such
transmittal, all subject to applicable statutory and regulatory requirements.
Fund distributions shall be made to DTC or its nominee, as the registered
holder of all Fund shares. DTC or its nominee, upon receipt of any such
distributions, shall immediately credit DTC Participants' accounts with payments
in amounts proportionate to their respective beneficial interests in shares of
the Fund as shown on the records of DTC or its nominee. Payments by DTC
Participants to Indirect Participants and Beneficial Owners of shares held
through such DTC Participants will be governed by standing instructions and
customary practices, as is now the case with securities held for the accounts of
customers in bearer form or registered in a "street name," and will be the
responsibility of such DTC Participants.
The Trust has no responsibility or liability for any aspect of the records
relating to or notices to Beneficial Owners, or payments made on account of
beneficial ownership interests in such shares, or for maintaining, supervising
or reviewing any records relating to such beneficial ownership interests, or for
any other aspect of the relationship between DTC and the DTC Participants or the
relationship between such DTC Participants and the Indirect Participants and
Beneficial Owners owning through such DTC Participants.
DTC may decide to discontinue providing its service with respect to shares
at any time by giving reasonable notice to the Trust and discharging its
responsibilities with respect thereto under applicable law. Under such
circumstances, the Trust shall take action to find a replacement for DTC to
perform its functions at a comparable cost.
Intra-Day Portfolio Value. The price of a non-U.S. security that is
primarily traded on a non-U.S. exchange shall be updated every 15 seconds
throughout its trading day, provided, that upon the closing of such non-U.S.
exchange the closing price of the security will be used throughout the remainder
of the business day where the markets remain open. These exchange rates may
differ from those used by First Trust and consequently result in intra-day
portfolio values that may vary. Furthermore, in calculating the intra-day
portfolio values of the Fund's shares, the exchange rates used throughout the
day (9:00 a.m. to 4:15 p.m. Eastern Time) shall be those that are deemed to be
most appropriate.
Policy Regarding Investment in Other Investment Companies. Beginning on or
about June 7, 2015, the Fund will not rely on Sections 12(d)(1)(F) or
12(d)(1)(G) of the 1940 Act to invest in other investment companies.
- 40 -
PROXY VOTING POLICIES AND PROCEDURES
The Trust has adopted a proxy voting policy that seeks to ensure that
proxies for securities held by the Fund are voted consistently with the best
interests of the Fund.
The Board has delegated to First Trust the proxy voting responsibilities
for the Fund and has directed First Trust to vote proxies consistent with the
Fund's best interests. First Trust has engaged the services of ISS Governance
Services, a division of RiskMetrics Group, Inc. ("ISS"), to make recommendations
to First Trust on the voting of proxies relating to securities held by the Fund.
If First Trust manages the assets of a company or its pension plan and any of
First Trust's clients hold any securities of that company, First Trust will vote
proxies relating to such company's securities in accordance with the ISS
recommendations to avoid any conflict of interest.
First Trust has adopted the ISS Proxy Voting Guidelines. While these
guidelines are not intended to be all-inclusive, they do provide guidance on
First Trust's general voting policies. The ISS Proxy Voting Guidelines are
attached hereto as Exhibit B. Information regarding how the Fund voted proxies
relating to portfolio securities during the most recent 12-month period ended
June 30, is available upon request and without charge on the Fund's website at
http://www.ftportfolios.com, by calling (800) 621-1675 or by accessing the SEC's
website at http://www.sec.gov.
Quarterly Portfolio Schedule. The Trust is required to disclose, after its
first and third fiscal quarters, the complete schedule of the Fund's portfolio
holdings with the SEC on Form N-Q. Form N-Q for the Trust is available on the
SEC's website at http://www.sec.gov. The Fund's Form N-Q may also be reviewed
and copied at the SEC's Public Reference Room in Washington, D.C. and
information on the operation of the Public Reference Room may be obtained by
calling 1-800-SEC-0330. The Trust's Forms N-Q are available without charge, upon
request, by calling (800) 621-1675 or by writing to First Trust Portfolios L.P.,
120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187.
Policy Regarding Disclosure of Portfolio Holdings. The Trust has adopted a
policy regarding the disclosure of information about the Fund's portfolio
holdings. The Board of Trustees must approve all material amendments to this
policy. The Fund's portfolio holdings are publicly disseminated each day the
Fund is open for business through financial reporting and news services,
including publicly accessible Internet websites. In addition, a basket
composition file, which includes the security names and share quantities to
deliver in exchange for Fund shares, together with estimates and actual cash
components, is publicly disseminated each day the NYSE is open for trading via
the National Securities Clearing Corporation ("NSCC"). The basket represents one
Creation Unit of the Fund. The Fund's portfolio holdings are also available on
the Fund's website at http://www.ftportfolios.com. The Trust, First Trust and
BBH will not disseminate non-public information concerning the Trust.
Codes of Ethics. In order to mitigate the possibility that the Fund will
be adversely affected by personal trading, the Trust, First Trust and the
Distributor have adopted Codes of Ethics under Rule 17j-1 of the 1940 Act. These
Codes of Ethics contain policies restricting securities trading in personal
- 41 -
accounts of the officers, Trustees and others who normally come into possession
of information on portfolio transactions. Personnel subject to the Codes of
Ethics may invest in securities that may be purchased or held by the Fund;
however, the Codes of Ethics require that each transaction in such securities be
reviewed by the CCO or his or her designee. These Codes of Ethics are on public
file with, and are available from, the SEC.
CREATION AND REDEMPTION OF CREATION UNIT AGGREGATIONS
GENERAL
The Trust issues and sells shares of the Fund only in Creation Unit
Aggregations on a continuous basis through the Distributor, without a sales
load, at their net asset values next determined after receipt, on any Business
Day (as defined below), of an order in proper form.
A "Business Day" is any day on which the NYSE is open for business. As of
the date of this SAI, the NYSE observes the following holidays: New Year's Day,
Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
PURCHASE AND ISSUANCE OF CREATION UNIT AGGREGATIONS
Fund Deposit. Unless cash purchases are required or permitted for the Fund
under the circumstances described below, the consideration for purchase of a
Creation Unit Aggregation of shares of the Fund generally consists of the
in-kind deposit of a designated portfolio of securities and other instruments
(the "Deposit Securities") generally corresponding pro rata (except in certain
circumstances) to the Fund's portfolio positions (including cash positions) as
of the end of the prior Business Day and an amount of cash computed as described
below (the "Cash Component"). Together, the Deposit Securities (and/or any cash
with respect to cash purchases and cash-in-lieu amounts) and the Cash Component
constitute the "Fund Deposit," which represents the minimum initial and
subsequent investment amount for a Creation Unit Aggregation of the Fund.
The Cash Component is sometimes also referred to as the Balancing Amount.
The Cash Component serves the function of compensating for any differences
between the net asset value per Creation Unit Aggregation and the Deposit Amount
(as defined below). The Cash Component is an amount equal to the difference
between (i) the net asset value of Fund shares (per Creation Unit Aggregation)
and (ii) the "Deposit Amount" - an amount equal to the aggregate market value of
the Deposit Securities. If the Cash Component is a positive number (i.e., the
net asset value per Creation Unit Aggregation exceeds the Deposit Amount), the
creator will deliver the Cash Component. If the Cash Component is a negative
number (i.e., the net asset value per Creation Unit Aggregation is less than the
Deposit Amount), the creator will receive the Cash Component.
The Custodian, through the NSCC, makes available on each Business Day,
prior to the opening of business of the Exchange (currently 9:30 a.m., Eastern
Time), the list of the names and the required quantity of each Deposit Security,
- 42 -
as well as the estimated Cash Component (if any) that will be applicable to Fund
Deposits for the Fund for that day (subject to correction of any errors). Such
Fund Deposit information is applicable in order to effect creations of Creation
Unit Aggregations of the Fund until the next Business Day.
The identities and quantities of the Deposit Securities required for a
Fund Deposit for the Fund change as corporate action events are reflected within
the Fund from time to time by the Advisor with a view to the investment
objectives of the Fund.
The Fund reserves the right to require or permit purchases of Creation
Unit Aggregations to be made in whole or in part on a cash basis, rather than
in-kind, under the following circumstances: (i) to the extent there is a Cash
Component; (ii) if, on a given Business Day, the Fund announces before the open
of trading that all purchases on that day will be made entirely in cash; (iii)
if, upon receiving a purchase order from an Authorized Participant (as defined
below), the Fund determines to require the purchase to be made entirely in cash;
(iv) if, on a given Business Day, the Fund requires all Authorized Participants
purchasing shares on that day to deposit cash in lieu of some or all of the
Deposit Securities because: (a) such instruments are not eligible for transfer
through either the Continuous Net Settlement System of the NSCC as such
processes have been enhanced to effect purchases and redemptions of Creation
Unit Aggregations (the "NSCC Process") or through the facilities of DTC (the
"DTC Process"); or (b) in the case of non-U.S. Deposit Securities, such
instruments are not eligible for trading due to local trading restrictions,
local restrictions on securities transfers or other similar circumstances; or
(v) if the Fund permits an Authorized Participant to deposit cash in lieu of
some or all of the Deposit Securities because: (a) such instruments are not
available in sufficient quantity; or (b) such instruments are not eligible for
trading by an Authorized Participant or the investor on whose behalf the
Authorized Participant is acting.
In addition, under the following circumstances, it is possible that
Deposit Securities may not correspond pro rata to the positions in the Fund's
portfolio as of the end of the prior Business Day: (i) in the case of bonds, for
minor differences when it is impossible to break up bonds beyond certain minimum
sizes needed for transfer and settlement; (ii) for minor differences when
rounding is necessary to eliminate fractional shares or lots that are not
tradeable round lots (a tradeable round lot for a security will be the standard
unit of trading in that particular type of security in its primary market); or
(iii) with respect to "to-be-announced" transactions, short positions and other
positions that cannot be transferred in kind (including instruments that can be
transferred in kind only with the consent of the original counterparty to the
extent the Fund does not intend to seek such consents), and they will therefore
be excluded from the Deposit Securities with their value reflected in the
determination of the Cash Component.
Procedures for Creation of Creation Unit Aggregations. In order to be
eligible to place orders with the Distributor and to create a Creation Unit
Aggregation of the Fund, an entity must be a DTC Participant (see the section
entitled "Book Entry Only System"), must have executed an agreement with the
Distributor and transfer agent, with respect to creations and redemptions of
Creation Unit Aggregations ("Participant Agreement") (discussed below), and must
have international operational capabilities. A DTC Participant is also referred
to as an "Authorized Participant." Investors should contact the Distributor for
- 43 -
the names of Authorized Participants that have signed a Participant Agreement.
All Fund shares, however created, will be entered on the records of DTC in the
name of Cede & Co. for the account of a DTC Participant.
All standard orders to create Creation Unit Aggregations must be received
by the transfer agent no later than the closing time of the regular trading
session on the NYSE ("Closing Time") (ordinarily 4:00 p.m., Eastern Time) in
each case on the date such order is placed in order for the creation of Creation
Unit Aggregations to be effected based on the net asset value of shares of the
Fund as next determined on such date after receipt of the order in proper form.
Subject to the provisions of the applicable Participant Agreement, in the case
of custom orders, the order must generally be received by the transfer agent no
later than 3:00 p.m. Eastern Time on the trade date. The Fund may require custom
orders for the purchase of Creation Unit Aggregations to be placed earlier in
the day (for example, on days when the generally accepted close of the Exchange
or the applicable fixed-income security market occurs earlier than normal (such
as the day before a holiday)). In addition, it is possible that orders to
purchase a Creation Unit Aggregation may not be accepted on any day when the
applicable fixed-income security markets are closed. The date on which an order
to create Creation Unit Aggregations (or an order to redeem Creation Unit
Aggregations, as discussed below) is placed is referred to as the "Transmittal
Date." Orders must be transmitted by an Authorized Participant by telephone or
other transmission method acceptable to the transfer agent pursuant to
procedures set forth in the Participant Agreement. Economic or market
disruptions or changes, or telephone or other communication failure may impede
the ability to reach the transfer agent or an Authorized Participant.
All orders from investors who are not Authorized Participants to create
Creation Unit Aggregations shall be placed with an Authorized Participant, as
applicable, in the form required by such Authorized Participant. In addition,
the Authorized Participant may request the investor to make certain
representations or enter into agreements with respect to the order, e.g., to
provide for payments of cash, when required. Investors should be aware that
their particular broker may not have executed a Participant Agreement and that,
therefore, orders to create Creation Unit Aggregations of the Fund have to be
placed by the investor's broker through an Authorized Participant that has
executed a Participant Agreement. In such cases there may be additional charges
to such investor. At any given time, there may be only a limited number of
broker-dealers that have executed a Participant Agreement. Those persons placing
orders should ascertain the deadlines applicable to DTC and the Federal Reserve
Bank wire system by contacting the operations department of the broker or
depository institution effectuating such transfer of Deposit Securities and Cash
Component.
Deposit Securities must be delivered to the Trust through the applicable
processes set forth in the Participant Agreement. Deposit Securities that are
non-U.S. securities must be delivered to an account maintained at the applicable
local subcustodian of the Trust on or before the International Contractual
Settlement Date (as defined below), all in accordance with the terms of the
Participant Agreement. If a Deposit Security is an American Depositary Receipt
("ADR") or similar domestic instrument, it may be delivered to the Custodian.
The Authorized Participant must also pay on or before the International
Contractual Settlement Date immediately available or same-day funds estimated by
Trust to be sufficient to pay the Cash Component next determined after
acceptance of the creation order, together with the applicable Creation
- 44 -
Transaction Fee (as defined below) and additional variable amounts, as described
below, all in accordance with the terms of the Participant Agreement. The
"International Contractual Settlement Date" is the earlier of (i) the date upon
which all of the required Deposit Securities, the Cash Component and any other
cash amounts which may be due are delivered to the Fund or (ii) the latest day
for settlement on the customary settlement cycle in the jurisdiction(s) where
any of the securities of the Fund are customarily traded. Any excess funds will
be returned following settlement of the issue of the Creation Unit Aggregation.
Issuance of Creation Unit Aggregations. A Creation Unit Aggregation will
generally not be issued until the transfer of good title to the Trust of the
portfolio of Deposit Securities and the payment of the Cash Component, the
Creation Transaction Fee (as defined below) and any other required cash amounts
have been completed. As described in the next paragraph, in the event that an
order for a Creation Unit is incomplete because certain or all of the Deposit
Securities are missing, the Trust may issue a Creation Unit notwithstanding such
deficiency in reliance on the undertaking of the Authorized Participant to
deliver the missing Deposit Securities as soon as possible, which undertaking
shall be secured by an additional cash deposit (described below) with respect to
the undelivered Deposit Securities.
