As filed with the Securities and Exchange Commission on June 13, 2007
===============================================================================
1933 Act File No. 333-______
1940 Act File No. 811-22039
U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-2
(Check appropriate box or boxes)
[X] REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
[ ] Pre-Effective Amendment No. _
[ ] Post-Effective Amendment No. _
and
[ ] REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
[X] Amendment No. 4
First Trust/Gallatin Specialty Finance and Financial Opportunities Fund
Exact Name of Registrant as Specified in Declaration of Trust
1001 Warrenville Road, Suite 300, Lisle, Illinois 60532
Address of Principal Executive Offices (Number, Street, City, State, Zip Code)
(630) 241-4141
Registrant's Telephone Number, including Area Code
W. Scott Jardine, Esq.
First Trust Portfolios L.P.
1001 Warrenville Road, Suite 300
Lisle, Illinois 60532
Name and Address (Number, Street, City, State, Zip Code) of Agent for Service
Copies of Communications to:
Eric F. Fess, Esq. Thomas A. Hale
Chapman and Cutler LLP Skadden, Arps, Slate, Meagher & Flom LLP
111 West Monroe Street 333 West Wacker Drive
Chicago, Illinois 60603 Chicago, Illinois 60606
Approximate Date of Proposed Public Offering: As soon as practicable after
the effective date of this Registration Statement
If any of the securities being registered on this form are offered on a
delayed or continuous basis in reliance on Rule 415 under the Securities
Act of 1933, other than securities offered in connection with a dividend
reinvestment plan, check the following box. [ ]
It is proposed that this filing will become effective (check appropriate box)
[ ] when declared effective pursuant to section 8(c)
CALCULATION OF REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933
===============================================================================
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
Proposed Maximum Proposed Maximum
Title of Securities Amount Being Offering Price Aggregate Offering Amount of Registration
Being Registered Registered Per Unit Price(1) Fee(2)
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
Auction Preferred 40 Shares $25,000 $1,000,000 $30.70
Shares, $0.01 par value
------------------------- ---------------------- ----------------------- ---------------------- ----------------------
(1) Estimated solely for the purpose of calculating the registration fee.
(2) Transmitted via federal wire transfer.
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the
Registrant shall file a further amendment which specifically states this
Registration Statement shall thereafter become effective in accordance
with Section 8(a) of the Securities Act of 1933 or until the Registration
Statement shall become effective on such dates as the Commission, acting
pursuant to said Section 8(a), may determine.
===============================================================================
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SUBJECT TO COMPLETION, DATED JUNE 13, 2007
PROSPECTUS
FIRST TRUST/GALLATIN SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
AUCTION PREFERRED SHARES
______ SHARES, SERIES ___
______ SHARES, SERIES ___
LIQUIDATION PREFERENCE $25,000 PER SHARE
First Trust/Gallatin Specialty Finance and Financial Opportunities Fund
(the "Fund"), a recently organized, non-diversified, closed-end management
investment company. The Fund's primary investment objective is to seek a high
level of current income. The Fund seeks attractive total return as a secondary
objective.
The Fund is offering ______ shares, Series ___ and ______ shares,
Series ___ auction preferred shares. These shares are collectively referred to
in this Prospectus as "Preferred Shares." The Preferred Shares will be preferred
shares of beneficial interest of the Fund that entitle their holders to receive
cash distributions at an annual rate that may vary for the successive rate
periods for each series. In general, except as described below, the rate period
following the initial rate period will be seven days in the case of Series ___
Preferred Shares and 28 days in the case of Series ___ Preferred Shares. The
applicable distribution for a particular rate period will be determined by an
auction conducted on the business day next preceding the start of that rate
period. Preferred Shares have a liquidation preference of $25,000 per share,
plus any accumulated, unpaid distributions. Preferred Shares also have priority
over the Fund's common shares (the "Common Shares") as to distribution of assets
as described in this Prospectus.
See "Description of Preferred Shares."
After the initial rate period described in this Prospectus, investors
and potential investors may buy or sell Preferred Shares through an order placed
at auction with or through a broker-dealer in accordance with the procedures
specified in this Prospectus.
(continued on following page)
INVESTING IN PREFERRED SHARES INVOLVES CERTAIN RISKS. SEE "RISKS"
BEGINNING ON PAGE __.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
PER SHARE TOTAL
Public Offering Price................. $ 25,000.00 $
Sales Load............................ $ $
Proceeds to the Fund(1)............... $ $
______________________
(1) Does not include offering expenses payable by the Fund estimated to
be $________, or $______ per Share.
The underwriters expect to deliver the Preferred Shares in book-entry
form through the facilities of The Depository Trust Company, on or about
_____________, 2007.
A.G. EDWARDS
Prospectus dated __________, 2007
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
(continued from previous page)
Investment Strategy. Under normal market conditions, the Fund will seek
to achieve its investment objectives by investing at least 80% of its Managed
Assets (as defined below) in a portfolio of securities of specialty finance and
other financial companies that the Fund's sub-adviser believes offer attractive
opportunities for income and capital appreciation. Under normal market
conditions, the Fund will concentrate its investments in securities of companies
within industries in the financial sector. The concentration of the Fund's
assets in a group of industries is likely to present more risks than a fund that
is broadly diversified over several industries or groups of industries.
Investment Adviser and Sub-Adviser. First Trust Advisors L.P. ("First
Trust Advisors" or the "Adviser") is the Fund's investment adviser. Gallatin
Asset Management, Inc. ("Gallatin" or the "Sub-Adviser") is the Fund's
Sub-Adviser. First Trust Advisors serves as investment adviser or portfolio
supervisor to investment portfolios with approximately $32.57 billion in assets
which it managed or supervised as of May 31, 2007. Gallatin had approximately
$10.3 billion of assets under management as of May 31, 2007.
You should review carefully the detailed information regarding the
auction procedures which appears in this Prospectus and the Fund's Statement of
Additional Information dated _____________, 2007 (the "SAI") and should note
that (i) an order placed at an auction constitutes an irrevocable commitment to
hold, purchase or sell Preferred Shares based upon the results of the related
auction, (ii) settlement for purchases and sales will be on the business day
following the auction and (iii) ownership of Preferred Shares will be maintained
in book-entry form by or through The Depository Trust Company ("DTC") (or any
successor securities depository). The Preferred Shares are redeemable, in whole
or in part, at the option of the Fund on the second business day prior to any
date distributions are paid on the Preferred Shares, and will be subject to
mandatory redemption in certain circumstances at a redemption price of $25,000
per share, plus accumulated but unpaid distributions to the date of redemption.
See "Description of Preferred Shares--Redemption."
You should read this Prospectus, which contains important information
about the Fund, before deciding whether to invest in Preferred Shares, and
retain it for future reference. The SAI, dated __________, 2007, containing
additional information about the Fund, has been filed with the Securities and
Exchange Commission, or SEC, and is incorporated by reference in its entirety
into this Prospectus. You may request a free copy of the SAI, the table of
contents of which is on page __ of this Prospectus, annual and semi-annual
reports to shareholders when available, and other information about the Fund,
and make shareholder inquiries by calling (800) 988-5891; by writing to the Fund
at 1001 Warrenville Road, Suite 300, Lisle, Illinois 60532; or from the Fund's
website (http://www.ftportfolios.com). You may also call the toll-free number
above to request other information about the Fund or to make shareholder
inquiries. You also may obtain a copy of the SAI (and other information
regarding the Fund) from the Securities and Exchange Commission's website
(http://www.sec.gov).
- ii -
PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this
Prospectus and in the SAI. This Summary does not contain all of the information
that you should consider before investing in the Fund's Preferred Shares. You
should carefully read the entire Prospectus, including the documents
incorporated by reference into it, particularly the section entitled "Risks"
beginning on page 28.
The Fund First Trust/Gallatin Specialty Finance and
Financial Opportunities Fund (the "Fund") is a
recently organized, non-diversified, closed-end
management investment company that commenced
operations in May 31, 2007. The Fund's common
shares of beneficial interest, par value $.01 per
share ("Common Shares") are traded on the NYSE
under the symbol "FGB." As of ________, 2007, the
Fund had ___ Common Shares outstanding and net
assets attributable to Common Shares of
approximately $______.
Investment Objectives
and Policies The Fund's primary investment objective is to seek
a high level of current income. The Fund seeks
attractive total return as a secondary objective.
There can be no assurance that the Fund's
investment objectives will be achieved.
Under normal market by investing at least 80% of
its Managed Assets (as defined below) in a
portfolio of securities of specialty finance and
other financial companies that the Sub-Adviser
believes offer attractive opportunities for income
and capital appreciation. The Fund is not limited
with respect to its investments in securities
issued by specific categories of specialty finance
and other financial companies. However, based on
current market conditions and assumptions, the
Sub-Adviser currently anticipates that investments
in business development companies ("BDCs") and real
estate investment trusts ("REITs") will each
initially represent approximately 25% to 50% of the
Fund's Managed Assets. These percentages are
expected to vary over time as market conditions
change. "Managed Assets" means the average daily
gross asset value of the Fund (including assets
attributable to the Fund's Preferred Shares and the
principal amount of borrowings, if any), minus the
sum of the Fund's accrued and unpaid distributions
on Preferred Shares and accrued liabilities (other
than the principal amount of any borrowings
incurred, commercial paper or notes issued by the
Fund). For purposes of determining Managed Assets,
- 1 -
the liquidation preference of the Preferred Shares
is not treated as a liability.
The Offering The Fund is offering a total of ______ shares,
Series ___ Auction Preferred Shares, par value $.01
per share (the "Series __ Preferred Shares") and
___ shares, Series ___ Auction Preferred Shares
(the "Series __ Preferred Shares"), par value $.01
per share, each at an offering price of $25,000 per
share. The preferred shares offered hereby are
called "Preferred Shares" in the rest of this
Prospectus. The Preferred Shares are being offered
through a group of underwriters (the
"Underwriters") led by A.G. Edwards & Sons, Inc.
See "Underwriting."
Ratings of Preferred
Shares It is a condition of the Underwriters' obligation
to purchase the Preferred Shares the Preferred
Shares receive a rating of "Aaa" from Moody's
Investor Service, Inc. ("Moody's") and "AAA" from
Fitch Rating Services, Inc. ("Fitch").
Secondary Market The Preferred Shares will not be listed on an
exchange. Instead, you may place orders to buy or
sell each series of Preferred Shares at an auction
that normally is held on the last business day of
the preceding rate period by submitting orders to a
Broker-Dealer, as defined in the Statement of Terms
Establishing and Fixing the Rights and Preferences
of the Series __ Auction Preferred Shares and the
Series __ Auction Preferred Shares (the "Statement
Terms"), or to a broker-dealer that has entered
into a separate agreement with a Broker-Dealer. In
addition to the auctions, Broker-Dealers and other
broker-dealers may maintain a secondary trading
market in Preferred Shares outside of auctions, but
may discontinue this activity at any time. There is
no assurance that a secondary market will exist or,
if one does exist, that it will provide Preferred
Shareholders with liquidity. You may transfer
Preferred Shares outside of auctions only to or
through a Broker-Dealer, or a broker-dealer that
has entered into a separate agreement with a
Broker-Dealer.
Distributions and Rate
Periods Distributions on each series of the Preferred
Shares will be cumulative from the date the shares
are first issued and payable at the annualized cash
distribution rate for the initial rate period on
the initial distribution payment date as follows:
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Number
Initial Subsequent of Days
Preferred Initial Date of Distribution Dividend in
Shares Distribution Accumulation at Payment Payment Initial
Series Rate Initial Rate Date Day Rate Period
___ % _______, 2007 _____, 2007 _____ _____
___ % _______, 2007 _____, 2007 _____ _____
After the initial rate period, the period for each
series of Preferred Shares will generally consist
of seven days in the case of Series ___ Preferred
Shares and 28 days in the case of Series ___
Preferred Shares.
In most instances, distributions are payable on the
first business day following the end of the rate
period. The rate set at an auction will not exceed
a maximum rate (which is determined in accordance
with procedures described in the Statement of
Terms).
The Fund may designate a special rate period of
more than seven days or 28 days, respectively, for
a series of the Preferred Shares if the Fund
provides notice to the Auction Agent, have
sufficient clearing bids at the auction and deposit
funds with the Auction Agent for any redemption. In
addition, full cumulative distributions, any
amounts due with respect to mandatory redemptions
and any additional distributions payable prior to
such date must be paid in full. The distribution
payment dates for special rate periods will be set
out in the notice designating a special rate
period. The Fund may designate a special rate
period if market conditions indicate that a longer
rate period would provide the Fund greater
stability or attractive distribution rates.
The first auction date for the Series ___ Preferred
Shares is _________, 2007 and for the Series ___
Preferred Shares is __________, 2007, and each
subsequent auction will normally be held for those
respective shares every seven days for the Series
___ Preferred Shares and every 28 days for the
Series ___ Preferred Shares. The first auction date
for each series of Preferred Shares will be the
business day before the distribution payment date
for the initial rate period for such series of
Preferred Shares. The start date for subsequent
rate periods for each series of the Preferred
Shares normally will be the business day following
- 3 -
the auction date unless the then-current rate
period is a special rate period.
See "Description of Preferred Shares--Distribution
and Rate Periods" and "The Auction."
Determination of Maximum
Applicable Rate Except during a default period, the applicable
rate for any rate period will not be more than the
Maximum Rate. The Maximum Rate for the Preferred
Shares will depend on the credit rating assigned to
the Preferred Shares and on the duration of the
rate period. The Maximum Rate is equal to the
applicable percentage of the Reference Rate,
subject to upward but not downward adjustment in
the discretion of the Board of Trustees after
consultation with the Broker-Dealers. The Reference
Rate is the greater of (1) the applicable AA
Composite Commercial Paper Rate (for a Rate Period
of fewer than 184 days) or the applicable Treasury
Index Rate (for a Rate Period of 184 days or more),
or (2) the applicable LIBOR. For Standard Rate
Periods or shorter periods only, the Applicable
Rate resulting from an auction will not be less
than the Minimum Rate, which is 70% of the
applicable AA Composite Commercial Paper Rate. No
Minimum Rate is specified for auctions with respect
to Rate Periods of more than the Standard Rate
Period.