To the extent contemplated by the applicable Participant Agreement,
Creation Unit Aggregations of the Fund will be issued to such Authorized
Participant notwithstanding the fact that the corresponding Fund Deposits have
not been received in part or in whole, in reliance on the undertaking of the
Authorized Participant to deliver the missing Deposit Securities as soon as
possible, which undertaking shall be secured by such Authorized Participant's
delivery and maintenance of collateral consisting of cash in the form of U.S.
dollars in immediately available funds having a value (marked to market daily)
at least equal to 115% (which First Trust may change from time to time) of the
value of the missing Deposit Securities. The Participant Agreement will permit
the Fund to buy the missing Deposit Securities at any time and will subject the
Authorized Participant to liability for any shortfall between the cost to the
Trust of purchasing such securities and the value of the collateral.
Acceptance of Orders for Creation Unit Aggregations. The Trust reserves
the absolute right to reject a creation order transmitted to it by the
Distributor with respect to the Fund if: (i) the order is not in proper form;
(ii) the investor(s), upon obtaining the Fund shares ordered, would own 80% or
more of the currently outstanding shares of the Fund; (iii) the required Fund
Deposit is not delivered; (iv) acceptance of the Deposit Securities would have
certain adverse tax consequences to the Fund; (v) acceptance of the Fund Deposit
would, in the opinion of the Trust, be unlawful; (vi) acceptance of the Fund
Deposit would otherwise, in the discretion of the Trust or the Distributor, have
an adverse effect on the Trust, the Fund or the rights of Beneficial Owners; or
(vii) circumstances outside the control of the Trust or the Fund make it
impossible to process creation orders for all practical purposes. Examples of
such circumstances include: acts of God or public service or utility problems
such as fires, floods, extreme weather conditions and power outages resulting in
telephone, telecopy and computer failures; market conditions or activities
causing trading halts; systems failures involving computer or other information
systems affecting the Trust, the Fund, First Trust, the Distributor, DTC, NSCC,
the transfer agent, the Custodian, the sub-custodian or any other participant in
the creation process; the imposition by a foreign government or a regulatory
body of controls, or other monetary, currency or trading restrictions that
- 45 -
directly affect the portfolio securities held; and similar extraordinary events.
The Distributor shall notify a prospective creator of a Creation Unit and/or the
Authorized Participant acting on behalf of such prospective creator of its
rejection of the order of such person. The Trust, the Fund, the Custodian, any
sub-custodian and the Distributor are under no duty, however, to give
notification of any defects or irregularities in the delivery of Fund Deposits,
nor shall any of them incur any liability for the failure to give any such
notification.
All questions as to the quantity of each security in the Deposit
Securities and the validity, form, eligibility, and acceptance for deposit of
any securities to be delivered shall be determined by the Trust, and the Trust's
determination shall be final and binding.
Creation Transaction Fee. Purchasers of Creation Units must pay a creation
transaction fee (the "Creation Transaction Fee") that is currently $500. The
Creation Transaction Fee is applicable to each purchase transaction regardless
of the number of Creation Units purchased in the transaction. The Creation
Transaction Fee may vary and is based on the composition of the securities
included in the Fund's portfolio and the countries in which the transactions are
settled. The price for each Creation Unit will equal the daily net asset value
per share times the number of shares in a Creation Unit plus the fees described
above and, if applicable, any operational processing and brokerage costs,
transfer fees or stamp taxes. When the Fund permits an Authorized Participant to
substitute cash in lieu of depositing one or more of the requisite Deposit
Securities, the Authorized Participant may also be assessed an amount to cover
the cost of purchasing the Deposit Securities, including operational processing
and brokerage costs, transfer fees, stamp taxes, and part or all of the spread
between the expected bid and offer side of the market related to such Deposit
Securities.
REDEMPTIONS OF CREATION UNIT AGGREGATIONS
Redemption of Fund Shares In Creation Unit Aggregations. Fund shares may
be redeemed only in Creation Unit Aggregations at their net asset value next
determined after receipt of a redemption request in proper form by the Fund
through the transfer agent and only on a Business Day. The Fund will not redeem
shares in amounts less than Creation Unit Aggregations. Beneficial Owners must
accumulate enough shares in the secondary market to constitute a Creation Unit
Aggregation in order to have such shares redeemed by the Trust. There can be no
assurance, however, that there will be sufficient liquidity in the public
trading market at any time to permit assembly of a Creation Unit Aggregation.
Investors should expect to incur customary brokerage and other costs in
connection with assembling a sufficient number of Fund shares to constitute a
redeemable Creation Unit Aggregation.
The Custodian, through the NSCC, makes available on each Business Day,
prior to the opening of business on the Exchange (currently 9:30 a.m. Eastern
Time), the list of the names and the required quantity of the securities and
other instruments ("Fund Securities"), as well as the estimated Cash Redemption
Amount (defined below) (if any), that will be applicable for the Fund for that
day (subject to correction of any errors) to redemption requests received in
proper form (as described below) on that day.
- 46 -
Unless cash redemptions are required or permitted for the Fund under the
circumstances described below, the redemption proceeds for a Creation Unit
Aggregation generally consist of Fund Securities--as announced on the Business
Day of the request for redemption received in proper form--plus or minus cash in
an amount equal to the difference between the net asset value of the Fund shares
(per Creation Unit Aggregation) being redeemed, as next determined after a
receipt of a request in proper form, and the aggregate market value of the Fund
Securities (the "Cash Redemption Amount"), less the applicable Redemption
Transaction Fee as listed below and, if applicable, any operational processing
and brokerage costs, transfer fees or stamp taxes. In the event that the Fund
Securities have an aggregate market value greater than the net asset value of
the Fund shares (per Creation Unit Aggregation), a compensating cash payment
equal to the difference plus, the applicable Redemption Transaction Fee and, if
applicable, any operational processing and brokerage costs, transfer fees or
stamp taxes is required to be made by or through an Authorized Participant by
the redeeming shareholder.
The Fund reserves the right to require or permit redemptions of Creation
Unit Aggregations to be made in whole or in part on a cash basis, rather than
in-kind, under the following circumstances: (i) to the extent there is a Cash
Redemption Amount; (ii) if, on a given Business Day, the Fund announces before
the open of trading that all redemptions on that day will be made entirely in
cash; (iii) if, upon receiving a redemption order from an Authorized
Participant, the Fund determines to require the redemption to be made entirely
in cash; (iv) if, on a given Business Day, the Fund requires all Authorized
Participants redeeming shares on that day to receive cash in lieu of some or all
of the Fund Securities because: (a) such instruments are not eligible for
transfer through either the NSCC Process or the DTC Process; or (b) in the case
of non-U.S. Fund Securities, such instruments are not eligible for trading due
to local trading restrictions, local restrictions on securities transfers or
other similar circumstances; or (v) if the Fund permits an Authorized
Participant to receive cash in lieu of some or all of the Fund Securities
because: (a) such instruments are not eligible for trading by an Authorized
Participant or the investor on whose behalf the Authorized Participant is
acting; or (b) with respect to non-U.S. Fund Securities, a holder of shares of
the Fund would be subject to unfavorable income tax treatment if the holder
receives redemption proceeds in kind.
In addition, under the following circumstances, it is possible that Fund
Securities may not correspond pro rata to the positions in the Fund's portfolio
as of the end of the prior Business Day: (i) in the case of bonds, for minor
differences when it is impossible to break up bonds beyond certain minimum sizes
needed for transfer and settlement; (ii) for minor differences when rounding is
necessary to eliminate fractional shares or lots that are not tradeable round
lots; or (iii) with respect to "to-be-announced" transactions, short positions
and other positions that cannot be transferred in kind (including instruments
that can be transferred in kind only with the consent of the original
counterparty to the extent the Fund does not intend to seek such consents), and
they will therefore be excluded from the Fund Securities with their value
reflected in the determination of the Cash Redemption Amount.
The right of redemption may be suspended or the date of payment postponed
(i) for any period during which the NYSE is closed (other than customary weekend
and holiday closings); (ii) for any period during which trading on the NYSE is
suspended or restricted; (iii) for any period during which an emergency exists
as a result of which disposal of the shares of the Fund or determination of the
- 47 -
Fund's net asset value is not reasonably practicable; or (iv) in such other
circumstances as are permitted by the SEC.
Redemption Transaction Fee. Parties redeeming Creation Units must pay a
redemption transaction fee (the "Redemption Transaction Fee") that is currently
$500. The Redemption Transaction Fee is applicable to each redemption
transaction regardless of the number of Creation Units redeemed in the
transaction. The Redemption Transaction Fee may vary and is based on the
composition of the securities included in the Fund's portfolio and the countries
in which the transactions are settled. Investors will also bear the costs of
transferring the Fund Securities from the Trust to their account or on their
order. Investors who use the services of a broker or other such intermediary in
addition to an Authorized Participant to effect a redemption of a Creation Unit
Aggregation may be charged an additional fee for such services.
Placement of Redemption Orders. Orders to redeem Creation Unit
Aggregations must be delivered through an Authorized Participant that has
executed a Participant Agreement and must comply with the applicable provisions
of such Participant Agreement. Investors other than Authorized Participants are
responsible for making arrangements for a redemption request to be made through
an Authorized Participant.
Deliveries of Fund Securities to investors are generally expected to be
made within three Business Days. Due to the schedule of holidays in certain
countries, however, the delivery of in-kind redemption proceeds for the Fund may
take longer than three Business Days after the day on which the redemption
request is received in proper form. In such cases, the local market settlement
procedures will not commence until the end of the local holiday periods. See
below for a list of the local holidays in the foreign countries relevant to the
Fund. Under the 1940 Act, the Fund would generally be required to make payment
of redemption proceeds within seven days after a security is tendered for
redemption. However, because the settlement of redemptions of Fund shares is
contingent not only on the settlement cycle of the United States securities
markets, but also on delivery cycles of foreign markets, pursuant to an
exemptive order on which the Fund may rely, the Fund's in-kind redemption
proceeds are permitted to be paid within the maximum number of calendar days
required for such payment or satisfaction in the principal local foreign markets
where transactions in portfolio securities customarily clear and settle, but no
later than 15 calendar days following tender of a Creation Unit Aggregation in
proper form.
In connection with taking delivery of shares of non-U.S. Fund Securities
upon redemption of shares of the Fund, a redeeming Beneficial Owner, or
Authorized Participant acting on behalf of such Beneficial Owner, must maintain
appropriate security arrangements with a qualified broker-dealer, bank or other
custody provider in each jurisdiction in which any of the Fund Securities are
customarily traded, to which account such Fund Securities will be delivered.
To the extent contemplated by an Authorized Participant's agreement, in
the event the Authorized Participant has submitted a redemption request in
proper form but is unable to transfer all or part of the Creation Unit
Aggregation to be redeemed to the Fund's transfer agent, the transfer agent may
nonetheless accept the redemption request in reliance on the undertaking by the
- 48 -
Authorized Participant to deliver the missing shares as soon as possible. Such
undertaking shall be secured by the Authorized Participant's delivery and
maintenance of collateral consisting of cash having a value (marked to market
daily) at least equal to 115%, (which First Trust may change from time to time),
of the value of the missing shares.
The current procedures for collateralization of missing shares require,
among other things, that any cash collateral shall be in the form of U.S.
dollars in immediately available funds and shall be held by BBH and marked to
market daily, and that the fees of BBH and any sub-custodians in respect of the
delivery, maintenance and redelivery of the cash collateral shall be payable by
the Authorized Participant. If the Authorized Participant's agreement provides
for collateralization, it will permit the Trust, on behalf of the affected Fund,
to purchase the missing shares at any time and will subject the Authorized
Participant to liability for any shortfall between the cost to the Trust of
purchasing such shares and the value of the collateral.
The calculation of the value of the Fund Securities and the Cash
Redemption Amount to be delivered/received upon redemption will be made by BBH
according to the procedures set forth in this SAI under "Determination of Net
Asset Value" computed on the Business Day on which a redemption order is deemed
received by the Trust. Therefore, if a redemption order in proper form is
submitted to BBH by a DTC Participant not later than Closing Time on the
Transmittal Date, and the requisite number of shares of the Fund are delivered
to BBH prior to the specified time, then the value of the Fund Securities and
the Cash Redemption Amount to be delivered will be determined by BBH on such
Transmittal Date. A redemption order must be submitted in proper form.
Redemptions of Fund shares for Fund Securities will be subject to
compliance with applicable federal and state securities laws and the Fund
reserves the right to redeem Creation Unit Aggregations for cash under the
circumstances described above. An Authorized Participant or an investor for
which it is acting may therefore be paid redemption proceeds in cash. The
Authorized Participant may request the redeeming Beneficial Owner of the Fund
shares to complete an order form or to enter into agreements with respect to
such matters as compensating cash payment, beneficial ownership of shares or
delivery instructions.
Because the portfolio securities of the Fund may trade on the relevant
exchange(s) on days that the listing exchange for the Fund is closed or that are
otherwise not Business Days for the Fund, shareholders may not be able to redeem
their shares of the Fund, or purchase and sell shares of the Fund on the listing
exchange for the Fund, on days when the net asset value of the Fund could be
significantly affected by events in the relevant foreign markets.
REGULAR HOLIDAYS
The Fund generally intends to effect deliveries of Creation Units and
securities in its portfolio ("Portfolio Securities") on a basis of "T" plus
three Business Days (i.e., days on which the NYSE is open). The Fund may effect
deliveries of Creation Units and portfolio securities on a basis other than "T"
plus three in order to accommodate local holiday schedules, to account for
different treatment among non-U.S. and U.S. markets of dividend record dates and
ex-dividend dates, or under certain other circumstances. The ability of the
Trust to effect in-kind creations and redemptions within three Business Days of
- 49 -
receipt of an order in good form is subject, among other things, to the
condition that, within the time period from the date of the order to the date of
delivery of the securities, there are no days that are holidays in the
applicable foreign market. For every occurrence of one or more intervening
holidays in the applicable non-U.S. market that are not holidays observed in the
U.S. equity market, the redemption settlement cycle will be extended by the
number of such intervening holidays. In addition to holidays, other
unforeseeable closings in a non-U.S. market due to emergencies may also prevent
the Trust from delivering securities within the normal settlement period.
The longest redemption cycle for the Fund is a function of the longest
redemption cycle among the countries whose securities comprise the Fund. The
securities delivery cycles currently practicable for transferring Portfolio
Securities to redeeming investors, coupled with non-U.S. market holiday
schedules, will require a delivery process longer than seven calendar days for
the Fund in certain circumstances. In no event, however, will the Fund take more
than fifteen calendar days from the date of the tender to deliver the redemption
proceeds. The holidays applicable to the Fund during such periods are listed
below. Certain holidays may occur on different dates in subsequent years. The
proclamation of new holidays, the treatment by market participants of certain
days as "informal holidays" (e.g., days on which no or limited securities
transactions occur, as a result of substantially shortened trading hours), the
elimination of existing holidays, or changes in local securities delivery
practices could affect the information set forth herein at some time in the
future.