Asset Maintenance Under the Statement of Terms, which establish the
rights and preferences of the Preferred Shares, the
Fund must maintain:
o asset coverage for the Preferred Shares as
required by Moody's and Fitch or by any
other rating agency engaged to rate the
Preferred Shares, and
o asset coverage (as defined in the 1940 Act)
of at least 200% with respect to senior
securities that are stock, including the
Preferred Shares.
In the event that the Fund does not maintain these
coverage tests or cure any deficiencies in the time
allowed, some or all of the Preferred Shares will
be subject to mandatory redemption. See
"Description of Preferred Shares -- Redemption --
Mandatory Redemption."
- 4 -
Based on the composition of the Fund's portfolio as
of ________, 2007, the asset coverage of the
Preferred Shares as measured pursuant to the 1940
Act would have been approximately _____%
immediately upon issuance of the Preferred Shares
offered in this Prospectus, representing
approximately _____% of the Fund's average daily
total assets since _________, 2007, minus
liabilities other than any aggregate indebtedness
that is entered into for purposes of leverage.
Voting Rights The 1940 Act requires that the holders of the
Preferred Shares and any other preferred shares of
the Fund, voting as a separate class, have the
right to elect at least two trustees of the Fund
and to elect a majority of the trustees at any time
when two years' distributions on the Preferred
Shares or any other preferred shares are unpaid.
As required under the Fund's Declaration of Trust,
By-Laws and the 1940 Act, certain other matters
must be approved by a vote of all shareholders of
all classes voting together and by a vote of the
holders of the outstanding preferred shares
(including the holders of the Preferred Shares
("Preferred Shareholders")) of the Fund voting as a
single class and tallied separately. Each Common
Share, each Preferred Share, and each share of any
other series of preferred shares of the Fund is
entitled to one vote per share. See "Description of
Preferred Shares--Voting Rights" and "Certain
Provisions in the Declaration of Trust and
By-Laws."
Redemption Although the Fund will not ordinarily redeem
Preferred Shares, the Fund may be required to
redeem Preferred Shares if, for example, the Fund
do not meet an asset coverage ratio required by law
or required by the Statement of Terms or in order
to correct a failure to meet a rating agency
guideline in a timely manner. See "Description of
Preferred Shares--Redemption--Mandatory
Redemption." The Fund also may redeem Preferred
Shares voluntarily in certain circumstances. See
"Description of Preferred
Shares--Redemption--Optional Redemption."
Liquidation The liquidation preference of the Preferred Shares
is $25,000 per share, plus an amount equal to
accumulated but unpaid distributions (whether or
not declared by the Fund). See "Description of
Preferred Shares-- Liquidation."
- 5 -
Investment Adviser and
Sub-Adviser First Trust Advisors is the Fund's Adviser and is
responsible for selecting and supervising the
Sub-Adviser, the ongoing monitoring of the Fund's
investment portfolio, managing the Fund's business
affairs and providing certain clerical, bookkeeping
and other administrative services. The Adviser, in
consultation with the Sub-Adviser, also is
responsible for determining the Fund's overall
investment strategy and overseeing its
implementation. Gallatin is the Fund's Sub-Adviser.
First Trust Advisors, a registered investment
adviser, is an Illinois limited partnership formed
in 1991. It serves as investment adviser or
portfolio supervisor to investment portfolios with
approximately $32.57 billion in assets which it
managed or supervised as of May 31, 2007. See the
SAI under "Adviser."
Gallatin, a registered investment adviser, is
located at One North Jefferson Street, St. Louis,
Missouri 63103. Gallatin, organized in 2005, is a
wholly-owned subsidiary of A.G. Edwards, Inc. with
approximately $10.3 billion in assets under
management as of May 31, 2007. See "Management of
the Fund--Sub-Adviser" in this Prospectus and
"Sub-Adviser" in the SAI.
On May 31, 2007, Wachovia Corp. announced that it
had reached an agreement in principle to acquire
A.G. Edwards, Inc. Gallatin is a wholly-owned
subsidiary of A.G. Edwards, Inc. If completed, such
acquisition by Wachovia Corp. of A.G. Edwards, Inc.
may require the Fund's Board of Trustees and the
Fund's shareholders to approve a new Sub-Advisory
Agreement among the Fund, the Adviser and the
Sub-Adviser. See "Risks -- Sub-Adviser Risk."
The Fund's Portfolio Under normal market conditions, the Fund will seek
to achieve its investment objectives by investing
at least 80% of its Managed Assets in a portfolio
of securities of specialty finance and other
financial companies that the Sub-Adviser believes
offer attractive opportunities for income and
capital appreciation. Under normal market
conditions, the Fund will invest at least 25% of
its total assets in securities of companies within
industries in the financial sector. The
concentration of the Fund's assets in a group of
- 6 -
industries is likely to present more risks than a
fund that is broadly diversified over several
industries or groups of industries.
Specialty Finance Companies. Specialty finance
companies provide capital or financing to
businesses and consumers within specified market
segments. These companies are distinguished by
their market specializations which allow them to
focus on the specific financial needs of their
clients. Specialty finance companies often engage
in asset-based and other forms of non-traditional
financing activities. While they generally compete
against financial companies with broad product
lines and, often, greater financial resources,
specialty finance companies seek competitive
advantage by focusing their attention on market
niches, which may provide them with deeper
knowledge of their target market and its needs.
Specialty finance companies include mortgage
specialists to certain consumers, equipment leasing
specialists to certain industries and equity or
debt-capital providers to certain small businesses.
Specialty finance companies often utilize
tax-efficient or other non-traditional structures,
such as BDCs and REITs. Based on current market
conditions and assumptions, the Sub-Adviser
currently anticipates that investments in BDCs and
REITs will each initially represent approximately
25% to 50% of the Fund's Managed Assets. However,
these percentages are expected to vary over time as
market conditions change.
Business Development Companies. BDCs are a type of
closed-end fund regulated under the Investment
Company Act of 1940, as amended (the "1940 Act"),
whose shares are typically listed for trading on a
U.S. securities exchange. BDCs are publicly-traded
funds that typically invest in and lend to small
and medium-sized private and certain public
companies that may not have access to public equity
markets for capital raising. BDCs invest in such
diverse industries as healthcare, chemical and
manufacturing, technology and service companies.
BDCs are unique in that at least 70% of their
investments must be made in private and certain
public U.S. businesses, and BDCs are required to
make available significant managerial assistance to
their portfolio companies. Unlike corporations,
BDCs are not taxed on income distributed to their
shareholders provided they comply with the
applicable requirements of the Internal Revenue
- 7 -
Code of 1986, as amended (the "Internal Revenue
Code"). BDCs, which are required to distribute
substantially all of their income to investors in
order to not be subject to entity level taxation,
often offer a yield advantage over other types of
securities. The Fund intends to invest primarily in
BDC shares which are trading in the secondary
market on a U.S. securities exchange but may, in
certain circumstances, invest in an initial public
offering of BDC shares or invest in certain debt
instruments issued by BDCs. The Fund will
indirectly bear its proportionate share of any
management and other expenses, and of any
performance based or incentive fees, charged by the
BDCs in which it invests, in addition to the
expenses paid by the Fund.
REITs and Other Mortgage-Related Securities. REITs
are financial vehicles that pool investors' capital
to invest primarily in income-producing real estate
or real estate-related loans or interests. REIT
shares are typically listed for trading in the
secondary market on a U.S. securities exchange.
REITs can generally be classified as "Mortgage
REITs," "Equity REITs" and "Hybrid REITs." Mortgage
REITs, which invest the majority of their assets in
real estate mortgages, derive their income
primarily from interest payments. The Fund intends
to focus its Mortgage REIT investments in companies
that invest primarily in prime-rated and commercial
mortgage securities. Equity REITs, which invest the
majority of their assets directly in real property,
derive their income primarily from rents, royalties
and lease payments. Equity REITs can also realize
capital gains by selling properties that have
appreciated in value. Some REITs which are
classified as Equity REITs provide specialized
financing solutions to their clients in the form of
sale-lease back transactions and triple net lease
financing. Hybrid REITs combine the characteristics
of both Equity REITs and Mortgage REITs. Debt
securities issued by REITs are, for the most part,
general and unsecured obligations and are subject
generally to risks associated with REITs.
Distributions received by the Fund from REITs may
consist of dividends, capital gains and/or return
of capital. REITs are not taxed on income
distributed to their shareholders provided they
comply with the applicable requirements of the
Internal Revenue Code. REITs, which are required to
distribute substantially all of their income to
investors in order to not be subject to entity
level taxation, often offer a yield advantage over
other types of securities. Many of these
- 8 -
distributions, however, will not generally qualify
for favorable treatment as qualified dividend
income. The Fund is not limited with respect to the
specific types of REITs in which it invests and
intends to invest primarily in REIT shares which
are trading in the secondary market on a U.S.
securities exchange but may, in certain
circumstances, invest in an initial public offering
of REIT shares or invest in certain debt
instruments issued by REITs. The Fund will
indirectly bear its proportionate share of any
management and other operating expenses charged by
the REITs in which it invests, in addition to the
expenses paid by the Fund.
Financial Companies. The principal industry groups
of financial companies include banks, savings
institutions, brokerage firms, investment
management companies, insurance companies, holding
companies of the foregoing, and companies that
provide related services to such companies. Banks
and savings institutions provide services to
customers such as demand, savings and time deposit
accounts and a variety of lending and related
services. Brokerage firms provide services to
customers in connection with the purchase and sale
of securities. Investment management companies
provide investment advisory and related services to
retail customers, high net-worth individuals and
institutions. Insurance companies provide a wide
range of commercial, life, health, disability,
personal property and casualty insurance products
and services to businesses, governmental units,
associations and individuals.
Principal Risks Auction Risk. If an auction fails you may not be
able to sell some or all of your Preferred Shares.
Neither the Broker-Dealers nor the Fund are
obligated to purchase Preferred Shares in an
auction or otherwise, nor is the Fund required to
redeem Preferred Shares in the event of a failed
auction.
Secondary Market Risk. If you try to sell your
Preferred Shares between auctions you may not be
able to sell any or all of your shares or you may
not be able to sell them for your purchase price
plus accumulated and unpaid distributions,
especially when market interest rates are rising.
If the Fund designates a special rate period,
changes in interest rates are more likely to affect
the price you would receive if you sold your shares
in the secondary market. The Preferred Shares are
- 9 -
not registered on any stock exchange. You may
transfer your shares outside of auctions only to or
through a Broker-Dealer or a broker-dealer that has
entered into an agreement with a Broker-Dealer.
Broker-Dealers are not required to maintain a
secondary market for Preferred Shares.
Ratings and Asset Coverage Risk. While Moody's and
Fitch assign ratings of "Aaa" and "AAA,"
respectively, to the Preferred Shares, the ratings
do not eliminate or necessarily mitigate the risks
of investing in Preferred Shares. A rating agency
could downgrade or withdraw its rating of the
Preferred Shares, which could affect their
liquidity and their value in a secondary market.
The Fund may be forced to redeem your Preferred
Shares to meet regulatory or rating agency
requirements or may voluntarily redeem your shares.
A material decline in the Fund's net asset value
may impair the Fund's ability to maintain required
levels of asset coverage. For a description of
risks affecting the Fund, see "Risks--General Risks
of Investing in the Fund."
Payment Restrictions. The Fund's ability to declare
and pay distributions on the Preferred Shares and
the Common Shares is restricted by the Statement of
Terms. The restrictions on distributions might
prevent the Fund from maintaining its qualification
as a regulated investment company for federal
income tax purposes. Although the Fund intends to
redeem Preferred Shares if necessary to meet asset
coverage requirements, there can be no assurance
that the Fund will have sufficient funds to redeem
or that redemptions will allow the Fund to maintain
its qualification as a regulated investment company
under the Internal Revenue Code of 1986, as amended
(the "Code"). See "Federal Tax Matters."
Leverage Risk. The Fund's leveraged capital
structure creates special risks not associated with
unleveraged funds having similar investment
objectives and policies. For example, if short term
interest rates rise, distribution rates on the
Preferred Shares set at auction may rise so that
the amount of distributions to be paid to Preferred
Shareholders exceeds the income from the Fund's
investment portfolio.
- 10 -
The Preferred Shares will be junior to any
borrowings of the Fund. Any borrowings may
constitute a substantial lien and burden on the
Preferred Shares by reason of their prior claim
against the income of the Fund and against the net
assets of the Fund in liquidation. If the Fund
leverages through borrowings, the Fund may not be
permitted to declare dividends or other
distributions with respect to the Preferred Shares
unless at the time thereof the Fund meets certain
asset coverage requirements and the payment of
principal and interest on such borrowings are not
in default.
Securities and Exchange Commission Settlements. On
May 31, 2006, the U.S. Securities and Exchange
Commission announced that it had settled its
investigation of fifteen firms, including [_______]
(collectively, the "Settlement Broker-Dealers"),
that participate in the auction rate securities
market regarding their respective practices and
procedures in this market. The Securities and
Exchange Commission alleged in the settlement that
the firms had managed auctions for auction rate
securities in which they participated in ways that
were not adequately disclosed or that did not
conform to disclosed auction procedures. As part of
the settlement, each Settlement Broker-Dealer
agreed to pay a civil penalty. In addition, each
Settlement Broker-Dealer, without admitting or
denying the Securities and Exchange Commission's
allegations, agreed to provide to customers written
descriptions of its material auction practices and
procedures, and to implement procedures reasonably
designed to detect and prevent any failures by such
Settlement Broker-Dealer to conduct the auction
process in accordance with disclosed procedures.
Each Settlement Broker-Dealer can offer no
assurance as to how the settlement may affect the
market for auction rate securities or the Preferred
Shares.