The dates of the regular holidays affecting the relevant securities
markets from May 1, 2015 through March 31, 2016 of the below-listed countries
are as follows:
ARGENTINA AUSTRALIA AUSTRIA BELGIUM
--------- --------- ------- -------
May 1 June 8 May 1 May 1
May 25 December 25 May 14 December 25
July 9 December 28 May 25 December 31
August 17 January 1 June 4 January 1
October 12 January 26 October 26 March 25
November 6 March 25 December 8 March 28
November 23 March 28 December 24
December 7 April 25 December 25
December 8 December 31
December 24 January 1
December 25 January 6
December 31 March 28
January 1
February 8
February 9
March 24
March 25
BRAZIL CANADA CHILE CHINA
------ ------ ----- -----
May 1 May 18 May 1 May 1
- 50 -
June 4 July 1 May 21 June 22
July 9 August 3 June 29 October 1
October 12 September 7 July 16 October 2
November 2 October 12 August 15 October 5
November 20 December 25 September 18 October 6
December 24 December 28 October 12 October 7
December 25 January 1 December 8 January 1
December 31 February 15 December 25 February 8
January 1 March 25 December 31 February 9
January 25 January 1 February 10
February 8 March 25 February 11
February 9 February 12
March 25 April 4
April 21
DENMARK FINLAND FRANCE GERMANY
------- ------- ------ -------
May 1 May 1 May 1 May 1
May 14 May 14 December 25 May 25
May 15 June 19 December 31 December 24
May 25 December 24 January 1 December 25
June 5 December 25 March 25 December 31
December 24 December 31 March 28 January 1
December 25 January 1 March 25
December 31 January 6 March 28
January 1 March 25
March 24 March 28
March 25
March 28
April 22
GREECE HONG KONG INDIA IRELAND
------ --------- ----- -------
May 1 May 1 May 1 May 4
June 1 May 25 September 17 June 1
October 28 July 1 September 25 December 25
December 24 September 28 October 2 December 28
December 25 October 1 October 22 January 1
January 1 October 21 November 11 March 17
January 6 December 25 November 12 March 28
March 25 January 1 November 25
April 29 February 8 December 25
February 9 January 26
February 10 March 23
March 25 March 25
March 28 April 14
April 4 April 19
- 51 -
ISRAEL ITALY JAPAN MALAYSIA
------ ----- ----- --------
May 24 April 3 May 4 May 1
July 26 April 6 May 5 May 4
September 13 May 1 May 6 July 17
September 14 December 24 July 20 August 31
September 15 December 25 September 21 September 16
September 22 December 31 September 22 September 24
September 23 January 1 September 23 October 14
September 27 March 25 October 12 November 10
September 28 November 3 December 24
October 4 November 23 December 25
October 5 December 23 January 1
March 24 December 31 February 8
April 22 January 1 February 9
April 28 January 2
April 29 January 11
February 11
March 21
April 29
MEXICO NEW ZEALAND NETHERLANDS NORWAY
------ ----------- ----------- ------
May 1 June 1 May 1 May 1
September 16 October 26 December 25 May 14
November 2 December 25 December 31 May 25
November 16 December 28 January 1 December 24
December 12 January 1 March 25 December 25
December 25 January 4 March 28 December 31
January 1 February 2 January 1
February 1 February 8 March 24
March 24 March 25 March 25
March 25 March 28 March 28
April 25
PORTUGAL SINGAPORE SOUTH AFRICA SOUTH KOREA
-------- --------- ------------ -----------
May 1 May 1 May 1 May 1
June 10 June 1 June 16 May 5
August 15 July 17 August 10 May 25
December 8 August 10 September 24 June 6
December 25 September 24 December 16 August 15
January 1 November 10 December 25 September 28
March 25 December 25 January 1 September 29
March 28 January 1 March 21 October 9
February 8 March 25 December 25
February 9 March 28 January 1
- 52 -
March 25 February 8
February 9
March 1
SPAIN SWEDEN SWITZERLAND TAIWAN
----- ------ ----------- ------
May 1 May 1 May 1 May 1
December 25 May 14 May 14 June 19
January 1 June 19 May 25 September 28
March 25 December 24 December 25 October 9
March 28 December 25 January 1 January 1
December 31 January 6 February 8
January 1 March 25 February 9
January 6 March 28 February 10
March 25 February 11
February 12
February 29
April 4
THAILAND UNITED KINGDOM UNITED STATES
-------- -------------- -------------
May 1 May 4 May 25
May 4 May 25 July 3
May 5 August 31 September 7
June 1 December 25 November 26
July 1 December 28 December 25
July 30 January 1 January 1
August 12 March 25 January 18
October 23 March 28 March 25
December 7
December 10
December 31
January 1
April 6
April 13
April 14
April 15
FEDERAL TAX MATTERS
This section summarizes some of the main U.S. federal income tax
consequences of owning shares of the Fund. This section is current as of the
date of the SAI. Tax laws and interpretations change frequently, and these
summaries do not describe all of the tax consequences to all taxpayers. For
example, these summaries generally do not describe your situation if you are a
corporation, a non-U.S. person, a broker-dealer, or other investor with special
circumstances. In addition, this section does not describe your state, local or
foreign tax consequences.
- 53 -
This federal income tax summary is based in part on the advice of counsel
to the Fund. The Internal Revenue Service could disagree with any conclusions
set forth in this section. In addition, our counsel was not asked to review, and
has not reached a conclusion with respect to the federal income tax treatment of
the assets to be deposited in the Fund. This may not be sufficient for
prospective investors to use for the purpose of avoiding penalties under federal
tax law.
As with any investment, prospective investors should seek advice based on
their individual circumstances from their own tax advisor.
The Fund intends to qualify annually and to elect to be treated as a
regulated investment company under the Internal Revenue Code (the "Code").
To qualify for the favorable U.S. federal income tax treatment generally
accorded to regulated investment companies, the Fund must, among other things,
(a) derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans and gains from the sale or
other disposition of stock, securities or foreign currencies or other income
derived with respect to its business of investing in such stock, securities or
currencies, or net income derived from interests in certain publicly traded
partnerships; (b) diversify its holdings so that, at the end of each quarter of
the taxable year, (i) at least 50% of the market value of the Fund's assets is
represented by cash and cash items (including receivables), U.S. government
securities, the securities of other regulated investment companies and other
securities, with such other securities of any one issuer generally limited for
the purposes of this calculation to an amount not greater than 5% of the value
of the Fund's total assets and not greater than 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25% of the value of its total
assets is invested in the securities (other than U.S. government securities or
the securities of other regulated investment companies) of any one issuer, or
two or more issuers which the Fund controls which are engaged in the same,
similar or related trades or businesses, or the securities of one or more of
certain publicly traded partnerships; and (c) distribute at least 90% of its
investment company taxable income (which includes, among other items, dividends,
interest and net short-term capital gains in excess of net long-term capital
losses) and at least 90% of its net tax-exempt interest income each taxable
year. There are certain exceptions for failure to qualify if the failure is for
reasonable cause or is de minimis, and certain corrective action is taken and
certain tax payments are made by the Fund.
As a regulated investment company, the Fund generally will not be subject
to U.S. federal income tax on its investment company taxable income (as that
term is defined in the Code, but without regard to the deduction for dividends
paid) and net capital gain (the excess of net long-term capital gain over net
short-term capital loss), if any, that it distributes to shareholders. The Fund
intends to distribute to its shareholders, at least annually, substantially all
of its investment company taxable income and net capital gain. If the Fund
retains any net capital gain or investment company taxable income, it will
generally be subject to federal income tax at regular corporate rates on the
amount retained. In addition, amounts not distributed on a timely basis in
accordance with a calendar year distribution requirement are subject to a
nondeductible 4% excise tax unless, generally, the Fund distributes during each
calendar year an amount equal to the sum of (1) at least 98% of its ordinary
income (not taking into account any capital gains or losses) for the calendar
- 54 -
year, (2) at least 98.2% of its capital gains in excess of its capital losses
(adjusted for certain ordinary losses) for the one-year period ending October 31
of the calendar year, and (3) any ordinary income and capital gains for previous
years that were not distributed during those years. In order to prevent
application of the excise tax, the Fund intends to make its distributions in
accordance with the calendar year distribution requirement. A distribution will
be treated as paid on December 31 of the current calendar year if it is declared
by the Fund in October, November or December with a record date in such a month
and paid by the Fund during January of the following calendar year. Such
distributions will be taxable to shareholders in the calendar year in which the
distributions are declared, rather than the calendar year in which the
distributions are received.
Subject to certain reasonable cause and de minimis exceptions, if the Fund
fails to qualify as a regulated investment company or fails to satisfy the 90%
distribution requirement in any taxable year, the Fund would be taxed as an
ordinary corporation on its taxable income (even if such income were distributed
to its shareholders) and all distributions out of earnings and profits would be
taxed to shareholders as ordinary income.
DISTRIBUTIONS
Dividends paid out of the Fund's investment company taxable income are
generally taxable to a shareholder as ordinary income to the extent of the
Fund's earnings and profits, whether paid in cash or reinvested in additional
shares. However, certain ordinary income distributions received from the Fund
may be taxed at capital gains tax rates. In particular, ordinary income
dividends received by an individual shareholder from a regulated investment
company such as the Fund are generally taxed at the same rates that apply to net
capital gain, provided that certain holding period requirements are satisfied
and provided the dividends are attributable to qualifying dividends received by
the Fund itself. Dividends received by the Fund from REITs and foreign
corporations are qualifying dividends eligible for this lower tax rate only in
certain circumstances. The Fund will provide notice to its shareholders of the
amount of any distributions that may be taken into account as a dividend which
is eligible for the capital gains tax rates. The Fund can not make any
guarantees as to the amount of any distribution which will be regarded as a
qualifying dividend.
Income from the Fund may also be subject to a 3.8% "Medicare tax." This
tax will generally apply to net investment income if the taxpayer's adjusted
gross income exceeds certain threshold amounts, which are $250,000 in the case
of married couples filing joint returns and $200,000 in the case of single
individuals.
A corporation that owns shares generally will not be entitled to the
dividends received deduction with respect to many dividends received from the
Fund because the dividends received deduction is generally not available for
distributions from regulated investment companies. However, certain ordinary
income dividends on shares that are attributable to qualifying dividends
received by the Fund from certain domestic corporations may be reported by the
Fund as being eligible for the dividends received deduction.
- 55 -
Distributions of net capital gain (the excess of net long-term capital
gain over net short-term capital loss), if any, properly reported as capital
gain dividends are taxable to a shareholder as long-term capital gains,
regardless of how long the shareholder has held Fund shares. Shareholders
receiving distributions in the form of additional shares, rather than cash,
generally will have a tax basis in each such share equal to the value of a share
of the Fund on the reinvestment date. A distribution of an amount in excess of
the Fund's current and accumulated earnings and profits will be treated by a
shareholder as a return of capital which is applied against and reduces the
shareholder's basis in his or her shares. To the extent that the amount of any
such distribution exceeds the shareholder's basis in his or her shares, the
excess will be treated by the shareholder as gain from a sale or exchange of the
shares.
Shareholders will be notified annually as to the U.S. federal income tax
status of distributions, and shareholders receiving distributions in the form of
additional shares will receive a report as to the value of those shares.
SALE OR EXCHANGE OF FUND SHARES
Upon the sale or other disposition of shares of the Fund, which a
shareholder holds as a capital asset, such a shareholder may realize a capital
gain or loss which will be long-term or short-term, depending upon the
shareholder's holding period for the shares. Generally, a shareholder's gain or
loss will be a long-term gain or loss if the shares have been held for more than
one year.
Any loss realized on a sale or exchange will be disallowed to the extent
that shares disposed of are replaced (including through reinvestment of
dividends) within a period of 61 days beginning 30 days before and ending 30
days after disposition of shares or to the extent that the shareholder, during
such period, acquires or enters into an option or contract to acquire,
substantially identical stock or securities. In such a case, the basis of the
shares acquired will be adjusted to reflect the disallowed loss. Any loss
realized by a shareholder on a disposition of Fund shares held by the
shareholder for six months or less will be treated as a long-term capital loss
to the extent of any distributions of long-term capital gain received by the
shareholder with respect to such shares.
TAXES ON PURCHASE AND REDEMPTION OF CREATION UNITS
If a shareholder exchanges equity securities for Creation Units the
shareholder will generally recognize a gain or a loss. The gain or loss will be
equal to the difference between the market value of the Creation Units at the
time and the shareholder's aggregate basis in the securities surrendered and the
Cash Component paid. If a shareholder exchanges Creation Units for equity
securities, then the shareholder will generally recognize a gain or loss equal
to the difference between the shareholder's basis in the Creation Units and the
aggregate market value of the securities received and the Cash Redemption
Amount. The Internal Revenue Service, however, may assert that a loss realized
upon an exchange of securities for Creation Units or Creation Units for
securities cannot be deducted currently under the rules governing "wash sales,"
or on the basis that there has been no significant change in economic position.
- 56 -
NATURE OF FUND'S INVESTMENTS
Certain of the Fund's investment practices are subject to special and
complex federal income tax provisions that may, among other things, (i)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (ii) convert lower taxed long-term capital gain into higher taxed
short-term capital gain or ordinary income, (iii) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited), (iv)
cause the Fund to recognize income or gain without a corresponding receipt of
cash, (v) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur and (vi) adversely alter the characterization of
certain complex financial transactions.
FUTURES CONTRACTS
The Subsidiary's transactions in Futures Contracts will be subject to
special provisions of the Code that, among other things, may affect the
character of gains and losses realized by the Fund (i.e., may affect whether
gains or losses are ordinary or capital, or short-term or long-term), may
accelerate recognition of income to the Fund and may defer Fund losses. These
rules could, therefore, affect the character, amount and timing of distributions
to shareholders. These provisions also (a) will require the Subsidiary to
mark-to-market certain types of the positions in its portfolio (i.e., treat them
as if they were closed out), and (b) may cause the Fund to recognize income
without receiving cash with which to make distributions in amounts necessary to
satisfy the 90% distribution requirement for qualifying to be taxed as a
regulated investment company and the distribution requirements for avoiding
excise taxes.
INVESTMENTS IN CERTAIN FOREIGN CORPORATIONS
If the Fund holds an equity interest in any "passive foreign investment
companies" ("PFICs"), which are generally certain foreign corporations that
receive at least 75% of their annual gross income from passive sources (such as
interest, dividends, certain rents and royalties or capital gains) or that hold
at least 50% of their assets in investments producing such passive income, the
Fund could be subject to U.S. federal income tax and additional interest charges
on gains and certain distributions with respect to those equity interests, even
if all the income or gain is timely distributed to its shareholders. The Fund
will not be able to pass through to its shareholders any credit or deduction for
such taxes. The Fund may be able to make an election that could ameliorate these
adverse tax consequences. In this case, the Fund would recognize as ordinary
income any increase in the value of such PFIC shares, and as ordinary loss any
decrease in such value to the extent it did not exceed prior increases included
in income. Under this election, the Fund might be required to recognize in a
year income in excess of its distributions from PFICs and its proceeds from
dispositions of PFIC stock during that year, and such income would nevertheless
be subject to the distribution requirement and would be taken into account for
purposes of the 4% excise tax (described above). Dividends paid by PFICs are not
treated as qualified dividend income.