In addition, on January 9, 2007, the Securities and
Exchange Commission announced that it had settled
its investigation of three banks, including
[___________] (collectively, the "Settling Auction
Agents"), that participate as auction agents in the
auction rate securities market, regarding their
respective practices and procedures in this market.
The Securities and Exchange Commission alleged in
the settlement that the Settling Auction Agents
allowed broker-dealers in auctions to submit bids
or revise bids after the submission deadlines and
- 11 -
allowed broker dealers to intervene in auctions in
ways that affected the rates paid on the auction
rate securities. As part of the settlement, the
Settling Auction Agents agreed to pay civil
penalties. In addition, each Settling Auction
Agent, without admitting or denying the Securities
and Exchange Commission's allegations, agreed to
provide to broker dealers and issuers written
descriptions of its material auction practices and
procedures and to implement procedures reasonably
designed to detect and prevent any failures by that
Settling Auction Agent to conduct the auction
process in accordance with disclosed procedures. No
assurance can be offered as to how the settlement
may affect the market for auction rate securities
or the Preferred Shares.
In addition to the risks described above, certain
risks of investing affect your investment and may
limit the Fund's ability to pay Preferred Share
distributions, reduce the value of the Fund's
investment portfolio, impair the Fund's ability to
meet the asset coverage requirements on the
Preferred Shares or make your investment in
Preferred Shares more volatile. These risks
include:
Limited Operating History. The Fund is a recently
organized company that commenced operations in May
2007.
Investment Risk. An investment in Preferred Shares
is subject to investment risk, including the
possible loss of the entire amount invested.
Management Risk. The Fund is subject to management
risk because it has an actively managed portfolio.
The Adviser and the Sub-Adviser will apply
investment techniques and risk analyses in making
investment decisions for the Fund, but there can be
no guarantee that these will produce the desired
results.
Sub-Adviser Risk. The Sub-Adviser, Gallatin, is an
entity organized in 2005 with limited management
and operating history, although the majority of its
investment personnel previously comprised the Asset
Management Department of A.G. Edwards & Sons, Inc.
and the investment team has largely worked together
since 1994. In addition, the Sub-Adviser is
dependent upon the experience and expertise of
certain key personnel in providing services with
respect to the Fund's investments. If the
- 12 -
Sub-Adviser were to lose the services of these
individuals, its ability to service the Fund could
be adversely affected.
On May 31, 2007, Wachovia Corp. announced that it
had reached an agreement in principle with A.G.
Edwards, Inc. under which Wachovia Corp. will
acquire A.G. Edwards, Inc. (the "Acquisition").
Gallatin is a wholly-owned subsidiary of A.G.
Edwards, Inc. Subject to certain regulatory
approvals and the approval by the shareholders of
A.G. Edwards, Inc., the Acquisition is expected to
be completed in the fourth quarter of 2007.
Depending on the structure and terms of the
Acquisition, the Acquisition, if completed, may
result in a change of control of Gallatin which
would constitute an assignment, as that term is
defined in the Investment Company Act of 1940, as
amended, of the Sub-Advisory Agreement by and among
the Fund, the Advisor and the Sub-Advisor. In the
event of the automatic termination of the
Sub-Advisory Agreement, it is expected that new
Sub-Advisory Agreement among the Fund, Gallatin and
First Trust Advisors L.P., pursuant to which
Gallatin would continue to serve as the Fund's
Sub-Adviser following completion of the
Acquisition, would be presented to the Fund's Board
of Trustees and the Fund's shareholders for their
approval.
Value Investing Risk. The Fund focuses its
investments on securities that the Sub-Adviser
believes are undervalued or inexpensive relative to
other investments. These types of securities may
present risks in addition to the general risks
associated with investing in them. These securities
generally are selected on the basis of an issuer's
business and economic fundamentals or the
securities' current and projected credit profiles,
relative to current market price. Such securities
are subject to the risk of misestimating certain
fundamental factors. Disciplined adherence to a
"value" investment mandate during periods in which
that style is "out of favor" can result in
significant underperformance relative to overall
market indices and other managed investment
vehicles that pursue growth style investments
and/or flexible style mandates.
Specialty Finance and Other Financial Companies
Risks. The Fund will invest substantially all of
its assets in specialty finance and other financial
- 13 -
companies and generally the Fund's portfolio
holdings will be concentrated in securities of
companies within industries in the financial
sector. A fund concentrated in a single industry or
group of industries is likely to present more risks
than a fund that is broadly diversified over
several industries or groups of industries.
Compared to the broad market, an individual sector
may be more strongly affected by changes in the
economic climate, broad market shifts, moves in a
particular dominant stock, or regulatory changes.
Specialty finance and other financial companies in
general are subject to extensive governmental
regulation, which may change frequently. The
profitability of specialty finance and other
financial companies is largely dependent upon the
availability and cost of capital funds, and may
fluctuate significantly in response to changes in
interest rates, as well as changes in general
economic conditions. From time to time, severe
competition may also affect the profitability of
specialty finance and other financial companies.
Financial companies can be highly dependent upon
access to capital markets and any impediments to
such access, such as general economic conditions or
a negative perception in the capital markets of a
company's financial condition or prospects could
adversely affect its business. Leasing companies
can be negatively impacted by changes in tax laws
which affect the types of transactions in which
such companies engage. The Fund is not limited with
respect to its investments in securities issued by
specific categories of specialty finance and other
financial companies. However, based on current
market conditions and assumptions, the Sub-Adviser
currently anticipates that investments in BDCs and
REITs will each initially represent approximately
25% to 50% of the Fund's Managed Assets. These
percentages are expected to vary over time as
market conditions change.
Common Stock Risk. The Fund may invest in common
stocks. Investments in common stocks involve common
stock risk, which is the risk that common stocks
and similar equity securities held by the Fund will
fall in value due to general market or economic
conditions, perceptions regarding the industries in
which the issuers of securities held by the Fund
participate, and the particular circumstances and
performance of individual companies whose
securities the Fund holds. For example, an adverse
event, such as an unfavorable earnings report, may
depress the value of equity securities of an issuer
- 14 -
held by the Fund; the price of common stock of an
issuer may be particularly sensitive to general
movements in the stock market; or a drop in the
stock market may depress the price of most or all
of the common stocks and other equity securities
held by the Fund. In addition, the common stock of
an issuer held in the Fund's portfolio may decline
in price if the issuer of such common stock fails
to make anticipated dividend payments because,
among other reasons, the issuer of the security
experiences a decline in its financial condition.
While broad market measures of common stocks have
historically generated higher average returns than
fixed income securities, common stocks have also
experienced significantly more volatility in those
returns.
Preferred Stock and Trust Preferred Securities
Risk. There are special risks associated with
investing in preferred securities, including risks
related to deferral, noncumulative dividends,
subordination, liquidity, limited voting rights and
special redemption rights. Trust preferred
securities are limited-life preferred securities
typically issued by corporations, generally in the
form of interest-bearing notes or preferred
securities issued by an affiliated business trust
of a corporation whose only assets are generally in
the form of beneficial interests in subordinated
debentures or similarly structured securities.
Dividend payments on the trust preferred securities
generally coincide with interest payments on the
underlying obligations. Trust preferred securities
generally have a yield advantage over traditional
preferred stocks, but unlike preferred stocks,
distributions are treated as interest rather than
dividends for federal income tax purposes and
therefore, are not eligible for the dividends
received deduction and do not constitute qualified
dividend income. Trust preferred securities prices
fluctuate for several reasons including changes in
investors' perception of the financial condition of
an issuer or the general economic condition of the
market for trust preferred securities, or when
political or economic events affecting the issuers
occur. Trust preferred securities are also
sensitive to interest rate fluctuations, as the
cost of capital rises and borrowing costs increase
in a rising interest rate environment and the risk
that a trust preferred security may be called for
redemption in a falling interest rate environment.
Certain of the other risks unique to trust
preferred securities include: (i) distributions on
trust preferred securities will be made only if
interest payments on the interest-bearing notes,
- 15 -
preferred securities or subordinated debentures are
made; (ii) a corporation issuing the
interest-bearing notes, preferred securities or
subordinated debentures may defer interest payments
on these instruments for up to 20 consecutive
quarters and if such election is made,
distributions will not be made on the trust
preferred securities during the deferral period;
(iii) certain tax or regulatory events may trigger
the redemption of the interest-bearing notes,
preferred securities or subordinated debentures by
the issuing corporation and result in prepayment of
the trust preferred securities prior to their
stated maturity date; (iv) future legislation may
be proposed or enacted that may prohibit the
corporation from deducting its interest payments on
the interest-bearing notes, preferred securities or
subordinated debentures for tax purposes, making
redemption of these instruments likely; (v) a
corporation may redeem the interest bearing notes,
preferred securities or subordinated debentures in
whole at any time or in part from time to time on
or after a stated call date; (vi) trust preferred
securities holders have very limited voting rights;
and (vii) payment of interest on the
interest-bearing notes, preferred securities or
subordinated debentures, and therefore
distributions on the trust preferred securities, is
dependent on the financial condition of the issuing
corporation.
Convertible Securities Risk. Convertible securities
generally offer lower interest or dividend yields
than non-convertible securities of similar quality.
Similar to traditional fixed-income securities, the
market values of convertible securities tend to
decline as interest rates increase and, conversely,
to increase as interest rates decline. However,
when the market price of the common stock
underlying a convertible security exceeds the
conversion price, the convertible security tends to
reflect the market price of the underlying common
stock. As the market price of the underlying common
stock declines, the convertible security tends to
trade increasingly on a yield basis and thus may
not decline in price to the same extent as the
underlying common stock. Convertible securities
rank senior to common stock in an issuer's capital
structure and consequently entail less risk than
the issuer's common stock.
Fixed-Income Securities Risk. In addition to the
risks discussed above, debt securities, including
high-yield securities, are subject to certain
- 16 -
risks, including weaker than expected performance
of the issuer, interest rate fluctuations and
prepayments of principal by an issuer.
Lower Grade and Distressed Securities Risk. The
Fund may invest in below-investment grade debt
securities. Below-investment grade debt securities
are rated below "Baa3" by Moody's Investors
Service, Inc. ("Moody's"), below "BBB-" by Standard
& Poor's Ratings Group, a division of The
McGraw-Hill Companies, Inc. ("S&P"), or comparably
rated by another nationally recognized statistical
rating organization ("NRSRO") or, if unrated,
determined by the Sub-Adviser to be of comparable
credit quality. Investment in below-investment
grade debt securities, commonly referred to as
"junk bonds," may involve a substantial risk of
loss as they are predominantly speculative with
respect to the issuer's capacity to pay interest
and repay principal when due. The market values for
below-investment grade debt securities also tend to
be more sensitive to individual corporate
developments and changes in economic conditions
than higher quality securities. In addition, lower
rated securities and comparable unrated securities
generally present a higher degree of credit risk.
The risk of loss due to default by these issuers is
significantly greater because such lower rated
securities and unrated securities of comparable
quality generally are unsecured and frequently are
subordinated to the prior payment of senior
indebtedness. The Fund may invest up to 10% of its
Managed Assets in securities issued by companies in
a bankruptcy reorganization proceeding, subject to
some other form of a public or private debt
restructuring or otherwise in default or in
significant risk of default in the payment of
interest or repayment of principal or trading at
prices substantially below other below-investment
grade debt securities of companies in similar
industries. Distressed securities frequently do not
produce income while they are outstanding. The Fund
may be required to incur certain extraordinary
expenses in order to protect and recover its
investment in distressed securities.
Business Development Company Risk. Investments in
closed-end funds that elect to be treated as BDCs
may be subject to a high degree of risk. BDCs
typically invest in small and medium-sized private
and certain public companies that may not have
access to public equity markets for capital
- 17 -
raising. As a result, a BDC's portfolio typically
will include a substantial amount of securities
purchased in private placements, and its portfolio
may carry risks similar to those of a private
equity or venture capital fund. Securities that are
not publicly registered may be difficult to value
and may be difficult to sell at a price
representative of their intrinsic value. Small and
medium-sized companies also may have fewer lines of
business so that changes in any one line of
business may have a greater impact on the value of
their stock than is the case with a larger company.
To the extent a BDC focuses its investments in a
specific sector, the BDC will be susceptible to
adverse conditions and economic or regulatory
occurrences affecting the specific sector or
industry group, which tends to increase volatility
and result in higher risk. Investments in BDCs are
subject to various risks, including management's
ability to meet the BDC's investment objective, and
to manage the BDC's portfolio when the underlying
securities are redeemed or sold, during periods of
market turmoil and as investors' perceptions
regarding a BDC or its underlying investments
change. BDC shares are not redeemable at the option
of the BDC shareholder and, as with shares of other
closed-end funds, they may trade in the secondary
market at a discount to their NAV.
Certain BDCs in which the Fund may invest may
employ the use of leverage in their portfolios
through borrowings or the issuance of preferred
stock. While leverage often serves to increase the
yield of a BDC, this leverage also subjects the BDC
to increased risks, including the likelihood of
increased volatility and the possibility that the
BDC's common share income will fall if the dividend
rate on any preferred shares or the interest rate
on any borrowings rises.
The Fund may be limited by provisions of the 1940
Act that generally limit the amount the Fund can
invest in any one closed-end fund, including any
one BDC, to 3% of the closed-end fund's total
outstanding stock. As a result, the Fund may hold a
smaller position in a BDC than if it were not
subject to this restriction. To comply with the
provisions of the 1940 Act, on any matter upon
which BDC shareholders are solicited to vote, the
Sub-Adviser may be required to vote shares of the
BDC held by the Fund in the same general proportion
as shares held by other shareholders of the BDC.
- 18 -
The Fund will indirectly bear its proportionate
share of any management and other operating
expenses, and of any performance based or incentive
fees, charged by the BDCs in which it invests, in
addition to the expenses paid by the Fund.