- 57 -
BACKUP WITHHOLDING
The Fund may be required to withhold U.S. federal income tax from all
taxable distributions and sale proceeds payable to shareholders who fail to
provide the Fund with their correct taxpayer identification number or fail to
make required certifications, or who have been notified by the Internal Revenue
Service that they are subject to backup withholding. Corporate shareholders and
certain other shareholders specified in the Code generally are exempt from such
backup withholding. This withholding is not an additional tax. Any amounts
withheld may be credited against the shareholder's U.S. federal income tax
liability.
NON-U.S. SHAREHOLDERS
U.S. taxation of a shareholder who, as to the United States, is a
nonresident alien individual, a foreign trust or estate, a foreign corporation
or foreign partnership ("non-U.S. shareholder") depends on whether the income of
the Fund is "effectively connected" with a U.S. trade or business carried on by
the shareholder.
In addition to the rules described in this section concerning the
potential imposition of withholding on distributions to non-U.S. persons,
distributions to non-U.S. persons that are "financial institutions" may be
subject to a withholding tax of 30% unless an agreement is in place between the
financial institution and the U.S. Treasury to collect and disclose information
about accounts, equity investments, or debt interests in the financial
institution held by one or more U.S. persons or the institution is resident in a
jurisdiction that has entered into such an agreement with the U.S. Treasury. For
these purposes, a "financial institution" means any entity that (i) accepts
deposits in the ordinary course of a banking or similar business, (ii) holds
financial assets for the account of others as a substantial portion of its
business, or (iii) is engaged (or holds itself out as being engaged) primarily
in the business of investing, reinvesting or trading in securities, partnership
interests, commodities or any interest (including a futures contract or option)
in such securities, partnership interests or commodities. Dispositions of shares
by such persons may be subject to such withholding after December 31, 2016.
Distributions to non-financial non-U.S. entities (other than publicly
traded foreign entities, entities owned by residents of U.S. possessions,
foreign governments, international organizations, or foreign central banks) will
also be subject to a withholding tax of 30% if the entity does not certify that
the entity does not have any substantial U.S. owners or provide the name,
address and TIN of each substantial U.S. owner. Dispositions of shares by such
persons may be subject to such withholding after December 31, 2016.
Income Not Effectively Connected. If the income from the Fund is not
"effectively connected" with a U.S. trade or business carried on by the non-U.S.
shareholder, distributions of investment company taxable income will generally
be subject to a U.S. tax of 30% (or lower treaty rate), which tax is generally
withheld from such distributions.
Distributions of capital gain dividends and any amounts retained by the
Fund which are properly reported by the Fund as undistributed capital gains will
not be subject to U.S. tax at the rate of 30% (or lower treaty rate) unless the
non-U.S. shareholder is a nonresident alien individual and is physically present
- 58 -
in the United States for more than 182 days during the taxable year and meets
certain other requirements. However, this 30% tax on capital gains of
nonresident alien individuals who are physically present in the United States
for more than the 182 day period only applies in exceptional cases because any
individual present in the United States for more than 182 days during the
taxable year is generally treated as a resident for U.S. income tax purposes; in
that case, he or she would be subject to U.S. income tax on his or her worldwide
income at the graduated rates applicable to U.S. citizens, rather than the 30%
U.S. tax. In the case of a non-U.S. shareholder who is a nonresident alien
individual, the Fund may be required to withhold U.S. income tax from
distributions of net capital gain unless the non-U.S. shareholder certifies his
or her non-U.S. status under penalties of perjury or otherwise establishes an
exemption. If a non-U.S. shareholder is a nonresident alien individual, any gain
such shareholder realizes upon the sale or exchange of such shareholder's shares
of the Fund in the United States will ordinarily be exempt from U.S. tax unless
the gain is U.S. source income and such shareholder is physically present in the
United States for more than 182 days during the taxable year and meets certain
other requirements.
In the case of dividends with respect to taxable years of the Fund
beginning prior to 2015, distributions from the Fund that are properly reported
by the Fund as an interest-related dividend attributable to certain interest
income received by the Fund or as a short-term capital gain dividend
attributable to certain net short-term capital gain income received by the Fund
may not be subject to U.S. federal income taxes, including withholding taxes
when received by certain non-U.S. investors, provided that the Fund makes
certain elections and certain other conditions are met.
In addition, capital gain distributions attributable to gains from U.S.
real property interests (including certain U.S. real property holding
corporations) will generally be subject to United States withholding tax and
will give rise to an obligation on the part of the foreign shareholder to file a
United States tax return.
Income Effectively Connected. If the income from the Fund is "effectively
connected" with a U.S. trade or business carried on by a non-U.S. shareholder,
then distributions of investment company taxable income and capital gain
dividends, any amounts retained by the Fund which are properly reported by the
Fund as undistributed capital gains and any gains realized upon the sale or
exchange of shares of the Fund will be subject to U.S. income tax at the
graduated rates applicable to U.S. citizens, residents and domestic
corporations. Non-U.S. corporate shareholders may also be subject to the branch
profits tax imposed by the Code. The tax consequences to a non-U.S. shareholder
entitled to claim the benefits of an applicable tax treaty may differ from those
described herein. Non-U.S. shareholders are advised to consult their own tax
advisors with respect to the particular tax consequences to them of an
investment in the Fund.
CAPITAL LOSS CARRY-FORWARD
Under the Regulated Investment Company Modernization Act of 2010
(the "RIC Modernization Act"), net capital losses of the Fund may be carried
forward indefinitely, and their character is retained as short-term and/or
long-term losses. To the extent that these loss carry-forwards are used to
- 59 -
offset future capital gains, it is probable that the capital gains so offset
will not be distributed to Fund shareholders. As of December 31, 2014, the Fund
did not have any net capital loss carry-forwards outstanding for federal income
tax purposes. The Fund is subject to certain limitations, under U.S. tax rules,
on the use of capital loss carry-forwards and net unrealized built-in losses.
These limitations apply when there has been a 50% change in ownership.
OTHER TAXATION
Fund shareholders may be subject to state, local and foreign taxes on
their Fund distributions. Shareholders are advised to consult their own tax
advisors with respect to the particular tax consequences to them of an
investment in the Fund.
DETERMINATION OF NET ASSET VALUE
The following information supplements and should be read in conjunction
with the section in the Prospectus entitled "Net Asset Value."
The per share net asset value of the Fund is determined by dividing the
total value of the securities and other assets, less liabilities, by the total
number of shares outstanding. Under normal circumstances, daily calculation of
the net asset value will utilize the last closing sale price of each security
held by the Fund at the close of the market on which such security is
principally listed. In determining net asset value, portfolio securities for the
Fund for which accurate market quotations are readily available will be valued
by the Fund accounting agent as follows:
(1) Common stocks and other equity securities listed on any
national or foreign exchange other than NASDAQ(R) and the London Stock
Exchange Alternative Investment Market ("AIM") will be valued at the last
sale price on the exchange on which they are principally traded, or the
official closing price for NASDAQ(R) and AIM securities. Portfolio
securities traded on more than one securities exchange are valued at the
last sale price or official closing price, as applicable, on the Business
Day as of which such value is being determined at the close of the
exchange representing the principal market for such securities.
(2) Securities traded in the OTC market are fair valued at the mean
of the bid and asked price, if available, and otherwise at their closing
bid price.
(3) Exchange traded options and futures contracts are valued at the
closing price in the market where such contracts are principally traded.
If no closing price is available, they will be fair valued at the mean of
the bid and asked price. If no mean price is available, they will be fair
valued at their closing bid price. OTC options and futures contracts are
fair valued at the mean of the most recent bid and asked price, if
available, and otherwise at their closing bid price.
- 60 -
In addition, the following types of securities will be fair valued by the
Fund accounting agent as follows:
(1) Fixed income and other debt securities having a remaining
maturity of 60 days or less when purchased are fair valued at cost
adjusted for amortization of premiums and accretion of discounts
(amortized cost), provided the Advisor's Pricing Committee has determined
that the use of amortized cost is an appropriate reflection of fair value
given market and issuer-specific conditions existing at the time of the
determination. Factors that may be considered in determining the
appropriateness of the use of amortized cost include, but are not limited
to, the following:
(i) the credit conditions in the relevant market and changes
thereto;
(ii) the liquidity conditions in the relevant market and
changes thereto;
(iii) the interest rate conditions in the relevant market and
changes thereto (such as significant changes in interest
rates);
(iv) issuer-specific conditions (such as significant credit
deterioration); and
(v) any other market-based data the Advisor's Pricing
Committee considers relevant. In this regard, the
Advisor's Pricing Committee may use last-obtained
market-based data to assist it when valuing portfolio
securities using amortized cost.
(2) Repurchase agreements will be valued as follows. Overnight
repurchase agreements will be fair valued at cost. Term repurchase
agreements (i.e., those whose maturity exceeds seven days) will be fair
valued by the Advisor's Pricing Committee at the average of the bid
quotations obtained daily from at least two recognized dealers.
If the Advisor's Pricing Committee has reason to question the accuracy or
reliability of a price supplied or the use of the amortized cost methodology,
the Advisor's Pricing Committee shall determine if "it needs to fair value" such
portfolio security pursuant to established valuation procedures. From time to
time, the Advisor's Pricing Committee will request that the Fund accounting
agent submit price challenges to a pricing service, usually in response to any
updated broker prices received.
Certain securities may not be able to be priced by pre-established pricing
methods. Such securities may be valued by the Board of Trustees or its delegate,
the Advisor's Pricing Committee, at fair value. These securities generally
include but are not limited to, restricted securities (securities that may not
be publicly sold without registration under the 1933 Act) for which a pricing
service is unable to provide a market price; securities whose trading has been
formally suspended; a security whose market or fair value price is not available
- 61 -
from a pre-established pricing source; a security with respect to which an event
has occurred that is likely to materially affect the value of the security after
the market has closed but before the calculation of Fund net asset value (as may
be the case in foreign markets on which the security is primarily traded) or is
likely to make it difficult or impossible to obtain a reliable market quotation;
and a security whose price, as provided by the pricing service, does not reflect
the security's fair value. Fair value prices represent any prices not considered
market value prices and are either obtained from a pricing service or are
determined by the Advisor's Pricing Committee. Market value prices represent
last sale or official closing prices from a national or foreign exchange (i.e.,
a regulated market) and are primarily obtained from pricing services. If no
market price or official close price is available from either a pricing service
or no quotations are available from one or more brokers or if the Advisor's
Pricing Committee has reason to question the reliability or accuracy of a price
supplied or the use of amortized cost, the value of any portfolio security held
by the Fund for which reliable market prices/quotations are not readily
available will be determined by the Advisor's Pricing Committee in a manner that
most appropriately reflects fair market value of the security on the valuation
date, based on a consideration of all available information. When fair value
prices are used, generally they will differ from market quotations or official
closing prices on the applicable exchange.
Because foreign markets may be open on different days than the days during
which a shareholder may purchase the shares of the Fund, the value of the Fund's
investments may change on the days when shareholders are not able to purchase
the shares of the Fund. For foreign securities, if an extraordinary market event
occurs between the time the last "current" market quotation is available for a
security in the Fund's portfolio and the time the Fund's net asset value is
determined and calls into doubt whether that earlier market quotation represents
fair value at the time the Fund's net asset value is determined, the Fund
accounting agent will immediately notify the Advisor's Pricing Committee and the
Advisor's Pricing Committee shall determine the fair valuation. For foreign
securities, the Advisor's Pricing Committee may seek to determine the "fair
value" of such securities by retaining a pricing service to determine the value
of the securities.
Foreign securities, currencies and other assets denominated in foreign
currencies are translated into U.S. dollars at the exchange rate of such
currencies against the U.S. dollar as provided by a pricing service. All assets
denominated in foreign currencies will be converted into U.S. dollars at the
exchange rates in effect at the time of valuation.
DIVIDENDS AND DISTRIBUTIONS
The following information supplements and should be read in conjunction
with the section in the Prospectus entitled "Dividends, Distributions and
Taxes."
General Policies. Dividends from net investment income of the Fund, if
any, are declared and paid quarterly. Distributions of net realized securities
gains, if any, generally are declared and paid once a year, but the Trust may
make distributions on a more frequent basis. The Trust reserves the right to
declare special distributions if, in its reasonable discretion, such action is
necessary or advisable to preserve the status of the Fund as a regulated
investment company or to avoid imposition of income or excise taxes on
undistributed income.
- 62 -
Dividends and other distributions of Fund shares are distributed, as
described below, on a pro rata basis to Beneficial Owners of such shares.
Dividend payments are made through DTC Participants and Indirect Participants to
Beneficial Owners then of record with proceeds received from the Fund.
Dividend Reinvestment Service. No reinvestment service is provided by the
Trust. Broker-dealers may make available the DTC book-entry Dividend
Reinvestment Service for use by Beneficial Owners of the Fund for reinvestment
of their dividend distributions. Beneficial Owners should contact their brokers
in order to determine the availability and costs of the service and the details
of participation therein. Brokers may require Beneficial Owners to adhere to
specific procedures and timetables. If this service is available and used,
dividend distributions of both income and realized gains will be automatically
reinvested in additional whole shares of the Fund purchased in the secondary
market.
MISCELLANEOUS INFORMATION
Counsel. Chapman and Cutler LLP, 111 West Monroe Street, Chicago, Illinois
60603, is counsel to the Trust.
Independent Registered Public Accounting Firm. Deloitte & Touche LLP, 111
S. Wacker Drive, Chicago, Illinois 60606 serves as the Fund's independent
registered public accounting firm. The firm audits the Fund's financial
statements and performs other related audit services.
FINANCIAL STATEMENTS
The audited financial statements and notes thereto for the Fund, contained
in the Annual Report to Shareholders dated December 31, 2014, are incorporated
by reference into this Statement of Additional Information and have been audited
by Deloitte & Touche LLP, independent registered public accounting firm, whose
report also appears in the Annual Report and are also incorporated by reference
herein. No other parts of the Annual Report are incorporated by reference
herein. The Annual Report is available without charge by calling (800) 621-1675
or by visiting the SEC's website at http://www.sec.gov.