REIT, Mortgage-Related and Asset-Backed Securities
Risks. Investing in REITs involves certain unique
risks in addition to investing in the real estate
industry in general. REITs are subject to interest
rate risks (especially Mortgage REITs) and the risk
of default by lessees or borrowers. An Equity REIT
may be affected by changes in the value of the
underlying properties owned by the REIT. A Mortgage
REIT may be affected by the ability of the issuers
of its portfolio mortgages to repay their
obligations. REITs whose underlying assets are
concentrated in properties used by a particular
industry are also subject to risks associated with
such industry. REITs may have limited financial
resources, their securities may trade less
frequently and in a limited volume, and their
securities may be subject to more abrupt or erratic
price movements than larger company securities.
In addition to REITs, the Fund may invest in a
variety of other mortgage-related securities,
including commercial mortgage securities and other
mortgage-backed instruments. Rising interest rates
tend to extend the duration of mortgage-related
securities, making them more sensitive to changes
in interest rates, and may reduce the market value
of the securities. In addition, mortgage-related
securities are subject to prepayment risk--the risk
that borrowers may pay off their mortgages sooner
than expected, particularly when interest rates
decline. This can reduce the Fund's returns because
the Fund may have to reinvest that money at lower
prevailing interest rates.
The Fund's investments in other asset-backed
securities are subject to risks similar to those
associated with mortgage-backed securities, as well
as additional risks associated with the nature of
the assets and the servicing of those assets.
Infrastructure Trust Risk. Infrastructure issuers,
including utilities and companies involved in
infrastructure projects, are subject to a variety
of factors that may adversely affect their business
- 19 -
operations, including high interest costs in
connection with capital construction programs,
costs associated with environmental and other
regulations, the effects of economic slowdown and
surplus capacity, increased competition from other
providers of services, uncertainties concerning the
availability of fuel at reasonable prices, the
effects of energy conservation policies and other
factors. Infrastructure issuers may be subject to
regulation by various governmental authorities and
may also be affected by governmental regulation of
rates charged to customers, service interruption
due to environmental, operational or other mishaps
and the imposition of special tariffs and changes
in tax laws, regulatory policies and accounting
standards.
Income Trust and Master Limited Partnership Risks.
Investments in income trusts and MLP interests are
subject to the risks generally applicable to
companies in the energy and natural resources
sectors, including commodity pricing risk, supply
and demand risk, depletion risk and exploration
risk. There are certain tax risks associated with
the income trusts in which the Fund may invest,
including the possibility that Canadian and U.S.
taxing authorities may challenge the deductibility
of certain interest payments and certain other
costs and expenses inherent in the structure of
certain income trusts and the risk that U.S. taxing
authorities could challenge the Fund's treatment
for federal income tax purposes of the income
trusts or MLPs in which the Fund invests. These tax
risks, and any adverse determination with respect
thereto, could have a negative impact on the
after-tax income available for distribution by the
income trusts or MLPs and/or the value of the
Fund's investments. There can be no assurance that
future changes to Canadian and U.S. tax laws or tax
rules would not adversely affect the Fund's
investments in income trusts or MLP interests.
Tax Risks. The extent to which the Fund may invest
in securities issued by infrastructure trusts and
certain income trust and MLP interests may be
limited by the Fund's intention to qualify as a
regulated investment company ("RIC") for federal
income tax purposes. Failure in any year for the
Fund to qualify as a RIC under applicable federal
tax laws would result in the Fund being subject to
tax as an ordinary corporation, which would have a
- 20 -
material and adverse effect on the earnings and
distributions of the Fund. See "Federal Tax
Matters."
Foreign Securities Risk. The Fund may invest in
securities (equity or debt) of foreign issuers.
Investing in securities of foreign issuers, which
are generally denominated in foreign currencies,
may involve certain risks not typically associated
with investing in securities of U.S. issuers. Risks
of foreign securities include, among others, higher
brokerage costs, different accounting standards,
expropriation, nationalization or other adverse
political or economic developments, currency
devaluations, blockages or transfer restrictions,
inadequate financial information, lack of liquidity
of certain foreign markets and less government
supervision and regulation of exchanges, brokers
and issuers in foreign countries. These risks may
be more pronounced to the extent that the Fund
invests a significant amount of its assets in
securities of issuers located in one region and to
the extent that the Fund invests in securities of
issuers in emerging markets. The Fund may invest in
securities of issuers located in countries
considered to be emerging markets, and investments
in such securities are considered speculative.
Currency Risk. The value of securities denominated
or quoted in foreign currencies may be adversely
affected by fluctuations in the relative currency
exchange rates and by exchange control regulations.
The Fund's investment performance may be negatively
affected by a devaluation of a currency in which
the Fund's investments are denominated or quoted.
Further, the Fund's investment performance may be
significantly affected, either positively or
negatively, by currency exchange rates because the
U.S. dollar value of securities denominated or
quoted in another currency will increase or
decrease in response to changes in the value of
such currency in relation to the U.S. dollar.
Liquidity Risk. The Fund may invest without limit
in illiquid securities. The Fund may also invest
without limit in Rule 144A Securities. Although
many of the Rule 144A Securities in which the Fund
may invest may be, in the view of the Sub-Adviser,
liquid, if qualified institutional buyers are
unwilling to purchase these Rule 144A Securities,
they may become illiquid. Illiquid securities may
be difficult to dispose of at a fair price at the
times when the Fund believes it is desirable to do
so. The market price of illiquid securities
- 21 -
generally is more volatile than that of more liquid
securities, which may adversely affect the price
that the Fund pays for or recovers upon the sale of
such illiquid securities. Illiquid securities are
also more difficult to value and the Sub-Adviser's
judgment may play a greater role in the valuation
process. Investment of the Fund's assets in
illiquid securities may restrict the Fund's ability
to take advantage of market opportunities. The
risks associated with an investment in illiquid
securities may be particularly acute in situations
in which the Fund's operations require cash and
could result in the Fund borrowing to meet its
short-term needs or incurring losses on the sale of
illiquid securities.
Non-Diversification Risk. The Fund is, and certain
of the BDCs in which the Fund may invest may be,
classified as "non-diversified" under the 1940 Act.
A non-diversified fund has the ability to invest
more of its assets in securities of a single issuer
than if it were classified as a "diversified" fund,
which may increase volatility. If the Fund's
investment in a BDC, or a BDC's investment in an
issuer, represents a relatively significant
percentage of the Fund's or the BDC's portfolio, as
applicable, the value of the respective portfolio
will be more impacted by a loss on that investment
than if the portfolio were more diversified.
Inflation/Deflation Risk. Inflation risk is the
risk that the value of the Fund's assets or income
from the Fund's investments will be worth less in
the future as inflation decreases the value of
money. As inflation increases, the real value of
the Preferred Shares and distributions can decline.
In addition, during any periods of rising
inflation, the dividend rates or borrowing costs
associated with the Preferred Shares would likely
increase. Deflation risk is the risk that prices
throughout the economy decline over time--the
opposite of inflation. Deflation may have an
adverse affect on the creditworthiness of issuers
and may make issuer default more likely, which may
result in a decline in the value of the Fund's
investment portfolio.
Market Disruption Risk. The terrorist attacks in
the United States on September 11, 2001 had a
disruptive effect on the securities markets. The
ongoing U.S. military and related action in Iraq
and events in the Middle East, as well as the
continuing threat of terrorist attacks, could have
significant adverse effects on the U.S. economy,
- 22 -
the stock market and world economies and markets
generally. Below-investment grade debt securities
tend to be more volatile than higher-rated
fixed-income securities so that these events and
any actions resulting from them may have a greater
impact on the prices and volatility of
below-investment grade debt securities than on
higher-rated fixed-income securities. A similar
disruption of financial markets or other terrorist
attacks could adversely affect Fund service
providers and/or the Fund's operations as well as
interest rates, secondary trading, credit risk,
inflation and other factors relating to the Fund's
shares. The Fund cannot predict the effects or
likelihood of similar events in the future on the
U.S. and world economies or the value of the assets
of the Fund.
Certain Affiliations. Certain broker-dealers may be
considered to be affiliated persons of the Fund,
First Trust Advisors or Gallatin. Gallatin is a
wholly-owned subsidiary of A.G. Edwards, Inc.,
which is also the holding company of A.G. Edwards &
Sons, Inc., the Fund's lead Underwriter. Wachovia
Corp. has agreed in principle to acquire A.G.
Edwards, Inc. Absent an exemption from the
Securities and Exchange Commission or other
regulatory relief, the Fund is generally precluded
from effecting certain principal transactions with
affiliated brokers, and its ability to utilize
affiliated brokers for agency transactions is
subject to restrictions. This could limit the
Fund's ability to engage in securities transactions
and take advantage of market opportunities.
Anti-Takeover Provisions. The Fund's Declaration of
Trust and By-Laws include provisions that could
limit the ability of other entities or persons to
acquire control of the Fund or convert the Fund to
open-end status. See "Certain Provisions in the
Declaration of Trust and By-Laws" and
"Risks--Anti-Takeover Provisions."
Administrator, Custodian
and Fund Accountant The Fund has retained PFPC Trust Company as
custodian, and PFPC Inc. as administrator and fund
accountant for the Fund. The Adviser and the Board
of Trustees will be responsible for monitoring the
activities of the custodian, administrator, fund
accountant and transfer agent for the Common
Shares. See "Administrator, Custodian, Fund
Accountant and Transfer Agent."
- 23 -
Auction Agent and
Transfer Agent ____________ (the "Auction Agent") will serve as
the Fund's auction agent and transfer agent,
registrar and distribution paying agent for the
Preferred Shares.
- 24 -
FINANCIAL HIGHLIGHTS
The following table includes selected data for a Common Share
outstanding throughout the indicated period and other performance information
derived from the Fund's financial information included in the SAI dated
_________, 2007.
Information contained in the table below under the headings "Income
From Investment Operations" and "Ratios/Supplemental Data" shows the unaudited
operating performance of the Fund from the commencement of investment operations
through _______, 2007. Because the Fund is recently organized, the table covers
only a short period of operations during which a substantial portion of the
Fund's portfolio was held in temporary investments pending investment in
accordance with the Fund's investment objectives and policies. Accordingly, the
information presented below may not necessarily be indicative of the Fund's
future operating performance.
For the Period
May 31, 2007*
through
_______, 2007
(Unaudited)
Net asset value, beginning of period.................................................... $
--------------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income.......................................................... $
Net realized/unrealized gain from investments.................................. $
--------------------
Total from investment operations...................................... $
--------------------
Offering costs................................................................. $
--------------------
--------------------
Net asset value, end of period.......................................................... $
====================
Per share market value, end of period................................................... $
====================
Total return based on net asset value (1)............................................... %
--------------------
Total return based on market value (2).................................................. %
--------------------
RATIOS/SUPPLEMENTAL DATA:
Net assets applicable to common shares, end of period (In thousands).................... $
--------------------
Ratio of expenses to average net assets applicable to common shares..................... % (3)
--------------------
Ratio of net investment income to average net assets applicable to common % (3)
shares..........................................................................
--------------------
Ratio of expenses to average net assets applicable to common shares..................... % (3)
--------------------
Ratio of net investment income to average net assets applicable to common (3)
shares.......................................................................... %
--------------------
Portfolio turnover rate................................................................. %
--------------------
_______________________________
* The Fund commenced operations on May 31, 2007.
(1) Total return based on net asset value is the combination of reinvested
dividend distributions, reinvested capital gains distributions, if any, at
prices obtained by the Dividend Reinvestment Plan and changes in net asset
value per share and does not reflect the sales load.
(2) Total return based on market value is the combination of reinvested
dividend distributions, reinvested capital gains distributions, if any, at
prices obtained by the Dividend Reinvestment Plan and changes in Common
Share market price per share, all based on Common Share market price per
share.
(3) Annualized.
See financial information and accompanying notes in the SAI.
- 25 -
THE FUND
The Fund is a recently organized, non-diversified, closed-end
management investment company registered under the 1940 Act. The Fund was
organized as a Massachusetts business trust on March 20, 2007. The Fund issued
an aggregate of 12,300,000 Common Shares, par value $0.01 per share, pursuant to
the initial public offering thereof and commenced operations on May 31, 2007. On
June 11, 2007, the Fund issued an aggregate 1,000,000 Common Shares pursuant to
the exercise of an overallotment option. The Common Shares are traded on the
NYSE under the symbol "FGB". The Fund's principal business location is 1001
Warrenville Road, Suite 300, Lisle, Illinois 60532, and the Fund's telephone
number is (630) 241-4141.
The following provides information about the Fund's outstanding shares
as of May 31, 2007:
AMOUNT HELD BY THE FUND
AMOUNT FOR ITS ACCOUNT AMOUNT
TITLE OF CLASS AUTHORIZED OUTSTANDING
Common Shares................ * 0 13,305,236
Preferred Shares
Series [ ] ........ * 0 0
Series [ ]......... * 0 0
________________________
* An unlimited number of capital shares of beneficial interest of the Fund are
authorized under the Declaration of Trust. The Fund's Board of Trustees may
classify or reclassify any unissued shares of beneficial interest from time to
time without shareholder approval into one or more classes of preferred or other
shares of beneficial interest by setting or changing the preferences, conversion
or other rights, voting powers, restrictions, limitations as to distributions,
or terms of redemption of such shares of beneficial interest. The Board of
Trustees has classified _____ shares of beneficial interest as Series __
Preferred Shares and has classified ____ shares of beneficial interest as Series
__ Preferred Shares, and has authorized the issuance of each series of Preferred
Shares.
USE OF PROCEEDS
The net proceeds of this offering of Preferred Shares will be
approximately $_________ million after payment of the sales load and the
estimated offering expenses. The Fund expects to invest the net proceeds of the
offering in a manner consistent with the investment objectives and policies
described in this Prospectus. The Fund currently anticipates that it will be
able to invest substantially all of the net proceeds within 90 days after the
closing of this offering. Pending investment in accordance with the Fund's
investment objectives and policies, the Fund anticipates that the net proceeds
will be invested in cash or cash equivalents.
- 26 -
CAPITALIZATION
The following table sets forth the capitalization of the Fund as of
_________, 2007, and as adjusted, to give effect to the issuance of the
Preferred Shares offered hereby.