- 63 -
EXHIBIT A - PRINCIPAL HOLDERS TABLE
--------------------------------------------------------------------------------
% OF OUTSTANDING SHARES
NAME OF BENEFICIAL OWNER OWNED
--------------------------------------------------------------------------------
FIRST TRUST GLOBAL TACTICAL COMMODITY STRATEGY FUND
--------------------------------------------------------------------------------
FIRST CLEARING L.L.C. (1) 27.55%
--------------------------------------------------------------------------------
MORGAN STANLEY SMITH BARNEY LLC (2) 16.53%
--------------------------------------------------------------------------------
SCHWAB (CHARLES) & CO., INC. (3) 9.94%
--------------------------------------------------------------------------------
CURIAN CAPITAL LLC (4) 7.97%
--------------------------------------------------------------------------------
UBS FINANCIAL SERVICES INC. (5) 6.09%
--------------------------------------------------------------------------------
RBC CAPITAL MARKETS (6) 5.30%
--------------------------------------------------------------------------------
----------------------
(1) 2801 Market Street, St. Louis, Missouri 63103
(2) 1300 Thames Street, 6th Floor, Baltimore, Maryland 21231
(3) 2423 E. Lincoln Drive, Phoenix, Arizona 85016
(4) 7601 Technology Way, Denver, Colorado 80237
(5) 1000 Harbor Blvd., Weehawken, New Jersey 70086
(6) 60 S. 6th Street, P09, Minneapolis, Minnesota 55402
A-1
EXHIBIT B
ISS
United States
Concise Proxy Voting Guidelines
--------------------------------------------------------------------------------
2015 Benchmark Policy Recommendations
EFFECTIVE FOR MEETINGS ON OR AFTER FEBRUARY 1, 2015
PUBLISHED JANUARY 7, 2015
B-1
ISS 2015 U.S. Concise Proxy Voting Guidelines
--------------------------------------------------------------------------------
THE POLICIES CONTAINED HEREIN ARE A SAMPLING OF SELECT, KEY U.S. PROXY VOTING
GUIDELINES AND ARE NOT EXHAUSTIVE. A FULL LISTING OF ISS' 2015
PROXY VOTING GUIDELINES CAN BE FOUND AT:
HTTP://WWW.ISSGOVERNANCE.COM/POLICY-GATEWAY/2015-POLICY-INFORMATION
ROUTINE/MISCELLANEOUS
AUDITOR RATIFICATION
GENERAL RECOMMENDATION: Vote for proposals to ratify auditors unless any of the
following apply:
o An auditor has a financial interest in or association with the
company, and is therefore not independent;
o There is reason to believe that the independent auditor has rendered
an opinion that is neither accurate nor indicative of the company's
financial position;
o Poor accounting practices are identified that rise to a serious level
of concern, such as: fraud; misapplication of GAAP; and material
weaknesses identified in Section 404 disclosures; or
o Fees for non-audit services ("Other" fees) are excessive.
Non-audit fees are excessive if:
o Non-audit ("other") fees > audit fees + audit-related fees + tax
compliance/preparation fees
BOARD OF DIRECTORS:
VOTING ON DIRECTOR NOMINEES IN UNCONTESTED ELECTIONS
GENERAL RECOMMENDATION: Generally vote for director nominees, except under the
following circumstances:
1. ACCOUNTABILITY
Vote against(1) or withhold from the entire board of directors (except new
nominees(2), who should be considered case-by-case) for the following:
--------
1 In general, companies with a plurality vote standard use "Withhold" as the
contrary vote option in director elections; companies with a majority vote
standard use "Against". However, it will vary by company and the proxy must
be checked to determine the valid contrary vote option for the particular
company.
2 A "new nominee" is any current nominee who has not already been elected by
shareholders and who joined the board after the problematic action in
question transpired. If ISS cannot determine whether the nominee joined the
board before or after the problematic action transpired, the nominee will be
considered a "new nominee" if he or she joined the board within the 12
months prior to the upcoming shareholder meeting.
B-2
Problematic Takeover Defenses
Classified Board Structure:
1.1. The board is classified, and a continuing director responsible for a
problematic governance issue at the board/committee level that would
warrant a withhold/against vote recommendation is not up for
election. All appropriate nominees (except new) may be held
accountable.
Director Performance Evaluation:
1.2. The board lacks accountability and oversight, coupled with sustained
poor performance relative to peers. Sustained poor performance is
measured by one- and three-year total shareholder returns in the
bottom half of a company's four-digit GICS industry group (Russell
3000 companies only). Take into consideration the company's
five-year total shareholder return and operational metrics.
Problematic provisions include but are not limited to:
o A classified board structure;
o A supermajority vote requirement;
o Either a plurality vote standard in uncontested director
elections or a majority vote standard with no plurality
carve-out for contested elections;
o The inability of shareholders to call special meetings;
o The inability of shareholders to act by written consent;
o A dual-class capital structure; and/or
o A non-shareholder-approved poison pill.
Poison Pills:
1.3. The company's poison pill has a "dead-hand" or "modified dead-hand"
feature. Vote against or withhold from nominees every year until
this feature is removed;
1.4. The board adopts a poison pill with a term of more than 12 months
("long-term pill"), or renews any existing pill, including any
"short-term" pill (12 months or less), without shareholder approval.
A commitment or policy that puts a newly adopted pill to a binding
shareholder vote may potentially offset an adverse vote
recommendation. Review such companies with classified boards every
year, and such companies with annually elected boards at least once
every three years, and vote against or withhold votes from all
nominees if the company still maintains a non-shareholder-approved
poison pill; or
1.5. The board makes a material adverse change to an existing poison pill
without shareholder approval.
Vote case-by-case on all nominees if:
1.6. The board adopts a poison pill with a term of 12 months or less
("short-term pill") without shareholder approval, taking into
account the following factors:
o The date of the pill's adoption relative to the date of the
next meeting of shareholders--i.e., whether the company had
time to put the pill on the ballot for shareholder
ratification given the circumstances;
o The issuer's rationale;
o The issuer's governance structure and practices; and
o The issuer's track record of accountability to shareholders.
Problematic Audit-Related Practices
Generally vote against or withhold from the members of the Audit Committee if:
1.7. The non-audit fees paid to the auditor are excessive (see discussion
under "Auditor Ratification");
1.8. The company receives an adverse opinion on the company's financial
statements from its auditor; or
1.9. There is persuasive evidence that the Audit Committee entered into
an inappropriate indemnification agreement with its auditor that
limits the ability of the company, or its shareholders, to pursue
legitimate legal recourse against the audit firm.
B-3
Vote case-by-case on members of the Audit Committee, and potentially the full
board, if:
1.10. Poor accounting practices are identified that rise to a level of
serious concern, such as: fraud, misapplication of GAAP; and
material weaknesses identified in Section 404 disclosures. Examine
the severity, breadth, chronological sequence, and duration, as well
as the company's efforts at remediation or corrective actions, in
determining whether withhold/against votes are warranted.
Problematic Compensation Practices/Pay for Performance Misalignment
In the absence of an Advisory Vote on Executive Compensation ballot item or in
egregious situations, vote against or withhold from the members of the
Compensation Committee, and potentially the full board, if:
1.11. There is a significant misalignment between CEO pay and company
performance (pay for performance);
1.12. The company maintains significant problematic pay practices;
1.13. The board exhibits a significant level of poor communication and
responsiveness to shareholders;
1.14. The company fails to submit one-time transfers of stock options to a
shareholder vote; or
1.15. The company fails to fulfill the terms of a burn rate commitment
made to shareholders.
Vote case-by-case on Compensation Committee members (or, in exceptional cases,
the full board) and the Management Say-on-Pay proposal if:
1.16. The company's previous say-on-pay received the support of less than
70 percent of votes cast, taking into account:
o The company's response, including:
- Disclosure of engagement efforts with major institutional
investors regarding the issues that contributed to the low
level of support;
- Specific actions taken to address the issues that
contributed to the low level of support;
- Other recent compensation actions taken by the company;
o Whether the issues raised are recurring or isolated;
o The company's ownership structure; and
o Whether the support level was less than 50 percent, which
would warrant the highest degree of responsiveness.
Unilateral Bylaw/Charter Amendments
1.17. Generally vote against or withhold from directors individually,
committee members, or the entire board (except new nominees, who
should be considered case-by-case) if the board amends the company's
bylaws or charter without shareholder approval in a manner that
materially diminishes shareholders' rights or that could adversely
impact shareholders, considering the following factors, as
applicable:
o The board's rationale for adopting the bylaw/charter amendment
without shareholder ratification;
o Disclosure by the company of any significant engagement with
shareholders regarding the amendment;
o The level of impairment of shareholders' rights caused by the
board's unilateral amendment to the bylaws/charter;
o The board's track record with regard to unilateral board
action on bylaw/charter amendments or other entrenchment
provisions;
o The company's ownership structure;
o The company's existing governance provisions;
o Whether the amendment was made prior to or in connection with
the company's initial public offering;
o The timing of the board's amendment to the bylaws/charter in
connection with a significant business development;
o Other factors, as deemed appropriate, that may be relevant to
determine the impact of the amendment on shareholders.
B-4
Governance Failures
Under extraordinary circumstances, vote against or withhold from directors
individually, committee members, or the entire board, due to:
1.18. Material failures of governance, stewardship, risk oversight(3), or
fiduciary responsibilities at the company;
1.19. Failure to replace management as appropriate; or
1.20. Egregious actions related to a director's service on other boards
that raise substantial doubt about his or her ability to effectively
oversee management and serve the best interests of shareholders at
any company.
2. RESPONSIVENESS
Vote case-by-case on individual directors, committee members, or the entire
board of directors, as appropriate, if:
2.1. The board failed to act on a shareholder proposal that received the
support of a majority of the shares cast in the previous year.
Factors that will be considered are:
o Disclosed outreach efforts by the board to shareholders in the
wake of the vote;
o Rationale provided in the proxy statement for the level of
implementation;
o The subject matter of the proposal;
o The level of support for and opposition to the resolution in
past meetings;
o Actions taken by the board in response to the majority vote
and its engagement with shareholders;
o The continuation of the underlying issue as a voting item on
the ballot (as either shareholder or management proposals);
and
o Other factors as appropriate.
2.2. The board failed to act on takeover offers where the majority of
shares are tendered;
2.3. At the previous board election, any director received more than 50
percent withhold/against votes of the shares cast and the company
has failed to address the issue(s) that caused the high
withhold/against vote;
2.4. The board implements an advisory vote on executive compensation on a
less frequent basis than the frequency that received the majority of
votes cast at the most recent shareholder meeting at which
shareholders voted on the say-on-pay frequency; or
2.5. The board implements an advisory vote on executive compensation on a
less frequent basis than the frequency that received a plurality,
but not a majority, of the votes cast at the most recent shareholder
meeting at which shareholders voted on the say-on-pay frequency,
taking into account:
o The board's rationale for selecting a frequency that is
different from the frequency that received a plurality;
o The company's ownership structure and vote results;
o ISS' analysis of whether there are compensation concerns or a
history of problematic compensation practices; and
o The previous year's support level on the company's say-on-pay
proposal.
--------
3 Examples of failure of risk oversight include, but are not limited to:
bribery; large or serial fines or sanctions from regulatory bodies;
significant adverse legal judgments or settlements; hedging of company
stock; or significant pledging of company stock.
B-5
3. COMPOSITION
Attendance at Board and Committee Meetings:
3.1. Generally vote against or withhold from directors (except new
nominees, who should be considered case-by-case(4)) who attend less
than 75 percent of the aggregate of their board and committee
meetings for the period for which they served, unless an acceptable
reason for absences is disclosed in the proxy or another SEC filing.
Acceptable reasons for director absences are generally limited to
the following:
o Medical issues/illness;
o Family emergencies; and
o Missing only one meeting (when the total of all meetings is
three or fewer).
3.2. If the proxy disclosure is unclear and insufficient to determine
whether a director attended at least 75 percent of the aggregate of
his/her board and committee meetings during his/her period of
service, vote against or withhold from the director(s) in question.
Overboarded Directors:
Vote against or withhold from individual directors who:
3.3. Sit on more than six public company boards; or
3.4. Are CEOs of public companies who sit on the boards of more than two
public companies besides their own--withhold only at their outside
boards(5).
4. INDEPENDENCE
Vote against or withhold from Inside Directors and Affiliated Outside Directors
(per the Categorization of Directors) when:
4.1. The inside or affiliated outside director serves on any of the three
key committees: audit, compensation, or nominating;
4.2. The company lacks an audit, compensation, or nominating committee so
that the full board functions as that committee;
4.3. The company lacks a formal nominating committee, even if the board
attests that the independent directors fulfill the functions of such
a committee; or
4.4. Independent directors make up less than a majority of the directors.
--------
4 For new nominees only, schedule conflicts due to commitments made prior to
their appointment to the board are considered if disclosed in the proxy or
another SEC filing.
5 Although all of a CEO's subsidiary boards will be counted as separate
boards, ISS will not recommend a withhold vote from the CEO of a parent
company board or any of the controlled (>50 percent ownership)
subsidiaries of that parent, but may do so at subsidiaries that are less
than 50 percent controlled and boards outside the parent/subsidiary
relationships.
B-6
INDEPENDENT CHAIR (SEPARATE CHAIR/CEO)
GENERAL RECOMMENDATION: Generally vote for shareholder proposals requiring that
the chairman's position be filled by an independent director, taking into
consideration the following:
o The scope of the proposal;
o The company's current board leadership structure;
o The company's governance structure and practices;
o Company performance; and
o Any other relevant factors that may be applicable.
PROXY ACCESS
ISS supports proxy access as an important shareholder right, one that is
complementary to other best-practice corporate governance features. However, in
the absence of a uniform standard, proposals to enact proxy access may vary
widely; as such, ISS is not setting forth specific parameters at this time and
will take a case-by-case approach in evaluating these proposals.
GENERAL RECOMMENDATION: Vote case-by-case on proposals to enact proxy access,
taking into account, among other factors:
o Company-specific factors; and
o Proposal-specific factors, including:
- The ownership thresholds proposed in the resolution (i.e.,
percentage and duration);
- The maximum proportion of directors that shareholders may
nominate each year; and
- The method of determining which nominations should appear on the
ballot if multiple shareholders submit nominations.
PROXY CONTESTS--VOTING FOR DIRECTOR NOMINEES IN CONTESTED ELECTIONS
GENERAL RECOMMENDATION: Vote case-by-case on the election of directors in
contested elections, considering the following factors:
o Long-term financial performance of the target company relative to its
industry;
o Management's track record;
o Background to the proxy contest;
o Nominee qualifications and any compensatory agreements;
o Strategic plan of dissident slate and quality of critique against
management;
o Likelihood that the proposed goals and objectives can be achieved
(both slates);
o Stock ownership positions.
When the addition of shareholder nominees to the management card ("proxy access
nominees") results in a number of nominees on the management card which exceeds
the number of seats available for election, vote case-by-case considering the
same factors listed above.
1. SHAREHOLDER RIGHTS & DEFENSES
LITIGATION RIGHTS (INCLUDING EXCLUSIVE VENUE AND FEE-SHIFTING BYLAW PROVISIONS)
Bylaw provisions impacting shareholders' ability to bring suit against the
company may include exclusive venue provisions, which provide that the state of
incorporation shall be the sole venue for certain types of litigation, and
fee-shifting provisions that require a shareholder who sues a company
unsuccessfully to pay all litigation expenses of the defendant corporation.
B-7
GENERAL RECOMMENDATION: Vote case-by-case on bylaws which impact shareholders'
litigation rights, taking into account factors such as:
o The company's stated rationale for adopting such a provision;
o Disclosure of past harm from shareholder lawsuits in which plaintiffs
were unsuccessful or shareholder lawsuits outside the jurisdiction of
incorporation;
o The breadth of application of the bylaw, including the types of
lawsuits to which it would apply and the definition of key terms; and
o Governance features such as shareholders' ability to repeal the
provision at a later date (including the vote standard applied when
shareholders attempt to amend the bylaws) and their ability to hold
directors accountable through annual director elections and a majority
vote standard in uncontested elections.
Generally vote against bylaws that mandate fee-shifting whenever plaintiffs are
not completely successful on the merits (i.e., in cases where the plaintiffs are
partially successful).
Unilateral adoption by the board of bylaw provisions which affect shareholders'
litigation rights will be evaluated under ISS' policy on Unilateral
Bylaw/Charter Amendments.
CAPITAL/RESTRUCTURING
COMMON STOCK AUTHORIZATION
GENERAL RECOMMENDATION: Vote for proposals to increase the number of authorized
common shares where the primary purpose of the increase is to issue shares in
connection with a transaction on the same ballot that warrants support.
Vote against proposals at companies with more than one class of common stock to
increase the number of authorized shares of the class of common stock that has
superior voting rights.
Vote against proposals to increase the number of authorized common shares if a
vote for a reverse stock split on the same ballot is warranted despite the fact
that the authorized shares would not be reduced proportionally.
Vote case-by-case on all other proposals to increase the number of shares of
common stock authorized for issuance. Take into account company-specific factors
that include, at a minimum, the following:
o Past Board Performance:
- The company's use of authorized shares during the last three years
o The Current Request:
- Disclosure in the proxy statement of the specific purposes of the
proposed increase;
- Disclosure in the proxy statement of specific and severe risks to
shareholders of not approving the request; and
- The dilutive impact of the request as determined by an allowable
increase calculated by ISS (typically 100 percent of existing
authorized shares) that reflects the company's need for shares and
total shareholder returns.
PREFERRED STOCK AUTHORIZATION
GENERAL RECOMMENDATION: Vote for proposals to increase the number of authorized
preferred shares where the primary purpose of the increase is to issue shares in
connection with a transaction on the same ballot that warrants support.
B-8
Vote against proposals at companies with more than one class or series of
preferred stock to increase the number of authorized shares of the class or
series of preferred stock that has superior voting rights.
Vote case-by-case on all other proposals to increase the number of shares of
preferred stock authorized for issuance. Take into account company-specific
factors that include, at a minimum, the following:
o Past Board Performance:
- The company's use of authorized preferred shares during the last
three years;
o The Current Request:
- Disclosure in the proxy statement of the specific purposes for the
proposed increase;
- Disclosure in the proxy statement of specific and severe risks to
shareholders of not approving the request;
- In cases where the company has existing authorized preferred
stock, the dilutive impact of the request as determined by an
allowable increase calculated by ISS (typically 100 percent of
existing authorized shares) that reflects the company's need for
shares and total shareholder returns; and
- Whether the shares requested are blank check preferred shares that
can be used for antitakeover purposes.
MERGERS AND ACQUISITIONS
GENERAL RECOMMENDATION: Vote case-by-case on mergers and acquisitions. Review
and evaluate the merits and drawbacks of the proposed transaction, balancing
various and sometimes countervailing factors including:
o Valuation - Is the value to be received by the target shareholders (or
paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation
reasonableness, emphasis is placed on the offer premium, market
reaction and strategic rationale.
o Market reaction - How has the market responded to the proposed deal? A
negative market reaction should cause closer scrutiny of a deal.
o Strategic rationale - Does the deal make sense strategically? From
where is the value derived? Cost and revenue synergies should not be
overly aggressive or optimistic, but reasonably achievable. Management
should also have a favorable track record of successful integration of
historical acquisitions.
o Negotiations and process - Were the terms of the transaction
negotiated at arm's-length? Was the process fair and equitable? A fair
process helps to ensure the best price for shareholders. Significant
negotiation "wins" can also signify the deal makers' competency. The
comprehensiveness of the sales process (e.g., full auction, partial
auction, no auction) can also affect shareholder value.
o Conflicts of interest - Are insiders benefiting from the transaction
disproportionately and inappropriately as compared to non-insider
shareholders? As the result of potential conflicts, the directors and
officers of the company may be more likely to vote to approve a merger
than if they did not hold these interests. Consider whether these
interests may have influenced these directors and officers to support
or recommend the merger. The CIC figure presented in the "ISS
Transaction Summary" section of this report is an aggregate figure
that can in certain cases be a misleading indicator of the true value
transfer from shareholders to insiders. Where such figure appears to
be excessive, analyze the underlying assumptions to determine whether
a potential conflict exists.
o Governance - Will the combined company have a better or worse
governance profile than the current governance profiles of the
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.
B-9
COMPENSATION
Executive Pay Evaluation
Underlying all evaluations are five global principles that most investors expect
corporations to adhere to in designing and administering executive and director
compensation programs:
1. Maintain appropriate pay-for-performance alignment, with emphasis on
long-term shareholder value: This principle encompasses overall
executive pay practices, which must be designed to attract, retain,
and appropriately motivate the key employees who drive shareholder
value creation over the long term. It will take into consideration,
among other factors, the link between pay and performance; the mix
between fixed and variable pay; performance goals; and equity-based
plan costs;
2. Avoid arrangements that risk "pay for failure": This principle
addresses the appropriateness of long or indefinite contracts,
excessive severance packages, and guaranteed compensation;
3. Maintain an independent and effective compensation committee: This
principle promotes oversight of executive pay programs by directors
with appropriate skills, knowledge, experience, and a sound process
for compensation decision-making (e.g., including access to
independent expertise and advice when needed);
4. Provide shareholders with clear, comprehensive compensation
disclosures: This principle underscores the importance of informative
and timely disclosures that enable shareholders to evaluate executive
pay practices fully and fairly;
5. Avoid inappropriate pay to non-executive directors: This principle
recognizes the interests of shareholders in ensuring that compensation
to outside directors does not compromise their independence and
ability to make appropriate judgments in overseeing managers' pay and
performance. At the market level, it may incorporate a variety of
generally accepted best practices.
ADVISORY VOTES ON EXECUTIVE COMPENSATION--MANAGEMENT PROPOSALS (MANAGEMENT
SAY-ON-PAY)
GENERAL RECOMMENDATION: Vote case-by-case on ballot items related to executive
pay and practices, as well as certain aspects of outside director compensation.
Vote against Advisory Votes on Executive Compensation (Management
Say-on-Pay--MSOP) if:
o There is a significant misalignment between CEO pay and company
performance (pay for performance);
o The company maintains significant problematic pay practices;
o The board exhibits a significant level of poor communication and
responsiveness to shareholders.
Vote against or withhold from the members of the Compensation Committee and
potentially the full board if:
o There is no MSOP on the ballot, and an against vote on an MSOP is
warranted due to a pay for performance misalignment, problematic pay
practices, or the lack of adequate responsiveness on compensation
issues raised previously, or a combination thereof;
o The board fails to respond adequately to a previous MSOP proposal that
received less than 70 percent support of votes cast;
o The company has recently practiced or approved problematic pay
practices, including option repricing or option backdating; or
o The situation is egregious.
B-10
PRIMARY EVALUATION FACTORS FOR EXECUTIVE PAY
Pay-for-Performance Evaluation
ISS annually conducts a pay-for-performance analysis to identify strong or
satisfactory alignment between pay and performance over a sustained period. With
respect to companies in the Russell 3000 or Russell 3000E Indices(6), this
analysis considers the following:
1. Peer Group(7) Alignment:
o The degree of alignment between the company's annualized TSR
rank and the CEO's annualized total pay rank within a peer
group, each measured over a three-year period.
o The multiple of the CEO's total pay relative to the peer group
median.
2. Absolute Alignment - the absolute alignment between the trend in CEO
pay and company TSR over the prior five fiscal years - i.e., the
difference between the trend in annual pay changes and the trend in
annualized TSR during the period.
If the above analysis demonstrates significant unsatisfactory long-term
pay-for-performance alignment or, in the case of companies outside the Russell
indices, misaligned pay and performance are otherwise suggested, our analysis
may include any of the following qualitative factors, as relevant to evaluating
how various pay elements may work to encourage or to undermine long-term value
creation and alignment with shareholder interests:
o The ratio of performance- to time-based equity awards;
o The overall ratio of performance-based compensation;
o The completeness of disclosure and rigor of performance goals;
o The company's peer group benchmarking practices;
o Actual results of financial/operational metrics, such as growth in
revenue, profit, cash flow, etc., both absolute and relative to peers;
o Special circumstances related to, for example, a new CEO in the prior
FY or anomalous equity grant practices (e.g., bi-annual awards);
o Realizable pay(9) compared to grant pay; and
o Any other factors deemed relevant.
Problematic Pay Practices
The focus is on executive compensation practices that contravene the global pay
principles, including:
o Problematic practices related to non-performance-based compensation
elements;
o Incentives that may motivate excessive risk-taking; and
o Options Backdating.
--------
6 The Russell 3000E Index includes approximately 4,000 of the largest U.S.
equity securities.
7 The revised peer group is generally comprised of 14-24 companies that are
selected using market cap, revenue (or assets for certain financial firms),
GICS industry group, and company's selected peers' GICS industry group, with
size constraints, via a process designed to select peers that are comparable
to the subject company in terms of revenue/assets and industry, and also
within a market cap bucket that is reflective of the company's. For Oil, Gas
& Consumable Fuels companies, market cap is the only size determinant.
8 Only Russell 3000 Index companies are subject to the Absolute Alignment
analysis.
9 ISS research reports include realizable pay for S&P 1500 companies.
B-11
Problematic Pay Practices related to Non-Performance-Based Compensation Elements
Pay elements that are not directly based on performance are generally evaluated
case-by-case considering the context of a company's overall pay program and
demonstrated pay-for-performance philosophy. Please refer to ISS' Compensation
FAQ document for detail on specific pay practices that have been identified as
potentially problematic and may lead to negative recommendations if they are
deemed to be inappropriate or unjustified relative to executive pay best
practices. The list below highlights the problematic practices that carry
significant weight in this overall consideration and may result in adverse vote
recommendations:
o Repricing or replacing of underwater stock options/SARS without prior
shareholder approval (including cash buyouts and voluntary surrender
of underwater options);
o Excessive perquisites or tax gross-ups, including any gross-up related
to a secular trust or restricted stock vesting;
o New or extended agreements that provide for:
- CIC payments exceeding 3 times base salary and average/target/most
recent bonus;
- CIC severance payments without involuntary job loss or substantial
diminution of duties ("single" or "modified single" triggers);
- CIC payments with excise tax gross-ups (including "modified"
gross-ups).
Incentives that may Motivate Excessive Risk-Taking
o Multi-year guaranteed bonuses;
o A single or common performance metric used for short- and long-term
plans;
o Lucrative severance packages;
o High pay opportunities relative to industry peers;
o Disproportionate supplemental pensions; or
o Mega annual equity grants that provide unlimited upside with no
downside risk.
Factors that potentially mitigate the impact of risky incentives include
rigorous claw-back provisions and robust stock ownership/holding guidelines.
Options Backdating
The following factors should be examined case-by-case to allow for distinctions
to be made between "sloppy" plan administration versus deliberate action or
fraud:
o Reason and motive for the options backdating issue, such as
inadvertent vs. deliberate grant date changes;
o Duration of options backdating;
o Size of restatement due to options backdating;
o Corrective actions taken by the board or compensation committee, such
as canceling or re-pricing backdated options, the recouping of option
gains on backdated grants; and
o Adoption of a grant policy that prohibits backdating, and creates a
fixed grant schedule or window period for equity grants in the future.
B-12
Compensation Committee Communications and Responsiveness
Consider the following factors case-by-case when evaluating ballot items related
to executive pay on the board's responsiveness to investor input and engagement
on compensation issues:
o Failure to respond to majority-supported shareholder proposals on
executive pay topics; or
o Failure to adequately respond to the company's previous say-on-pay
proposal that received the support of less than 70 percent of votes
cast, taking into account:
- The company's response, including:
o Disclosure of engagement efforts with major institutional
investors regarding the issues that contributed to the low
level of support;
o Specific actions taken to address the issues that contributed
to the low level of support;
o Other recent compensation actions taken by the company;
- Whether the issues raised are recurring or isolated;
- The company's ownership structure; and
- Whether the support level was less than 50 percent, which would
warrant the highest degree of responsiveness.
EQUITY-BASED AND OTHER INCENTIVE PLANS
GENERAL RECOMMENDATION: Vote case-by-case on certain equity-based compensation
plans(10) depending on a combination of certain plan features and equity grant
practices, where positive factors may counterbalance negative factors, and vice
versa, as evaluated using an "equity plan scorecard" (EPSC) approach with three
pillars:
o Plan Cost: The total estimated cost of the company's equity plans
relative to industry/market cap peers, measured by the company's
estimated Shareholder Value Transfer (SVT) in relation to peers and
considering both:
- SVT based on new shares requested plus shares remaining for
future grants, plus outstanding unvested/unexercised grants; and
- SVT based only on new shares requested plus shares remaining for
future grants.
o Plan Features:
- Automatic single-triggered award vesting upon a change in
control (CIC);
- Discretionary vesting authority;
- Liberal share recycling on various award types;
- Lack of minimum vesting period for grants made under the plan.
o Grant Practices:
- The company's three year burn rate relative to its
industry/market cap peers;
- Vesting requirements in most recent CEO equity grants (3-year
look-back);
- The estimated duration of the plan (based on the sum of shares
remaining available and the new shares requested, divided by the
average annual shares granted in the prior three years);
- The proportion of the CEO's most recent equity grants/awards
subject to performance conditions;
- Whether the company maintains a claw-back policy;
- Whether the company has established post exercise/vesting
share-holding requirements.
------
10 Proposals evaluated under the EPSC policy generally include those to approve
or amend (1) stock option plans for employees and/or employees and
directors, (2) restricted stock plans for employees and/or employees and
directors, and (3) omnibus stock incentive plans for employees and/or
employees and directors.
B-13
Generally vote against the plan proposal if the combination of above factors
indicates that the plan is not, overall, in shareholders' interests, or if any
of the following egregious factors apply:
o Awards may vest in connection with a liberal change-of-control
definition;
o The plan would permit repricing or cash buyout of underwater options
without shareholder approval (either by expressly permitting it - for
NYSE and Nasdaq listed companies -- or by not prohibiting it when the
company has a history of repricing - for non-listed companies);
o The plan is a vehicle for problematic pay practices or a significant
pay-for-performance disconnect under certain circumstances; or
o Any other plan features are determined to have a significant negative
impact on shareholder interests.
SOCIAL/ENVIRONMENTAL ISSUES
GLOBAL APPROACH
Issues covered under the policy include a wide range of topics, including
consumer and product safety, environment and energy, labor standards and human
rights, workplace and board diversity, and corporate political issues. While a
variety of factors goes into each analysis, the overall principle guiding all
vote recommendations focuses on how the proposal may enhance or protect
shareholder value in either the short or long term.