ACTUAL AS ADJUSTED
(UNAUDITED) (UNAUDITED)
Preferred Shares, $25,000 stated value per share, at liquidation $ $
value; unlimited shares authorized (no shares issued and
[___] shares issued, as adjusted respectively)(1)(2).........
Common Shareholders' Equity:
Common Shares, $0.01 par value per share; unlimited shares $ $
authorized (13,305,236 shares outstanding)(2)................
Paid-in capital in excess of par value(3).........................
Undistributed net investment income...............................
Accumulated net realized gain from investment transactions........
Net unrealized appreciation of investments........................
Net assets applicable to Common Shares
________________________
(1) Assumes [___] Series ____ Preferred Shares and [___] Series ___ Preferred
Shares to be sold hereby.
(2) None of these outstanding shares are held by or for the account of the Fund.
(3) As adjusted paid-in capital in excess of par value reflects a reduction
for the __% sales load and estimated offering expenses of the Preferred Shares
issuance ($________).
- 27 -
RISKS
Risk is inherent in all investing. The following discussion summarizes
the principal risks that you should consider before deciding whether to invest
in the Fund. For additional information about the risks associated with
investing in the Fund, see "Additional Information About the Fund's Investments"
in the SAI.
RISKS OF INVESTING IN PREFERRED SHARES
Auction Risk. There is no assurance that any particular auction will be
successful and your ability to sell your Preferred Shares may be largely
dependent on the success of an auction. You may not be able to sell your
Preferred Shares at an auction if the auction fails; that is, if there are more
Preferred Shares offered for sale than there are buyers for those Preferred
Shares. Also, if you place a hold order at an auction (an order to retain
Preferred Shares) only at a specified rate, and that specified rate exceeds the
rate set at the auction, you will not retain your Preferred Shares.
Additionally, if you elect to buy or retain Preferred Shares without specifying
a rate below which you would not wish to continue to hold those Preferred
Shares, and the auction sets a rate below the current market rate, you may
receive a lower rate of return on your Preferred Shares than the current market
rate. Finally, the rate period may be changed, subject to certain conditions and
with notice to the Preferred Shareholders, which could also affect the liquidity
of your investment. Neither the Broker-Dealers nor the Fund are obligated to
purchase Preferred Shares in an auction or otherwise, nor is the Fund required
to redeem Preferred Shares in the event of a failed auction. See "Description of
Preferred Shares" and "The Auction--Auction Procedures."
Secondary Market Risk. If you try to sell your Preferred Shares between
auctions, you may not be able to sell any or all of your shares, or you may not
be able to sell them for your purchase price or their $25,000 per share
liquidation preference plus accrued and unpaid distributions. The value of
income securities typically falls when market interest rates rise, and
securities with longer maturities or interest rate reset periods are often
affected more than securities whose maturities or interest rate reset periods
are short. Accordingly, if the Fund designates a special rate period (a rate
period of more than seven days in the case of Series __ Preferred Shares or more
than 28 days in the case of Series __ Preferred Shares), changes in interest
rates are more likely to affect the price you would receive if you sold your
shares in the secondary market. Only Broker-Dealers or persons who have
relationships with Broker-Dealers may submit bids at Auctions and this
restriction may limit the potential buyers for Preferred Shares, even though the
Fund does not anticipate imposing significant restrictions on transfers to other
persons. Broker-Dealers that participate in a secondary trading market for
Preferred Shares are not required to maintain this market, and the Fund is not
required to redeem shares if either an auction or an attempted secondary market
sale fails. The Preferred Shares will not be listed on any stock exchange.
Accordingly, there is no assurance that you will have liquidity of your
investment.
- 28 -
Rating and Asset Coverage Risk. While Moody's and Fitch assign ratings
of "Aaa" and "AAA," respectively, to the Preferred Shares, the ratings do not
eliminate or necessarily mitigate the risks of investing in the Preferred
Shares. In order to obtain ratings of "Aaa" and "AAA" from Moody's and Fitch,
respectively, the Fund must satisfy certain asset coverage and diversification
requirements. See "Description of Preferred Shares--Rating Agency Guidelines and
Asset Coverage" for a more detailed description of these requirements. A rating
agency could downgrade its rating or withdraw its rating of the Preferred
Shares, which may make the Preferred Shares less liquid at an auction or in a
secondary market, although such downgrade or withdrawal may result in higher
distribution rates. If a rating agency downgrades or withdraws its rating of
Preferred Shares, the Fund may alter is portfolio or redeem Preferred Shares, if
appropriate, to address rating agency concerns. Moreover, the asset coverage and
diversification requirements may have an impact on the Fund's investment
decisions. For example, the Fund may prefer investments which provide superior
coverage and diversification to investments which may provide superior income or
growth prospects.
A material decline in the Fund's net asset value may impair the Fund's
ability to maintain required levels of asset coverage. For a description of
risks affecting the Fund, see "--General Risks of Investing in the Fund."
Payment Restrictions. The Fund's ability to declare and pay
distributions on the Preferred Shares and the Common Shares is restricted by the
Statement of Terms unless, generally, the Fund continues to satisfy asset
coverage requirements and in the case of Common Shares, unless all accumulated
distributions on Preferred Shares have been paid. See "Description of Preferred
Shares--Rating Agency Guidelines and Asset Coverage" and "Description of Common
Shares." The restrictions on distributions might prevent the Fund from
maintaining its qualification as a regulated investment company for federal
income tax purposes. See "Federal Tax Matters." Although the Fund intends to
redeem Preferred Shares if necessary to meet asset coverage requirements, there
can be no assurance that the Fund will have sufficient funds to redeem or that
redemptions will allow the Fund to maintain its qualification as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code").
Leverage Risk. The Fund has the ability to borrow an amount up to 33
1/3% (or such other percentage as permitted by law) of its Managed Assets
(including the amount borrowed) less all liabilities other than borrowings. The
Fund also has the ability to issue preferred shares in an amount up to 50% of
the Fund's Managed Assets (including the proceeds from leverage). However, the
Fund currently anticipates that under normal market conditions it will issue
leverage in an aggregate amount of approximately 35% of the Fund's Managed
Assets. The Fund may use leverage for investment purposes, to finance the
repurchase of its Common Shares and to meet cash requirements.
With respect to a leverage borrowing program instituted by the Fund,
the credit agreements governing such a program (the "Credit Agreements") likely
will include usual and customary covenants for this type of transaction,
including, but not limited to, limits on the Fund's ability to: (1) issue
preferred shares; (2) incur liens or pledge portfolio securities or investments;
(3) change its investment objective or fundamental investment restrictions
- 29 -
without the approval of lenders; (4) make changes in any of its business
objectives, purposes or operations that could result in a material adverse
effect; (5) make any changes in its capital structure; (6) amend the Fund
documents in a manner which could affect adversely the rights, interests or
obligations of any of the lenders; (7) engage in any business other than the
business currently engaged in; (8) create, incur, assume or permit to exist
certain debt except for certain specific types of debt; and (9) permit any of
its Employment Retirement Income Security Act ("ERISA") affiliates to cause or
permit to occur an event that could result in the imposition of a lien under the
Code or ERISA. In addition, the Credit Agreements would not permit the Fund's
asset coverage ratio (as defined in the Credit Agreements) to fall below 300% at
any time.
The funds borrowed pursuant to a leverage borrowing program (such as a
credit line or commercial paper program), or obtained through the issuance of
preferred shares, including the Preferred Shares, constitute a substantial lien
and burden by reason of their prior claim against the income of the Fund and
against the net assets of the Fund in liquidation. The rights of lenders to
receive payments of interest on and repayments of principal on any borrowings
made by the Fund under a leverage borrowing program are senior to the rights of
Common Shareholders and the holders of Preferred Shares, with respect to the
payment of dividends or upon liquidation. The Fund may not be permitted to
declare dividends or other distributions, including dividends and distributions
with respect to Common Shares or Preferred Shares or purchase Common Shares or
Preferred Shares, unless at the time thereof the Fund meets certain asset
coverage requirements and no event of default exists under any leverage program.
In addition, the Fund may not be permitted to pay dividends on Common Shares
unless all dividends on the Preferred Shares and/or accrued interest on
borrowings have been paid, or set aside for payment. In an event of default
under a leverage borrowing program, the lenders have the right to cause a
liquidation of collateral (i.e., sell securities and other assets of the Fund)
and, if any such default is not cured, the lenders may be able to control the
liquidation as well. Certain types of leverage may result in the Fund being
subject to covenants relating to asset coverage and Fund composition
requirements. The Fund may be subject to certain restrictions on investments
imposed by guidelines of one or more rating agencies, which may issue ratings
for leverage securities issued by the Fund. The Fund is subject to such rating
agency guidelines with respect to the Preferred Shares. These guidelines may
impose asset coverage and/or Fund composition requirements that are more
stringent than those imposed by the 1940 Act. The Sub Adviser does not believe
that these covenants or guidelines will impede it from managing the Fund's
portfolio in accordance with the Fund's investment objectives and policies.
While the Fund may from time to time consider reducing leverage in
response to actual or anticipated changes in interest rates in an effort to
mitigate the increased volatility of current income and NAV associated with
leverage, there can be no assurance that the Fund will actually reduce leverage
in the future or that any reduction, if undertaken, will benefit the Preferred
Shareholders. Changes in the future direction of interest rates are very
difficult to predict accurately. The Fund may decide that this risk outweighs
the likelihood of achieving the desired reduction to volatility in income if the
prediction were to turn out to be correct, and determine not to reduce leverage
as described above.
Securities and Exchange Commission Settlements. On May 31, 2006, the
Securities and Exchange Commission announced that it had settled its
investigation of fifteen firms, including each Settlement Broker-Dealer, that
- 30 -
participate in the auction rate securities market regarding their respective
practices and procedures in this market. The Securities and Exchange Commission
alleged in the settlement that the firms had managed auctions for auction rate
securities in which they participated in ways that were not adequately disclosed
or that did not conform to disclosed auction procedures. As part of the
settlement, each Settlement Broker-Dealer agreed to pay a civil penalty. In
addition, each Settlement Broker-Dealer without admitting or denying the
Securities and Exchange Commission's allegations, agreed to provide to customers
written descriptions of its material auction practices and procedures, and to
implement procedures reasonably designed to detect and prevent any failures by
such Settlement Broker-Dealer to conduct the auction process in accordance with
disclosed procedures. Each Settlement Broker-Dealer can offer no assurance as to
how the settlement may affect the market for auction rate securities generally
or the Preferred Shares.
In addition, on January 9, 2007, the Securities and Exchange Commission
announced that it had settled its investigation of three banks, including
[__________________], that participate as auction agents in the auction rate
securities market, regarding their respective practices and procedures in this
market. The Securities and Exchange Commission alleged in the settlement that
the Settling Auction Agents allowed broker-dealers in auctions to submit bids or
revise bids after the submission deadlines and allowed broker-dealers to
intervene in auctions in ways that affected the rates paid on the auction rate
securities. As part of the settlement, the Settling Auction Agents agreed to pay
civil penalties. In addition, each Settling Auction Agent, without admitting or
denying the Securities and Exchange Commission's allegations, agreed to provide
to broker-dealers and issuers written descriptions of its material auction
practices and procedures and to implement procedures reasonably designed to
detect and prevent any failures by that Settling Auction Agent to conduct the
auction process in accordance with disclosed procedures. No assurance can be
offered as to how the settlement may affect the market for auction rate
securities generally or the Preferred Shares.
GENERAL RISKS OF INVESTING IN THE FUND
Limited Operating History. The Fund is a recently organized,
non-diversified, closed-end management investment company that commenced
operations on May 31, 2007.
Investment Risk. An investment in Preferred Shares is subject to
investment risk, including the possible loss of the entire amount invested. An
investment in the Preferred Shares represents an indirect investment in the
securities owned by the Fund. The value of these securities, like other market
investments, may increase or decrease, sometimes quite rapidly and
unpredictably.
Management Risk. The Fund is subject to management risk because it has
an actively managed portfolio. The Adviser and the Sub-Adviser will apply
investment techniques and risk analyses in making investment decisions for the
Fund, but there can be no guarantee that these will produce the desired results.
Sub-Adviser Risk. The Sub-Adviser, Gallatin, is an entity organized in
2005 with limited management and operating history, although the majority of its
investment personnel previously comprised the Asset Management Department of
- 31 -
A.G. Edwards & Sons, Inc. and the investment team has largely worked together
since 1994. In addition, the Sub-Adviser is dependent upon the experience and
expertise of certain key personnel in providing services with respect to the
Fund's investments. If the Sub-Adviser were to lose the services of these
individuals, its ability to service the Fund could be adversely affected.
On May 31, 2007, Wachovia Corp. announced that it had reached an
agreement in principle with A.G. Edwards, Inc. under which Wachovia Corp. will
acquire A.G. Edwards, Inc. (the "Acquisition"). Gallatin is a wholly-owned
subsidiary of A.G. Edwards, Inc. Subject to certain regulatory approvals and the
approval by the shareholders of A.G. Edwards, Inc., the Acquisition is expected
to be completed in the fourth quarter of 2007. Depending on the structure and
terms of the Acquisition, the Acquisition, if completed, may result in a change
of control of Gallatin which would constitute an assignment, as that term is
defined in the Investment Company Act of 1940, as amended, of the Sub-Advisory
Agreement among the Fund, Gallatin and First Trust Advisors L.P., the Fund's
Adviser, thus having the effect of automatically terminating the Sub-Advisory
Agreement by and among the Fund, the Advisor and the Sub-Advisor. In the event
of the automatic termination of the Sub-Advisory Agreement, it is expected that
a new Sub-Advisory Agreement among the Fund, Gallatin and First Trust Advisors
L.P., pursuant to which Gallatin would continue to serve as the Fund's
Sub-Adviser following completion of the Acquisition, would be presented to the
Fund's Board of Trustees and the Fund's shareholders for their approval.