GENERAL RECOMMENDATION: Generally vote case-by-case, taking into consideration
whether implementation of the proposal is likely to enhance or protect
shareholder value, and, in addition, the following will also be considered:
o If the issues presented in the proposal are more appropriately or
effectively dealt with through legislation or government regulation;
o If the company has already responded in an appropriate and sufficient
manner to the issue(s) raised in the proposal;
o Whether the proposal's request is unduly burdensome (scope or
timeframe) or overly prescriptive;
o The company's approach compared with any industry standard practices
for addressing the issue(s) raised by the proposal;
o If the proposal requests increased disclosure or greater transparency,
whether or not reasonable and sufficient information is currently
available to shareholders from the company or from other publicly
available sources; and
o If the proposal requests increased disclosure or greater transparency,
whether or not implementation would reveal proprietary or confidential
information that could place the company at a competitive
disadvantage.
CLIMATE CHANGE/GREENHOUSE GAS (GHG) EMISSIONS
GENERAL RECOMMENDATION: Generally vote for resolutions requesting that a company
disclose information on the impact of climate change on its operations and
investments, considering:
o Whether the company already provides current, publicly-available
information on the impacts that climate change may have on the company
as well as associated company policies and procedures to address
related risks and/or opportunities;
o The company's level of disclosure is at least comparable to that of
industry peers; and
o There are no significant controversies, fines, penalties, or
litigation associated with the company's environmental performance.
B-14
Generally vote for proposals requesting a report on greenhouse gas (GHG)
emissions from company operations and/or products and operations, unless:
o The company already discloses current, publicly-available information
on the impacts that GHG emissions may have on the company as well as
associated company policies and procedures to address related risks
and/or opportunities;
o The company's level of disclosure is comparable to that of industry
peers; and
o There are no significant, controversies, fines, penalties, or
litigation associated with the company's GHG emissions.
Vote case-by-case on proposals that call for the adoption of GHG reduction goals
from products and operations, taking into account:
o Whether the company provides disclosure of year-over-year GHG
emissions performance data;
o Whether company disclosure lags behind industry peers;
o The company's actual GHG emissions performance;
o The company's current GHG emission policies, oversight mechanisms, and
related initiatives; and
o Whether the company has been the subject of recent, significant
violations, fines, litigation, or controversy related to GHG
emissions.
POLITICAL ACTIVITIES
LOBBYING
GENERAL RECOMMENDATION: Vote case-by-case on proposals requesting information on
a company's lobbying (including direct, indirect, and grassroots lobbying)
activities, policies, or procedures, considering:
o The company's current disclosure of relevant lobbying policies, and
management and board oversight;
o The company's disclosure regarding trade associations or other groups
that it supports, or is a member of, that engage in lobbying
activities; and
o Recent significant controversies, fines, or litigation regarding the
company's lobbying-related activities.
POLITICAL CONTRIBUTIONS
GENERAL RECOMMENDATION: Generally vote for proposals requesting greater
disclosure of a company's political contributions and trade association spending
policies and activities, considering:
o The company's policies, and management and board oversight related to
its direct political contributions and payments to trade associations
or other groups that may be used for political purposes;
o The company's disclosure regarding its support of, and participation
in, trade associations or other groups that may make political
contributions; and
o Recent significant controversies, fines, or litigation related to the
company's political contributions or political activities.
Vote against proposals barring a company from making political contributions.
Businesses are affected by legislation at the federal, state, and local level;
barring political contributions can put the company at a competitive
disadvantage.
Vote against proposals to publish in newspapers and other media a company's
political contributions. Such publications could present significant cost to the
company without providing commensurate value to shareholders.
B-15
POLITICAL TIES
GENERAL RECOMMENDATION: Generally vote against proposals asking a company to
affirm political nonpartisanship in the workplace, so long as:
o There are no recent, significant controversies, fines, or litigation
regarding the company's political contributions or trade association
spending; and
o The company has procedures in place to ensure that employee
contributions to company-sponsored political action committees (PACs)
are strictly voluntary and prohibit coercion.
Vote against proposals asking for a list of company executives, directors,
consultants, legal counsels, lobbyists, or investment bankers that have prior
government service and whether such service had a bearing on the business of the
company. Such a list would be burdensome to prepare without providing any
meaningful information to shareholders.
This document and all of the information contained in it, including without
limitation all text, data, graphs, and charts (collectively, the "Information")
is the property of Institutional Shareholder Services Inc. (ISS), its
subsidiaries, or, in some cases third party suppliers.
The Information has not been submitted to, nor received approval from, the
United States Securities and Exchange Commission or any other regulatory body.
None of the Information constitutes an offer to sell (or a solicitation of an
offer to buy), or a promotion or recommendation of, any security, financial
product or other investment vehicle or any trading strategy, and ISS does not
endorse, approve, or otherwise express any opinion regarding any issuer,
securities, financial products or instruments or trading strategies.
The user of the Information assumes the entire risk of any use it may make or
permit to be made of the Information.
ISS MAKES NO EXPRESS OR IMPLIED WARRANTIES OR REPRESENTATIONS WITH RESPECT TO
THE INFORMATION AND EXPRESSLY DISCLAIMS ALL IMPLIED WARRANTIES (INCLUDING,
WITHOUT LIMITATION, ANY IMPLIED WARRANTIES OF ORIGINALITY, ACCURACY, TIMELINESS,
NON-INFRINGEMENT, COMPLETENESS, MERCHANTABILITY, AND FITNESS for A PARTICULAR
PURPOSE) WITH RESPECT TO ANY OF THE INFORMATION.
Without limiting any of the foregoing and to the maximum extent permitted by
law, in no event shall ISS have any liability regarding any of the Information
for any direct, indirect, special, punitive, consequential (including lost
profits), or any other damages even if notified of the possibility of such
damages. The foregoing shall not exclude or limit any liability that may not by
applicable law be excluded or limited.
B-16
EXHIBIT C
EXHIBIT C - CREDIT RATING DEFINITIONS
Standard & Poor's
A Standard & Poor's issue credit rating is a forward-looking opinion about
the creditworthiness of an obligor with respect to a specific financial
obligation, a specific class of financial obligations, or a specific financial
program (including ratings on medium-term note programs and commercial paper
programs). It takes into consideration the creditworthiness of guarantors,
insurers, or other forms of credit enhancement on the obligation and takes into
account the currency in which the obligation is denominated. The opinion
reflects Standard & Poor's view of the obligor's capacity and willingness to
meet its financial commitments as they come due, and may assess terms, such as
collateral security and subordination, which could affect ultimate payment in
the event of default.
LONG-TERM ISSUE CREDIT RATINGS
Issue credit ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of payment: capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance with the terms
of the obligation;
2. Nature of and provisions of the obligation and the promise S&P imputes;
3. Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization, or other arrangement under the
laws of bankruptcy and other laws affecting creditors' rights.
The issue rating definitions are an assessment of default risk, but
may incorporate an assessment of relative seniority or ultimate recovery
in the event of default. Junior obligations are typically rated lower than
senior obligations, to reflect the lower priority in bankruptcy, as noted
above. (Such differentiation may apply when an entity has both senior and
subordinated obligations, secured and unsecured obligations, or operating
company and holding company obligations.)
AAA. An obligation rated "AAA" has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its financial commitment
on the obligation is extremely strong.
AA. An obligation rated "AA" differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its
financial commitment on the obligation is very strong.
A. An obligation rated "A" is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
C-1
obligations in higher rated categories. However, the obligor's capacity to
meet its financial commitment on the obligation is still strong.
BBB. An obligation rated "BBB" exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances
are more likely to lead to a weakened capacity of the obligor to meet its
financial commitment on the obligation.
Obligations rated "BB," "B," "CCC," "CC" and "C" are regarded as
having significant speculative characteristics. "BB" indicates the least
degree of speculation and "C" the highest. While such obligations will
likely have some quality and protective characteristics, these may be
outweighed by large uncertainties or major exposures to adverse
conditions.
BB. An obligation rated "BB" is less vulnerable to nonpayment than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which
could lead to the obligor's inadequate capacity to meet its financial
commitment on the obligation.
B. An obligation rated "B" is more vulnerable to nonpayment than
obligations rated "BB," but the obligor currently has the capacity to meet
its financial commitment on the obligation. Adverse business, financial,
or economic conditions will likely impair the obligor's capacity or
willingness to meet its financial commitment on the obligation.
CCC. An obligation rated "CCC" is currently vulnerable to
nonpayment, and is dependent upon favorable business, financial, and
economic conditions for the obligor to meet its financial commitment on
the obligation. In the event of adverse business, financial, or economic
conditions, the obligor is not likely to have the capacity to meet its
financial commitment on the obligation.
CC. An obligation rated "CC" is currently highly vulnerable to
nonpayment.
C. An obligation rated 'C' is currently highly vulnerable to
nonpayment and the obligation is expected to have lower relative seniority
or lower ultimate recovery compared to obligations that are rated higher.
D. An obligation rated 'D' is in default or in breach of an imputed
promise. For non-hybrid capital instruments, the 'D' rating category is
used when payments on an obligation are not made on the date due unless
S&P believes that such payments will be made within five business days in
the absence of a stated grace period or within the earlier of the stated
grace period or 30 calendar days. The 'D' rating also will be used upon
the filing of a bankruptcy petition or the taking of similar action and
where default on an obligation is a virtual certainty, for example due to
automatic stay provisions. An obligation's rating is lowered to 'D' if it
is subject to a distressed exchange offer.
C-2
Plus(+) or Minus(-): The ratings from "AA" to "CCC" may be modified
by the addition of a plus or minus sign to show relative standing within
the major rating categories.
Moody's Investors Service, Inc.
-------------------------------
A brief description of the applicable Moody's Investors Service,
Inc. ("Moody's") rating symbols and their meanings (as published by
Moody's) follows.
Ratings assigned on Moody's global long-term and short-term rating
scales are forward-looking opinions of the relative credit risks of
financial obligations issued by non-financial corporates, financial
institutions, structured finance vehicles, project finance vehicles, and
public sector entities. Long-term ratings are assigned to issuers or
obligations with an original maturity of one year or more and reflect both
on the likelihood of a default on contractually promised payments and the
expected financial loss suffered in the event of default. Short-term
ratings are assigned to obligations with an original maturity of thirteen
months or less and reflect the likelihood of a default on contractually
promised payments.
Long-Term Obligation Ratings
Aaa Obligations rated Aaa are judged to be of the highest quality,
subject to the lowest level of credit risk.
Aa Obligations rated Aa are judged to be of high quality and are
subject to very low credit risk.
A Obligations rated A are judged to be upper-medium grade and are
subject to low credit risk.
Baa Obligations rated Baa are judged to be medium-grade and subject
to moderate credit risk and as such may possess certain speculative
characteristics.
Ba Obligations rated Ba are judged to be speculative and are subject
to substantial credit risk.
B Obligations rated B are considered speculative and are subject to
high credit risk.
Caa Obligations rated Caa are judged to be speculative of poor
standing and are subject to very high credit risk.
Ca Obligations rated Ca are highly speculative and are likely in, or
very near, default, with some prospect of recovery of principal and
interest.
C-3
C Obligations rated C are the lowest rated and are typically in
default, with little prospect for recovery of principal or interest.
Note: Moody's appends numerical modifiers 1, 2, and 3 to each
generic rating classification from Aa through Caa. The modifier 1
indicates that the obligation ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates a ranking in the lower end of that generic rating
category.
Fitch Ratings
-------------
A brief description of the applicable Fitch Ratings ("Fitch")
ratings symbols and meanings (as published by Fitch) follows:
Fitch's credit ratings provide an opinion on the relative ability of
an entity to meet financial commitments, such as interest, preferred
dividends, repayment of principal, insurance claims or counterparty
obligations. Credit ratings are used by investors as indications of the
likelihood of receiving the money owed to them in accordance with the
terms on which they invested. The agency's credit ratings cover the global
spectrum of corporate, sovereign (including supranational and
sub-national), financial, bank, insurance, municipal and other public
finance entities and the securities or other obligations they issue, as
well as structured finance securities backed by receivables or other
financial assets.
The terms "investment grade" and "speculative grade" have
established themselves over time as shorthand to describe the categories
'AAA' to 'BBB' (investment grade) and 'BB' to 'D' (speculative grade). The
terms "investment grade" and "speculative grade" are market conventions,
and do not imply any recommendation or endorsement of a specific security
for investment purposes. "Investment grade" categories indicate relatively
low to moderate credit risk, while ratings in the "speculative" categories
either signal a higher level of credit risk or that a default has already
occurred.
A designation of "Not Rated" or "NR" is used to denote securities
not rated by Fitch where Fitch has rated some, but not all, securities
comprising an issuance capital structure.
Credit ratings express risk in relative rank order, which is to say
they are ordinal measures of credit risk and are not predictive of a
specific frequency of default or loss.
Fitch's credit ratings do not directly address any risk other than
credit risk. In particular, ratings do not deal with the risk of a market
value loss on a rated security due to changes in interest rates, liquidity
and other market considerations. However, in terms of payment obligation
on the rated liability, market risk may be considered to the extent that
it influences the ability of an issuer to pay upon a commitment. Ratings
C-4
nonetheless do not reflect market risk to the extent that they influence
the size or other conditionality of the obligation to pay upon a
commitment (for example, in the case of index-linked bonds).
In the default components of ratings assigned to individual
obligations or instruments, the agency typically rates to the likelihood
of non-payment or default in accordance with the terms of that
instrument's documentation. In limited cases, Fitch may include additional
considerations (i.e. rate to a higher or lower standard than that implied
in the obligation's documentation). In such cases, the agency will make
clear the assumptions underlying the agency's opinion in the accompanying
rating commentary.
International Long-Term Ratings
Issuer Credit Rating Scales
Investment Grade
AAA Highest credit quality. 'AAA' ratings denote the lowest
expectation of default risk. They are assigned only in cases of
exceptionally strong capacity for payment of financial commitments. This
capacity is highly unlikely to be adversely affected by foreseeable
events.
AA Very high credit quality. 'AA' ratings denote expectations of
very low default risk. They indicate very strong capacity for payment of
financial commitments. This capacity is not significantly vulnerable to
foreseeable events.
A High credit quality. 'A' ratings denote expectations of low
default risk. The capacity for payment of financial commitments is
considered strong. This capacity may, nevertheless, be more vulnerable to
adverse business or economic conditions than is the case for higher
ratings.
BBB Good credit quality. 'BBB' ratings indicate that expectations of
default risk are currently low. The capacity for payment of financial
commitments is considered adequate but adverse business or economic
conditions are more likely to impair this capacity.
BB Speculative. 'BB' ratings indicate an elevated vulnerability to
default risk, particularly in the event of adverse changes in business or
economic conditions over time; however, business or financial flexibility
exists which supports the servicing of financial commitments.
B Highly speculative. 'B' ratings indicate that material default
risk is present, but a limited margin of safety remains. Financial
commitments are currently being met; however, capacity for continued
payment is vulnerable to deterioration in the business and economic
environment.
C-5
CCC Substantial credit risk. Default is a real possibility.
CC Very high levels of credit risk. Default of some kind appears
probable.