Value Investing Risk. The Fund focuses its investments on securities
that the Sub-Adviser believes are undervalued or inexpensive relative to other
investments. These types of securities may present risks in addition to the
general risks associated with investing in them. These securities generally are
selected on the basis of an issuer's business and economic fundamentals or the
securities' current and projected credit profiles, relative to current market
price. Such securities are subject to the risk of misestimating certain
fundamental factors. Disciplined adherence to a "value" investment mandate
during periods in which that style is "out of favor" can result in significant
underperformance relative to overall market indices and other managed investment
vehicles that pursue growth style investments and/or flexible style mandates.
Specialty Finance and Other Financial Companies Risk. The Fund will
invest substantially all of its assets in specialty finance and other financial
companies and generally the Fund's portfolio holdings will be concentrated in
securities of companies within industries in the financial sector. A fund
concentrated in a single industry or group of industries is likely to present
more risks than a fund that is broadly diversified over several industries or
groups of industries.
Specialty finance and other financial companies in a given country may
be subject to greater governmental regulation than many other industries, and
changes in governmental policies and the need for regulatory approval may have a
material effect on the services offered by companies in the financial services
industry. Governmental regulation may limit both the financial commitments banks
can make, including the amounts and types of loans, and the interest rates and
- 32 -
fees they can charge. In addition, governmental regulation in certain foreign
countries may impose interest rate controls, credit controls and price controls.
Specialty finance and other financial companies are subject to rapid
business changes, significant competition, value fluctuations due to the
concentration of loans in particular industries significantly affected by
economic conditions (such as real estate or energy) and volatile performance
based upon the availability and cost of capital and prevailing interest rates.
In addition, general economic conditions significantly affect these companies.
Credit and other losses resulting from the financial difficulties of borrowers
or other third parties potentially may have an adverse effect on companies in
these industries. Foreign banks, particularly those in Japan and certain Asian
countries, have reported financial difficulties attributed to increased
competition, regulatory changes and general economic conditions.
The financial industry in the United States currently is changing
relatively rapidly as historical distinctions between various industry segments
become less clear. For instance, recent business combinations have included
insurance, finance, investment management services and securities brokerage
under single ownership. Some primarily retail corporations have expanded into
securities and insurance fields. Investment banking, securities brokerage and
investment management firms, like banks, are subject to government regulation
and risk due to securities trading and underwriting activities.
Under current regulations of the Securities and Exchange Commission,
the Fund may not invest more than 5% of its total assets in the securities of
any company that derives more than 15% of its gross revenues from securities
brokerage, underwriting or investment management activities. In addition, the
Fund may not acquire more than 5% of the outstanding equity securities, or more
than 10% of the outstanding principal amount of debt securities of any such
company. This may limit the Fund's ability to invest in certain specialty
finance and other financial companies.
In addition to the risks of the Fund's investments in specialty finance
and other financial companies generally, as described below, investments in
certain types of specialty finance and other financial companies are subject to
additional risks.
Banks may invest and operate in an especially highly regulated
environment and are subject to extensive supervision by numerous federal and
state regulatory agencies including, but not limited to, the Federal Reserve
Board, the Federal Deposit Insurance Corporation and state banking authorities.
Such regulation is intended primarily for the protection of bank depositors and
customers rather than for the benefit of investors. Changes in regulations and
governmental policies and accounting principles could adversely affect the
business and operations of banks in which the Fund may invest.
Savings institutions frequently have a large proportion of their assets
in the form of loans and securities secured by residential real estate. As a
result, the financial condition and results of operations of such savings
institutions would likely be affected by the conditions in the residential real
estate markets in the areas in which these savings institutions do business.
- 33 -
Investment management companies in which the Fund may invest operate in
a highly competitive environment with investors generally favoring investment
advisers with a sustained successful performance record. The performance of
investment management companies may be affected by factors over which such
companies have little or no control, including general economic conditions,
other factors influencing the capital markets, the net sales of mutual fund
shares generally and interest rate fluctuations.
Finance companies can be highly dependent upon access to capital
markets and any impediments to such access, such as general economic conditions
or a negative perception in the capital markets of a company's financial
condition or prospects could adversely affect its business. Leasing companies
can be negatively impacted by changes in tax laws which affect the types of
transactions in which such companies may engage.
The Fund's investments in insurance companies will be subject to risk
from several additional factors. The earnings of insurance companies will be
affected by, in addition to general economic conditions, pricing (including
severe pricing competition from time to time), claims activity and marketing
competition. Particular insurance lines will also be influenced by specific
matters. Property and casualty insurer profits may be affected by certain
weather catastrophes and other disasters. Life and health insurer profits may be
affected by mortality and morbidity rates. Individual companies may be exposed
to material risks, including reserve inadequacy, problems in investment
portfolios (due to real estate or "junk" bond holdings, for example), and the
inability to collect from reinsurance carriers. Insurance companies are subject
to extensive governmental regulation, including the imposition of maximum rate
levels, which may not be adequate for some lines of business. Proposed or
potential anti-trust or tax law changes also may adversely affect insurance
companies' policy sales, tax obligations and profitability.
Common Stock Risk. The Fund may invest in common stocks. Investments in
common stocks involve common stock risk, which is the risk that common stocks
and similar equity securities held by the Fund will fall in value due to general
market or economic conditions, perceptions regarding the industries in which the
issuers of securities held by the Fund participate, and the particular
circumstances and performance of individual companies whose securities the Fund
holds. For example, an adverse event, such as an unfavorable earnings report,
may depress the value of equity securities of an issuer held by the Fund; the
price of common stock of an issuer may be particularly sensitive to general
movements in the stock market; or a drop in the stock market may depress the
price of most or all of the common stocks and other equity securities held by
the Fund. In addition, the common stock of an issuer held in the Fund's
portfolio may decline in price if the issuer of such common stock fails to make
anticipated dividend payments because, among other reasons, the issuer of the
security experiences a decline in its financial condition. While broad market
measures of common stocks have historically generated higher average returns
than fixed income securities, common stocks have also experienced significantly
more volatility in those returns.
Preferred Stock and Trust Preferred Securities Risk. The Fund may
invest in preferred stocks, including trust preferred securities. Preferred
stocks are unique securities that combine some of the characteristics of both
common stocks and bonds. Preferred stocks generally pay a fixed rate of return
- 34 -
and are sold on the basis of current yield, like bonds. However, because they
are equity securities, preferred stocks provide equity ownership of a company
and the income is paid in the form of dividends. Preferred stocks typically have
a yield advantage over common stocks as well as comparably-rated fixed income
investments. Preferred stocks are typically subordinated to bonds and other debt
instruments in a company's capital structure, in terms of priority to corporate
income, and therefore will be subject to greater credit risk than those debt
instruments. Unlike interest payments on debt securities, preferred stock
dividends are payable only if declared by the issuer's board of directors.
Preferred stock also may be subject to optional or mandatory redemption
provisions. Certain of the preferred stocks in which the Fund may invest may be
convertible preferred stocks, which have risks similar to convertible securities
as described above in "Risks--Convertible Securities Risk."
Trust preferred securities are limited-life preferred securities
typically issued by corporations, generally in the form of interest-bearing
notes or preferred securities issued by an affiliated business trust of a
corporation whose only assets are generally in the form of beneficial interests
in subordinated debentures or similarly structured securities. Dividend payments
on the trust preferred securities generally coincide with interest payments on
the underlying obligations. Trust preferred securities generally have a yield
advantage over traditional preferred stocks, but unlike preferred stocks,
distributions are treated as interest rather than dividends for federal income
tax purposes and therefore, are not eligible for the dividends-received
deduction and do not constitute qualified dividend income. Trust preferred
securities prices fluctuate for several reasons including changes in investors'
perception of the financial condition of an issuer or the general economic
condition of the market for trust preferred securities, or when political or
economic events affecting the issuers occur. Trust preferred securities are also
sensitive to interest rate fluctuations, as the cost of capital rises and
borrowing costs increase in a rising interest rate environment and the risk that
a trust preferred security may be called for redemption in a falling interest
rate environment. Certain of the other risks unique to trust preferred
securities include: (i) distributions on trust preferred securities will be made
only if interest payments on the interest-bearing notes, preferred securities or
subordinated debentures are made; (ii) a corporation issuing the
interest-bearing notes, preferred securities or subordinated debentures may
defer interest payments on these instruments for up to 20 consecutive quarters
and if such election is made, distributions will not be made on the trust
preferred securities during the deferral period; (iii) certain tax or regulatory
events may trigger the redemption of the interest-bearing notes, preferred
securities or subordinated debentures by the issuing corporation and result in
prepayment of the trust preferred securities prior to their stated maturity
date; (iv) future legislation may be proposed or enacted that may prohibit the
corporation from deducting its interest payments on the interest-bearing notes,
preferred securities or subordinated debentures for tax purposes, making
redemption of these instruments likely; (v) a corporation may redeem the
interest-bearing notes, preferred securities or subordinated debentures in whole
at any time or in part from time to time on or after a stated call date; (vi)
trust preferred securities holders have very limited voting rights; and (vii)
payment of interest on the interest bearing notes, preferred securities or
subordinated debentures, and therefore distributions on the trust preferred
securities, is dependent on the financial condition of the issuing corporation.
Convertible Securities Risk. Convertible securities generally offer
lower interest or dividend yields than non-convertible securities of similar
quality. Similar to traditional fixed-income securities, the market values of
- 35 -
convertible securities tend to decline as interest rates increase and,
conversely, to increase as interest rates decline. However, when the market
price of the common stock underlying a convertible security exceeds the
conversion price, the convertible security tends to reflect the market price of
the underlying common stock. As the market price of the underlying common stock
declines, the convertible security tends to trade increasingly on a yield basis
and thus may not decline in price to the same extent as the underlying common
stock. Convertible securities rank senior to common stocks in an issuer's
capital structure and consequently entail less risk than the issuer's common
stock.
Fixed-Income Securities Risk. In addition to the risks discussed above,
debt securities, including high-yield securities, are subject to certain risks,
including:
o Issuer/Credit Risk. The value of fixed-income securities may
decline for a number of reasons which directly relate to the issuer,
such as management performance, financial leverage, reduced demand for
the issuer's goods and services and failure.
o Interest Rate Risk. Interest rate risk is the risk that
fixed-income securities will decline in value because of changes in
market interest rates. When market interest rates rise, the market
value of such securities generally will fall. During periods of rising
interest rates, the average life of certain types of securities may be
extended because of slower than expected prepayments. This may lock in
a below market yield, increase the security's duration and reduce the
value of the security. Investments in debt securities with long-term
maturities may experience significant price declines if long-term
interest rates increase.
o Prepayment Risk. During periods of declining interest rates, the
issuer of a security may exercise its option to prepay principal
earlier than scheduled, forcing the Fund to reinvest the proceeds from
such prepayment in lower yielding securities. This is known as call or
prepayment risk. Debt securities frequently have call features that
allow the issuer to repurchase the security prior to its stated
maturity. An issuer may redeem an obligation if the issuer can
refinance the debt at a lower cost due to declining interest rates or
an improvement in the credit standing of the issuer.
o Reinvestment Risk. Reinvestment risk is the risk that income from
the Fund's portfolio will decline if the Fund invests the proceeds from
matured, traded or called bonds at market interest rates that are below
the Fund portfolio's current earnings rate. A decline in income could
affect the performance of the Fund.
Lower Grade and Distressed Securities Risk. The Fund may invest in
below-investment grade debt securities. Below-investment grade debt securities
are rated below "Baa3" by Moody's, below "BBB-" by S&P, comparably rated by
another NRSRO or, if unrated, determined to be of comparable credit quality by
the Sub-Adviser. Below-investment grade debt instruments are commonly referred
to as "high-yield" or "junk" bonds and are considered speculative with respect
to the issuer's capacity to pay interest and repay principal and are susceptible
to default or decline in market value due to adverse economic and business
developments. The market values for high-yield securities tend to be very
volatile, and these securities are generally less liquid than investment grade
debt securities. For these reasons, your investment in the Fund is subject to
- 36 -
the following specific risks: (i) increased price sensitivity to changing
interest rates and to a deteriorating economic environment; (ii) greater risk of
loss due to default or declining credit quality; (iii) adverse company specific
events more likely to render the issuer unable to make interest and/or principal
payments; and (iv) negative perception of the high-yield market which may
depress the price and liquidity of high-yield securities.
Adverse changes in economic conditions are more likely to lead to a
weakened capacity of a high-yield issuer to make principal payments and interest
payments than an investment grade issuer. An economic downturn could severely
affect the ability of highly leveraged issuers to service their debt obligations
or to repay their obligations upon maturity.
The secondary market for high-yield securities may not be as liquid as
the secondary market for more highly rated securities, a factor which may have
an adverse effect on the Fund's ability to dispose of a particular security.
There are fewer dealers in the market for high-yield securities than for
investment grade obligations. The prices quoted by different dealers may vary
significantly and the spread between the bid and asked price is generally much
larger than for higher quality instruments. Under adverse market or economic
conditions, the secondary market for high-yield securities could contract
further, independent of any specific adverse changes in the condition of a
particular issuer, and these securities may become illiquid. As a result, the
Fund could find it more difficult to sell these securities or may be able to
sell the securities only at prices lower than if such securities were widely
traded. Prices realized upon the sale of such lower rated or unrated securities,
under these circumstances, may be less than the prices used in calculating the
Fund's NAV.
The Fund may invest up to 10% of its Managed Assets in securities
issued by companies in a bankruptcy reorganization proceeding, subject to some
other form of a public or private debt restructuring or otherwise in default or
in significant risk of default in the payment of interest or repayment of
principal or trading at prices substantially below other below-investment grade
debt securities of companies in similar industries. Distressed securities
frequently do not produce income while they are outstanding. The Fund may be
required to incur certain extraordinary expenses in order to protect and recover
its investment. Therefore, to the extent the Fund seeks capital appreciation
through investment in distressed securities, the Fund's ability to achieve
current income may be diminished. The Fund also will be subject to significant
uncertainty as to when and in what manner and for what value the obligations
evidenced by the distressed securities will eventually be satisfied (e.g.,
through a liquidation of the obligor's assets, an exchange offer or plan of
reorganization involving the distressed securities or a payment of some amount
in satisfaction of the obligation). In addition, even if an exchange offer is
made or a plan of reorganization is adopted with respect to distressed
securities held by the Fund, there can be no assurance that the securities or
other assets received by the Fund in connection with such exchange offer or plan
of reorganization will not have a lower value or income potential than may have
been anticipated when the investment was made. Moreover, any securities received
by the Fund upon completion of an exchange offer or plan of reorganization may
be restricted as to resale. As a result of the Fund's participation in
negotiations with respect to any exchange offer or plan of reorganization with
respect to an issuer of distressed securities, the Fund may be restricted from
disposing of such securities.
- 37 -
Business Development Company Risk. Investments in closed-end funds that
elect to be treated as BDCs may be subject to a high degree of risk. BDCs
typically invest in small and medium-sized private and certain public companies
that may not have access to public equity markets for capital raising. As a
result, a BDC's portfolio typically will include a substantial amount of
securities purchased in private placements, and its portfolio may carry risks
similar to those of a private equity or venture capital fund. Securities that
are not publicly registered may be difficult to value and may be difficult to
sell at a price representative of their intrinsic value. Small and medium-sized
companies also may have fewer lines of business so that changes in any one line
of business may have a greater impact on the value of their stock than is the
case of a larger company. Some BDCs invest substantially, or even exclusively,
in one sector or industry group and therefore carry risk of that particular
sector or industry group. To the extent a BDC focuses its investments in a
specific sector, the BDC will be susceptible to adverse conditions and economic
or regulatory occurrences affecting the specific sector or industry group, which
tends to increase volatility and result in higher risk. Investments in BDCs are
subject to various risks, including management's ability to meet the BDC's
investment objective, and to manage the BDC's portfolio when the underlying
securities are redeemed or sold, during periods of market turmoil and as
investors' perceptions regarding a BDC or its underlying investments change. BDC
shares are not redeemable at the option of the BDC shareholder and, as with
shares of other closed-end funds, they may trade in the secondary market at a
discount to their NAV. BDCs generally qualify as "regulated investment
companies" under the federal tax laws and, provided they distribute all of their
income in the time and manner as required by the tax law, generally will not pay
federal income taxes.
Certain BDCs in which the Fund may invest may employ the use of
leverage in their portfolios through borrowings or the issuance of preferred
stock. While leverage often serves to increase the yield of a BDC, this leverage
also subjects the BDC to increased risks, including the likelihood of increased
volatility and the possibility that the BDC's common share income will fall if
the dividend rate on any preferred shares or the interest rate on any borrowings
rises.
The Fund may be limited by provisions of the 1940 Act that generally
limit the amount the Fund can invest in any one closed-end fund, including any
one BDC, to 3% of the closed-end fund's total outstanding stock. As a result,
the Fund may hold a smaller position in a BDC than if it were not subject to
this restriction. To comply with the provisions of the 1940 Act, on any matter
upon which BDC shareholders are solicited to vote, the Sub-Adviser may be
required to vote shares of the BDC held by the Fund in the same general
proportion as shares held by other shareholders of the BDC. The Fund will
indirectly bear its proportionate share of any management and other operating
expenses, and of any performance based or incentive fees, charged by the BDCs in
which it invests, in addition to the expenses paid by the Fund.
REIT, Mortgage-Related and Asset-Backed Securities Risk. Investing in
REITs involves certain unique risks in addition to those risks associated with
investing in the real estate industry in general. An Equity REIT may be affected
by changes in the value of the underlying properties owned by the REIT. A
Mortgage REIT may be affected by changes in interest rates and the ability of
the issuers of its portfolio mortgages to repay their obligations. REITs are
dependent upon the skills of their managers and are not diversified. REITs are
generally dependent upon maintaining cash flows to repay borrowings and to make
- 38 -
distributions to shareholders and are subject to the risk of default by lessees
or borrowers. REITs whose underlying assets are concentrated in properties used
by a particular industry, such as health care, are also subject to risks
associated with such industry.
REITs (especially Mortgage REITs) are also subject to interest rate
risks. When interest rates decline, the value of a REIT's investment in fixed
rate obligations can be expected to rise. Conversely, when interest rates rise,
the value of a REIT's investment in fixed rate obligations can be expected to
decline. If the REIT invests in adjustable rate mortgage loans the interest
rates on which are reset periodically, yields on a REIT's investments in such
loans will gradually align themselves to reflect changes in market interest
rates. This causes the value of such investments to fluctuate less dramatically
in response to interest rate fluctuations than would investments in fixed rate
obligations.
REITs may have limited financial resources, may trade less frequently
and in a limited volume and their securities may be subject to more abrupt or
erratic price movements than larger company securities. Historically, REITs have
been more volatile in price than the larger capitalization stocks included in
Standard & Poor's 500 Stock Index.
In addition to REITs, the Fund may invest in a variety of other
mortgage-related securities, including commercial mortgage securities and other
mortgage-backed instruments. Rising interest rates tend to extend the duration
of mortgage-related securities, making them more sensitive to changes in
interest rates. As a result, in a period of rising interest rates,
mortgage-related securities held by the Fund may exhibit additional volatility.
This is known as extension risk. In addition, mortgage-related securities are
subject to prepayment risk--the risk that borrowers may pay off their mortgages
sooner than expected, particularly when interest rates decline. This can reduce
the Fund's returns because the Fund may have to reinvest that money at lower
prevailing interest rates.
The Fund's investments in other asset-backed securities are subject to
risks similar to those associated with mortgage-related securities, as well as
additional risks associated with the nature of the assets and the servicing of
those assets.
Infrastructure Trust Risk. Infrastructure issuers, including utilities
and companies involved in infrastructure projects, are subject to a variety of
factors that may adversely affect their business operations, including high
interest costs in connection with capital construction programs, costs
associated with environmental and other regulations, the effects of economic
slowdown and surplus capacity, increased competition from other providers of
services, uncertainties concerning the availability of fuel at reasonable
prices, the effects of energy conservation policies and other factors.
Infrastructure issuers may be subject to regulation by various governmental
authorities and may also be affected by governmental regulation of rates charged
to customers, service interruption due to environmental, operational or other
mishaps and the imposition of special tariffs and changes in tax laws,
regulatory policies and accounting standards.
Income Trust Risk. Income trusts are subject to the risk generally
applicable to companies in the energy and natural resources sectors, such as
commodity pricing risk, supply and demand risk and depletion risk and
- 39 -
exploration risk. The return on the Fund's investments in income trusts will be
dependent on the prices for natural gas, natural gas liquids, crude oil, refined
petroleum products, coal or other natural resources. These prices may fluctuate
widely in response to a variety of factors including global and domestic
economic conditions, weather conditions, the supply and price of imported energy
commodities, the production and storage levels of energy commodities in certain
regions or in the world, political stability, transportation facilities, energy
conservation, domestic and foreign governmental regulation and taxation and the
availability of local, intrastate and interstate transportation systems. Income
trusts have naturally depleting assets. As a result, in order to maintain or
grow their revenues, income trusts or their customers need to maintain or expand
their reserves through new sources of supply, the development of existing
sources or acquisitions, and the inability to do so may adversely affect the
financial performance of the income trusts.
Tax Risk. Infrastructure trusts, and certain income trusts (such as
U.S. royalty trusts) and MLPs that are not "qualified publicly traded
partnerships" (as defined for U.S. federal income tax purposes) generally pass
through tax items such as income, gain or loss to interest holders. In such
cases, the Fund will be required to monitor the individual underlying items of
income that it receives from such entities to determine how it will characterize
such income for purposes of meeting the 90% gross income requirement. In
addition, the Fund will be deemed to own the assets of such entities and would
need to look to such assets in determining the Fund's compliance with the asset
diversification rules applicable to RICs. Thus, the extent to which the Fund may
invest in securities issued by such entities may be limited by the Fund's
intention to qualify as a RIC under the Internal Revenue Code. Prospective
investors should be aware that if, contrary to the Fund's intention, the Fund
fails to limit its direct and indirect investments in such entities, or if such
investments are re-characterized for U.S. federal income tax purposes, the
Fund's status as a RIC may be jeopardized.
There are certain other tax risks associated with the income trusts in
which the Fund may invest. These tax risks include the possibility that Canadian
and/or U.S. taxing authorities may challenge the deductibility of certain
interest payments and certain other costs and expenses inherent in the structure
of certain income trusts, or U.S. taxing authorities could challenge the Fund's
treatment of the income trusts in which the Fund invests as corporations or
grantor trusts for tax purposes. These tax risks, and any adverse determination
with respect thereto, could have a negative impact on the value of the Fund's
investments in income trust interests, as well as on the after-tax income
available for distribution by the income trusts, which in turn would reduce the
cash available to the Fund for distributions. There can be no assurance that
future changes to Canadian and U.S. tax laws or tax rules or interpretations
thereof would not adversely affect the Fund's investments in income trusts. See
"Federal Tax Matters."
Foreign Securities Risk. The Fund may invest in securities (equity or
debt) of foreign issuers. Investing in securities of foreign issuers, which are
generally denominated in foreign currencies, may involve certain risks not
typically associated with investing in securities of U.S. issuers. These risks
include: (i) there may be less publicly available information about foreign
issuers or markets due to less rigorous disclosure or accounting standards or
regulatory practices; (ii) foreign markets may be smaller, less liquid and more
volatile than the U.S. market; (iii) potential adverse effects of fluctuations
- 40 -
in currency exchange rates or controls on the value of the Fund's investments;
(iv) the economies of foreign countries may grow at slower rates than expected
or may experience a downturn or recession; (v) the impact of economic,
political, social or diplomatic events; (vi) certain foreign countries may
impose restrictions on the ability of foreign issuers to make payments of
principal and interest to investors located in the United States due to blockage
of foreign currency exchanges or otherwise; and (vii) withholding and other
foreign taxes may decrease the Fund's return. These risks may be more pronounced
to the extent that the Fund invests a significant amount of its assets in
securities of issuers located in one region and to the extent that the Fund
invests in securities of issuers in emerging markets.
The Fund may invest in securities of issuers located in countries
considered to be emerging markets, and investments in such securities are
considered speculative. Heightened risks of investing in emerging markets
securities include: (i) smaller market capitalization of securities markets,
which may suffer periods of relative illiquidity; (ii) significant price
volatility; (iii) restrictions on foreign investment; and (iv) possible
repatriation of investment income and capital. Furthermore, foreign investors
may be required to register the proceeds of sales and future economic or
political crises could lead to price controls, forced mergers, expropriation or
confiscatory taxation, seizure, nationalization or creation of government
monopolies. The currencies of emerging market countries may experience
significant declines against the U.S. dollar, and devaluation may occur
subsequent to investments in these currencies by the Fund. Inflation and rapid
fluctuations in inflation rates have had, and may continue to have, negative
effects on the economies and securities markets of certain emerging market
countries.
Currency Risk. The value of securities denominated or quoted in foreign
currencies may be adversely affected by fluctuations in the relative currency
exchange rates and by exchange control regulations. The Fund's investment
performance may be negatively affected by a devaluation of a currency in which
the Fund's investments are denominated or quoted. Further, the Fund's investment
performance may be significantly affected, either positively or negatively, by
currency exchange rates because the U.S. dollar value of securities denominated
or quoted in another currency will increase or decrease in response to changes
in the value of such currency in relation to the U.S. dollar.
Liquidity Risk. The Fund may invest in securities that, at the time of
investment, are illiquid (determined using the Securities and Exchange
Commission's standard applicable to investment companies, i.e., securities that
cannot be disposed of by the Fund within seven days in the ordinary course of
business at approximately the amount at which the Fund has valued the
securities). The Fund may also invest in restricted securities. Investments in
restricted securities could have the effect of increasing the amount of the
Fund's assets invested in illiquid securities if qualified institutional buyers
are unwilling to purchase these securities. Illiquid and restricted securities
may be difficult to dispose of at a fair price at the times when the Fund
believes it is desirable to do so. The market price of illiquid and restricted
securities generally is more volatile than that of more liquid securities, which
may adversely affect the price that the Fund pays for or recovers upon the sale
of such securities. Illiquid and restricted securities are also more difficult
to value and the Adviser's and the Sub-Adviser's judgment may each play a
greater role in the valuation process. Investment of the Fund's assets in
illiquid and restricted securities may restrict the Fund's ability to take
advantage of market opportunities. The risks associated with an investment in
- 41 -
illiquid and restricted securities may be particularly acute in situations in
which the Fund's operations require cash and could result in the Fund borrowing
to meet its short-term needs or incurring losses on the sale of illiquid or
restricted securities. In order to dispose of an unregistered security, the
Fund, where it has contractual rights to do so, may have to cause such security
to be registered. A considerable period may elapse between the time the decision
is made to sell the security and the time the security is registered, therefore
enabling the Fund to sell it. Contractual restrictions on the resale of
securities vary in length and scope and are generally the result of a
negotiation between the issuer and acquiror of the securities. In either case,
the Fund would bear market risks during that period.