C Exceptionally high levels of credit risk. Default is imminent or
inevitable, or the issuer is in standstill. Conditions that are indicative
of a 'C' category rating for an issuer include:
o the issuer has entered into a grace or cure period following
non-payment of a material financial obligation;
o the issuer has entered into a temporary negotiated waiver or
standstill agreement following a payment default on a material
financial obligation; or
o Fitch otherwise believes a condition of 'RD' or 'D' to be
imminent or inevitable, including through the formal announcement
of a distressed debt exchange.
RD Restricted default. 'RD' ratings indicate an issuer that in
Fitch's opinion has experienced an uncured payment default on a bond, loan
or other material financial obligation but which has not entered into
bankruptcy filings, administration, receivership, liquidation or other
formal winding-up procedure, and which has not otherwise ceased operating.
This would include:
o the selective payment default on a specific class or currency of
debt;
o the uncured expiry of any applicable grace period, cure period or
default forbearance period following a payment default on a bank
loan, capital markets security or other material financial
obligation;
o the extension of multiple waivers or forbearance periods upon a
payment default on one or more material financial obligations,
either in series or in parallel; or
o execution of a distressed debt exchange on one or more material
financial obligations.
D Default. 'D' ratings indicate an issuer that in Fitch's opinion
has entered into bankruptcy filings, administration, receivership,
liquidation or other formal winding-up procedure, or which has otherwise
ceased business.
Default ratings are not assigned prospectively to entities or their
obligations; within this context, non-payment on an instrument that
contains a deferral feature or grace period will generally not be
considered a default until after the expiration of the deferral or grace
period, unless a default is otherwise driven by bankruptcy or other
similar circumstance, or by a distressed debt exchange.
C-6
"Imminent" default typically refers to the occasion where a payment
default has been intimated by the issuer, and is all but inevitable. This
may, for example, be where an issuer has missed a scheduled payment, but
(as is typical) has a grace period during which it may cure the payment
default. Another alternative would be where an issuer has formally
announced a distressed debt exchange, but the date of the exchange still
lies several days or weeks in the immediate future.
In all cases, the assignment of a default rating reflects the
agency's opinion as to the most appropriate rating category consistent
with the rest of its universe of ratings, and may differ from the
definition of default under the terms of an issuer's financial obligations
or local commercial practice.
C-7
First Trust Exchange-Traded Fund VII
PART C - OTHER INFORMATION
ITEM 28. EXHIBITS
EXHIBIT NO. DESCRIPTION
(a) Declaration of Trust of the Registrant. (1)
(b) By-Laws of the Registrant. (1)
(c) Not Applicable.
(d) Investment Management Agreement. (3)
(e) Distribution Agreement. (3)
(f) Not Applicable.
(g) Custodian Agreement by and between the Registrant and Brown
Brothers Harriman and Co., dated as of September 3, 2013. (4)
(h) (1) Administrative Agency Agreement by and between the Registrant
and Brown Brothers Harriman and Co., dated as of September 3,
2013. (4)
(2) Form of Subscription Agreement. (3)
(3) Form of Participant Agreement. (3)
(i) Not Applicable.
(j) Consent of Independent Registered Public Accounting Firm. (5)
(k) Not Applicable.
(l) Not Applicable.
(m) (1) 12b-1 Distribution and Service Plan. (3)
(2) 12b-1 Plan Extension Letter, dated March 30, 2015. (5)
(n) Not Applicable.
(o) Not Applicable.
(p) (1) First Trust Advisors L.P., First Trust Portfolios L.P. Code of
Ethics, amended on July 1, 2013. (4)
(2) First Trust Funds Code of Ethics, amended on October 30,
2013. (4)
(q) Powers of Attorney for Messrs. Bowen, Erickson, Kadlec and Keith
authorizing James A. Bowen, W. Scott Jardine, Mark R. Bradley,
Kristi A. Maher and Eric F. Fess to execute the Registration
Statement. (2)
----------------
(1) Incorporated by reference to the Registrant's Registration on Form N-1A
(File No. 333-181507) filed on November 13, 2012.
(2) Incorporated by reference to the Pre-Effective Amendment No. 1 filed on
Form N-1A (File No. 333-181507) for Registrant on August 30, 2013.
(3) Incorporated by reference to the Pre-Effective Amendment No. 2 filed on
Form N-1A (File No. 333-181507) for Registrant on September 18, 2013.
(4) Incorporated by reference to the Post-Effective Amendment No. 2 filed on
Form N-1A (File No. 333-181507) for Registrant on April 30, 2014.
(5) Filed herewith.
ITEM 29. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
Not Applicable.
ITEM 30. INDEMNIFICATION
Section 9.5 of the Registrant's Declaration of Trust provides as follows:
Section 9.5. Indemnification and Advancement of Expenses. Subject to the
exceptions and limitations contained in this Section 9.5, every person who is,
or has been, a Trustee, officer, or employee of the Trust, including persons who
serve at the request of the Trust as directors, trustees, officers, employees or
agents of another organization in which the Trust has an interest as a
shareholder, creditor or otherwise (hereinafter referred to as a "Covered
Person"), shall be indemnified by the Trust to the fullest extent permitted by
law against liability and against all expenses reasonably incurred or paid by
him or in connection with any claim, action, suit or proceeding in which he
becomes involved as a party or otherwise by virtue of his being or having been
such a Trustee, director, officer, employee or agent and against amounts paid or
incurred by him in settlement thereof.
No indemnification shall be provided hereunder to a Covered Person to the
extent such indemnification is prohibited by applicable federal law.
The rights of indemnification herein provided may be insured against by
policies maintained by the Trust, shall be severable, shall not affect any other
rights to which any Covered Person may now or hereafter be entitled, shall
continue as to a person who has ceased to be such a Covered Person and shall
inure to the benefit of the heirs, executors and administrators of such a
person.
Subject to applicable federal law, expenses of preparation and
presentation of a defense to any claim, action, suit or proceeding subject to a
claim for indemnification under this Section 9.5 shall be advanced by the Trust
prior to final disposition thereof upon receipt of an undertaking by or on
behalf of the recipient to repay such amount if it is ultimately determined that
he is not entitled to indemnification under this Section 9.5.
To the extent that any determination is required to be made as to whether
a Covered Person engaged in conduct for which indemnification is not provided as
described herein, or as to whether there is reason to believe that a Covered
Person ultimately will be found entitled to indemnification, the Person or
Persons making the determination shall afford the Covered Person a rebuttable
presumption that the Covered Person has not engaged in such conduct and that
there is reason to believe that the Covered Person ultimately will be found
entitled to indemnification.
As used in this Section 9.5, the words "claim," "action," "suit" or
"proceeding" shall apply to all claims, demands, actions, suits, investigations,
regulatory inquiries, proceedings or any other occurrence of a similar nature,
whether actual or threatened and whether civil, criminal, administrative or
other, including appeals, and the words "liability" and "expenses" shall include
without limitation, attorneys' fees, costs, judgments, amounts paid in
settlement, fines, penalties and other liabilities.
ITEM 31. BUSINESS AND OTHER CONNECTIONS OF THE INVESTMENT ADVISER
First Trust Advisors L.P. ("First Trust"), investment adviser to the
Registrant, serves as adviser or sub-adviser to various other open-end and
closed-end management investment companies and is the portfolio supervisor of
certain unit investment trusts. The principal business of certain of First
Trust's principal executive officers involves various activities in connection
with the family of unit investment trusts sponsored by First Trust Portfolios
L.P. ("FTP"). The principal address for all these investment companies, First
Trust, FTP and the persons below is 120 East Liberty Drive, Suite 400, Wheaton,
Illinois 60187.
A description of any business, profession, vocation or employment of a
substantial nature in which the officers of First Trust who serve as officers or
trustees of the Registrant have engaged during the last two years for his or her
account or in the capacity of director, officer, employee, partner or trustee
appears under "Management of the Fund" in the Statement of Additional
Information. Such information for the remaining senior officers of First Trust
appears below:
NAME AND POSITION WITH FIRST TRUST EMPLOYMENT DURING PAST TWO YEARS
Andrew S. Roggensack, President Managing Director and President,
First Trust
R. Scott Hall, Managing Director Managing Director, First Trust
Ronald D. McAlister, Managing Managing Director, First Trust
Director
David G. McGarel, Chief Investment Managing Director; Senior Vice President,
Officer and Managing Director First Trust
Kathleen Brown, Chief Compliance Chief Compliance Officer and Senior Vice
Officer and Senior Vice President President, First Trust
Brian Wesbury, Chief Economist and Chief Economist and Senior Vice President,
Senior Vice President First Trust
ITEM 32. PRINCIPAL UNDERWRITER
(a) FTP serves as principal underwriter of the shares of the Registrant,
First Trust Exchange-Traded Fund, First Trust Exchange-Traded Fund II, First
Trust Exchange-Traded Fund III, First Trust Exchange-Traded Fund IV, First Trust
Exchange-Traded Fund V, First Trust Exchange Traded Fund VI, First Trust
Exchange-Traded AlphaDEX(R) Fund and First Trust Exchange-Traded AlphaDEX(R)
Fund II, First Trust Variable Insurance Trust and First Trust Series Fund. FTP
serves as principal underwriter and depositor of the following investment
companies registered as unit investment trusts: the First Trust Combined Series,
FT Series (formerly known as the First Trust Special Situations Trust), the
First Trust Insured Corporate Trust, the First Trust of Insured Municipal Bonds
and the First Trust GNMA.
(b)
NAME AND PRINCIPAL POSITIONS AND OFFICES POSITIONS AND
BUSINESS ADDRESS* WITH UNDERWRITER OFFICES WITH FUND
The Charger Corporation General Partner None
Grace Partners of DuPage L.P. Limited Partner None
James A. Bowen Chief Executive Officer and Trustee and Chairman of the Board
Managing Director
Mark R. Bradley Chief Financial Officer, Chief President and Chief Executive
Operating Officer and Managing Officer
Director
Frank L. Fichera Managing Director None
Russell J. Graham Managing Director None
R. Scott Hall Managing Director None
W. Scott Jardine General Counsel, Secretary and Secretary
Managing Director
Daniel J. Lindquist Managing Director Vice President
Ronald D. McAlister Managing Director None
David G. McGarel Managing Director None
Richard A. Olson Managing Director None
Marisa Prestigiacomo Managing Director None
Andrew S. Roggensack President and Managing Director None
Kristi A. Maher Deputy General Counsel Chief Compliance Officer and
Assistant Secretary
* All addresses are
120 East Liberty Drive,
Wheaton, Illinois 60187.
(c) Not Applicable
ITEM 33. LOCATION OF ACCOUNTS AND RECORDS
First Trust, 120 East Liberty Drive, Suite 400, Wheaton, Illinois 60187,
maintains the Registrant's organizational documents, minutes of meetings,
contracts of the Registrant and all advisory material of the investment adviser.
The Bank of New York Mellon Corporation ("BNYM") maintains all general and
subsidiary ledgers, journals, trial balances, records of all portfolio purchases
and sales, and all other requirement records not maintained by First Trust.
BNYM also maintains all the required records in its capacity as transfer,
accounting, dividend payment and interest holder service agent for the
Registrant.
ITEM 34. MANAGEMENT SERVICES
Not Applicable.
ITEM 35. UNDERTAKINGS
Not Applicable.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Registration Statement under Rule
485(b) under the Securities Act of 1933 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, duly authorized in the
City of Wheaton, and State of Illinois, on the 22nd day of April, 2015.
FIRST TRUST EXCHANGE-TRADED FUND VII
By: /s/ Mark R. Bradley
--------------------------------
Mark R. Bradley, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the date indicated:
SIGNATURE TITLE DATE
President and Chief April 22, 2015
/s/ Mark R. Bradley Executive Officer
------------------------
Mark R. Bradley
Treasurer, Chief Financial April 22, 2015
Officer and Chief
Accounting Officer
/s/ James M. Dykas
------------------------
James M. Dykas
)
James A. Bowen* Trustee )
)
)
Richard E. Erickson* Trustee )
)
)
Thomas R. Kadlec* Trustee ) BY: /s/ W. Scott Jardine
) ----------------------
) W. Scott Jardine
Robert F. Keith* Trustee ) Attorney-In-Fact
) April 22, 2015
)
Niel B. Nielson* Trustee )
)
)
* Original powers of attorney authorizing James A. Bowen, W. Scott
Jardine, Eric F. Fess and Kristi A. Maher to execute Registrant's
Registration Statement, and Amendments thereto, for each of the trustees
of the Registrant on whose behalf this Registration Statement is filed,
were previously executed, filed as an exhibit and are incorporated by
reference herein.
INDEX TO EXHIBITS
(j) Consent of Independent Registered Public Accounting Firm
(m)(2) 12b-1 Plan Extension Letter
EX-99.J OTHER OPININ
2
exhibit_j.txt
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in this Post-Effective Amendment
No. 4 to Registration Statement No. 333-184918 on Form N-1A of our report dated
February 24, 2015, relating to the financial statements and financial highlights
of First Trust Exchange-Traded Fund VII, comprised of First Trust Global
Tactical Commodity Strategy Fund, appearing in the Annual Report on Form N-CSR
for First Trust Exchange-Traded Fund VII for the year ended December 31, 2014,
and to the references to us under the headings "Financial Highlights" in the
Prospectus and "Independent Registered Public Accounting Firm" and "Financial
Statements" in the Statement of Additional Information, which are part of such
Registration Statement.
/s/ Deloitte & Touche LLP
Chicago, Illinois
April 22, 2015
EX-99.M 12B-1 PLAN
3
exhibit_m2.txt
12B-1 PLAN EXTENSION LETTER
March 30, 2015
First Trust Exchange-Traded Fund VII
120 East Liberty Drive
Wheaton, Illinois 60187
Ladies and Gentlemen:
It is hereby acknowledged that First Trust Portfolios L.P. serves as the
distributor of the Shares (as defined below) of the series of First Trust
Exchange-Traded Fund VII (the "Trust"). The Trust is an open-end management
investment company registered under the Investment Company Act of 1940, as
amended (the "1940 Act"), comprised of one exchange-traded fund (the "Fund"),
which may be amended from time to time.
It is further acknowledged that the Trust has adopted a Distribution and
Service Plan (the "Plan") pursuant to Rule l2b-1 under the 1940 Act with respect
to the shares of beneficial interest (the "Shares") of the Fund. Pursuant to the
Plan, the Fund may bear a fee not to exceed 0.25% per annum of the Fund's
average daily net assets. Capitalized terms used herein but not otherwise
defined shall have the meanings assigned to them in the Plan.
The purpose of this letter agreement is to agree and acknowledge that the
Fund shall not pay, and we shall not collect, any fees pursuant to the Plan any
time before April 30, 2016.
Very Truly Yours,
FIRST TRUST PORTFOLIOS L.P.
/s/ James M. Dykas
------------------------------
James M. Dykas
Controller
AGREED AND ACKNOWLEDGED:
FIRST TRUST EXCHANGE-TRADED FUND VII
/s/ James M. Dykas
-------------------------------------
James M. Dykas
Treasurer and Chief Financial Officer