Privately-Issued Securities Risk. In addition to being subject to the
risks applicable to restricted and/or illiquid securities, as described above,
privately-issued securities are also subject to the following risks:
o Availability Risk. The Fund's ability to make investments in
privately-issued securities is dependent upon the availability of a
sufficient supply of such securities that meets the investment criteria
established by the Adviser and Sub-Adviser. While the Fund may purchase
a substantial portion of such securities from or through one or more
broker-dealers or intermediaries and/or directly from the issuers
thereof, the Fund has no current obligations to purchase any such
securities and none of such parties has a current obligation to sell
any such securities to the Fund. To the extent the Fund must pay any
fees associated with the issuance of such securities, including
brokers' or finders' fees, it may reduce the Fund's targeted yield. If
the Fund is unsuccessful in obtaining any such securities, the Fund's
overall current yield and tax-advantaged benefits may be adversely
affected. In addition, under such circumstances the Fund may be
required to invest its Managed Assets in other investments that do not
pay rates of return that are as high as those expected to be paid on
such securities, in which case the Fund may not be able to achieve its
investment objectives.
o Valuation Risk. The Fund will use an independent pricing service
to value any privately-issued preferred securities, which generally are
expected initially, and for some extended period of time, to be
illiquid. Based on information provided to the Fund by such independent
pricing service, in determining the value of privately-issued preferred
securities, such pricing service will consider (i) the characteristics
of, and fundamental analytical data relating to, the privately-issued
preferred securities, including cost, size of the issuance, current
dividend rate and the time period until the next dividend rate
readjustment, (ii) the credit quality of the issuer, based on an
evaluation of its financial condition and regulatory filings and (iii)
transactions in securities comparable to such privately-issued
preferred securities and various relationships between securities that
are recognized by institutional traders. The Fund will use a fair value
methodology if the independent pricing service is unable to provide a
price for a privately-issued security, if the price provided by the
independent pricing service is deemed unreliable or if events occurring
after the close of a securities market and before the Fund values its
Managed Assets would materially affect NAV. A security that is fair
valued may be valued at a price higher or lower than (i) the price that
may be received if such security were to be sold or (ii) the value
determined by other funds using their own fair valuation procedures. In
addition, where no market currently exists for privately-issued
preferred securities, there can be no assurance that any such market
- 42 -
will develop in the future, which may adversely affect the valuation of
such securities, which in turn may adversely affect the ability of the
Fund to sell such securities at times or prices desired by the Fund.
Derivatives Risk. Strategic Transactions have risks, including the
imperfect correlation between the value of such instruments and the underlying
assets, the possible default of the other party to the transaction or
illiquidity of the derivative investments. Furthermore, the ability to
successfully use Strategic Transactions depends on the Sub-Adviser's ability to
predict pertinent market movements, which cannot be assured. Thus, the use of
Strategic Transactions to generate income or for hedging, currency and interest
rate management or other purposes may result in losses greater than if they had
not been used, may require the Fund to sell or purchase portfolio securities at
inopportune times or for prices other than current market values, may limit the
amount of appreciation the Fund can realize on an investment or may cause the
Fund to hold a security that it might otherwise sell. Additionally, amounts paid
by the Fund as premiums and cash or other assets held in margin accounts with
respect to the Fund's Strategic Transactions will not otherwise be available to
the Fund for investment purposes.
There are several risks associated with transactions in options on
securities. For example, there are significant differences between the
securities and options markets that could result in an imperfect correlation
between these markets, causing a given transaction not to achieve its
objectives. A decision as to whether, when and how to use options involves the
exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
There are several risks associated with the use of futures contracts
and futures options. The purchase or sale of a futures contract may result in
losses in excess of the amount invested in the futures contract. While the Fund
may enter into futures contracts and options on futures contracts for hedging or
investment purposes, the use of futures contracts and options on futures
contracts might result in a poorer overall performance for the Fund than if it
had not engaged in any such transactions. There may be an imperfect correlation
between the Fund's portfolio holdings and futures contracts or options on
futures contracts entered into by the Fund, which may prevent the Fund from
achieving the intended hedge or expose the Fund to risk of loss. The degree of
imperfection of correlation depends on circumstances such as variations in
market demand for futures, options on futures and their related securities,
including technical influences in futures and futures options trading, and
differences between the securities markets and the securities underlying the
standard contracts available for trading. Further, the Fund's use of futures
contracts and options on futures contracts involves costs and will be subject to
the Sub-Adviser's ability to correctly predict changes in interest rate
relationships or other factors.
Depending on whether the Fund would be entitled to receive net payments
from the counterparty on a swap or cap, which in turn would depend on the
general state of short-term interest rates at that point in time, a default by a
counterparty could negatively impact the performance of the Fund. In addition,
at the time an interest rate swap or cap transaction reaches its scheduled
termination date, there is a risk that the Fund would not be able to obtain a
replacement transaction or that the terms of the replacement would not be as
favorable as on the expiring transaction. If this occurs, it could have a
negative impact on the performance of the Fund. If the Fund fails to maintain
any required asset coverage ratios in connection with any use by the Fund of
- 43 -
leverage, including the Preferred Shares, the Fund may be required to redeem or
prepay some or all of the leverage. Such redemption or prepayment would likely
result in the Fund seeking to terminate early all or a portion of any swap or
cap transaction. Early termination of a swap could result in a termination
payment by or to the Fund. Early termination of a cap could result in a
termination payment to the Fund. The Fund currently intends to segregate assets
on the Fund's records in the form of cash, cash equivalents or liquid securities
in an amount equal to the notional value of the credit default swaps of which it
is the seller. The Fund will not enter into interest rate swap or cap
transactions having a notional amount that exceeds the outstanding amount of the
Fund's leverage.
The Fund may purchase credit derivative instruments for investment
purposes or to hedge the Fund's credit risk exposure to certain issuers of
securities that the Fund owns. For example, the Fund may enter into credit
default swap contracts where the Fund would be the buyer of such a contract. The
Fund would be entitled to receive the par (or other agreed-upon) value of a
referenced debt obligation from the counterparty to the contract in the event of
a default by a third party, such as a U.S. issuer, on the referenced debt
obligation. In return, the Fund would pay to the counterparty a periodic stream
of payments over the term of the contract provided that no event of default has
occurred. If the Fund is a buyer and no event of default occurs, the Fund will
have made a series of periodic payments and recover nothing of monetary value.
The Fund may enter into currency exchange transactions to hedge the
Fund's exposure to foreign currency exchange rate risk to the extent the Fund
invests in non-U.S. denominated securities of non-U.S. issuers. The Fund's
currency transactions will be limited to portfolio hedging involving portfolio
positions. Portfolio hedging is the use of a forward contract with respect to a
portfolio security position denominated or quoted in a particular currency. A
forward contract is an agreement to purchase or sell a specified currency at a
specified future date (or within a specified time period) and price set at the
time of the contract. Forward contracts are usually entered into with banks,
foreign exchange dealers or broker-dealers, are not exchange-traded, and are
usually for less than one year, but may be renewed.
At the maturity of a forward contract to deliver a particular currency,
the Fund may either sell the portfolio security related to such contract and
make delivery of the currency, or it may retain the security and either acquire
the currency on the spot market or terminate its contractual obligation to
deliver the currency by purchasing an offsetting contract with the same currency
trader obligating it to purchase on the same maturity date the same amount of
the currency.
It is impossible to forecast with absolute precision the market value
of portfolio securities at the expiration of a forward contract. Accordingly, it
may be necessary for the Fund to purchase additional currency on the spot market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of currency that the Fund is obligated to deliver and if a
decision is made to sell the security and make delivery of the currency.
Conversely, it may be necessary to sell on the spot market some of the currency
received upon the sale of the portfolio security if its market value exceeds the
amount of currency the Fund is obligated to deliver.
- 44 -
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
currency. Should forward prices decline during the period between the Fund's
entering into a forward contract for the sale of a currency and the date it
enters into an offsetting contract for the purchase of the currency, the Fund
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should forward
prices increase, the Fund will suffer a loss to the extent the price of the
currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell. A default on the contract would deprive the Fund of unrealized
profits or force the Fund to cover its commitments for purchase or sale of
currency, if any, at the current market price.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the hedged currency should rise. Moreover,
it may not be possible for the Fund to hedge against a devaluation that is so
generally anticipated that the Fund is not able to contract to sell the currency
at a price above the devaluation level it anticipates. The cost to the Fund of
engaging in currency exchange transactions varies with such factors as the
currency involved, the length of the contract period, and prevailing market
conditions. Since currency exchange transactions are usually conducted on a
principal basis, no fees or commissions are involved.
The use of interest rate swaps and caps is a highly specialized
activity that involves investment techniques and risks different from those
associated with ordinary portfolio transactions. Depending on market conditions
in general, the Fund's use of swaps or caps could enhance or harm the overall
performance of the Fund. To the extent there is a decline in interest rates, the
value of the interest rate swap or cap could decline. In addition, if short-term
interest rates are lower than the Fund's fixed rate of payment on the interest
rate swap, the swap will reduce net earnings of the Fund. If, on the other hand,
short-term interest rates are higher than the fixed rate of payment on the
interest rate swap, the swap will enhance net earnings of the Fund. Buying
interest rate caps could decrease the net earnings of the Fund in the event that
the premium paid by the Fund to the counterparty to the swap exceeds the
additional amount the Fund would have been required to pay had it not entered
into the cap agreement. The Fund has no current intention of selling interest
rate swaps or caps.
Interest rate swaps and caps do not involve the delivery of securities
or other underlying assets or principal. Accordingly, the risk of loss with
respect to interest rate swaps is limited to the net amount of interest payments
that the Fund is contractually obligated to make. If the counterparty defaults,
the Fund would not be able to use the anticipated net receipts under the swap or
cap to offset any declines in the value of the Fund's portfolio assets being
hedged. Depending on whether the Fund would be entitled to receive net payments
from the counterparty on the swap or cap, which in turn would depend on the
general state of the market rates at that point in time, such a default could
negatively impact the performance of the Fund.
Credit Default Swaps Risk. The Fund may invest in credit default swap
transactions for hedging or investment purposes. The "buyer" in a credit default
contract is obligated to pay the "seller" a periodic stream of payments over the
- 45 -
term of the contract, provided that no event of default on an underlying
reference obligation has occurred. If an event of default occurs, the seller
must pay the buyer the full notional value, or "par value," of the underlying
reference obligation. The Fund may be either the buyer or seller in a credit
default swap transaction. If the Fund is a buyer and no event of default occurs,
the Fund will have made a series of periodic payments and recover nothing of
monetary value. However, if an event of default occurs, the Fund (if the buyer)
will receive the full notional value of the underlying reference obligation
either through a cash payment in exchange for the asset or a cash payment in
addition to owning the underlying reference asset. As a seller, the Fund
receives a fixed rate of income throughout the term of the contract, which
typically is between six months and five years, provided that there is no event
of default. The Fund currently intends to segregate assets on the Fund's records
in the form of cash, cash equivalents or liquid securities in an amount equal to
the full notional value of the credit default swaps of which it is the seller.
If such assets are not fully segregated on the Fund's records by the Fund, the
use of credit default swap transactions could then be considered leverage. If an
event of default occurs, the seller must pay the buyer the full notional value
of the underlying reference obligation through either physical settlement or
cash settlement. Credit default swap transactions involve greater risks than if
the Fund had invested in the underlying reference obligation directly.
Non-Diversification Risk. The Fund is, and certain of the BDCs in which
the Fund may invest may be, classified as "non-diversified" under the 1940 Act.
A non-diversified fund has the ability to invest more of its assets in
securities of a single issuer than if it were classified as a "diversified"
fund, which may increase volatility. If the Fund's investment in a BDC, or a
BDC's investment in an issuer, represents a relatively significant percentage of
the Fund's or the BDC's portfolio, as applicable, the value of the respective
portfolio will be more impacted by a loss on that investment than if the
portfolio were more diversified.
Inflation/Deflation Risk. Inflation risk is the risk that the value of
the Fund's assets or income from the Fund's investments will be worth less in
the future as inflation decreases the value of money. As inflation increases,
the real value of the Preferred Shares and distributions can decline. In
addition, during any periods of rising inflation, the dividend rates or
borrowing costs associated with the Fund's use of leverage would likely
increase, which would tend to further reduce returns to the Fund. Deflation risk
is the risk that prices throughout the economy decline over time--the opposite
of inflation. Deflation may have an adverse affect on the creditworthiness of
issuers and may make issuer default more likely, which may result in a decline
in the value of the Fund's portfolio.
Market Discount From Net Asset Value Risk. Shares of closed-end
investment companies, including BDCs, frequently trade at a discount from their
NAV. This characteristic is a risk separate and distinct from the risk that the
Fund's NAV could decrease as a result of its investment activities and may be
greater for investors expecting to sell their Common Shares in a relatively
short period following completion of this offering. The NAV of the Common Shares
will be reduced immediately following this offering as a result of the payment
of certain offering costs. Although the value of the Fund's net assets is
generally considered by market participants in determining whether to purchase
or sell Common Shares, whether investors will realize gains or losses upon the
sale of the Common Shares will depend entirely upon whether the market price of
- 46 -
the Common Shares at the time of sale is above or below the investor's purchase
price for the Common Shares. Because the market price of the Common Shares will
be determined by factors such as NAV, dividend and distribution levels and their
stability (which will in turn be affected by levels of dividend and interest
payments by the Fund's portfolio holdings, the timing and success of the Fund's
investment strategies, regulations affecting the timing and character of the
Fund's distributions, the Fund's expenses and other factors), supply of and
demand for the Common Shares, trading volume of the Common Shares, general
market, interest rate and economic conditions and other factors beyond the
control of the Fund, the Fund cannot predict whether the Common Shares will
trade at, below or above NAV or at, below or above the initial public offering
price.
Portfolio Turnover Risk. The Fund's annual portfolio turnover rate may
vary greatly from year to year. Although the Fund cannot accurately predict its
annual portfolio turnover rate, it is not expected to exceed 50% under normal
circumstances. However, portfolio turnover rate is not considered a limiting
factor in the execution of investment decisions for the Fund. High portfolio
turnover may result in the realization of net short-term capital gains by the
Fund. In addition, a higher portfolio turnover rate results in correspondingly
greater brokerage commissions and other transactional expenses that are borne by
the Fund. See "The Fund's Investments--Investment Practices--Portfolio Turnover"
and "Federal Tax Matters."
Certain Affiliations. Certain broker-dealers may be considered to be
affiliated persons of the Fund, First Trust Advisors or Gallatin. Gallatin is a
wholly-owned subsidiary of A.G. Edwards, Inc., which is also the holding company
of A.G. Edwards & Sons, Inc., the Fund's lead underwriter. Wachovia Corp. has
agreed in principle to acquire A.G. Edwards Inc. Absent an exemption from the
Securities and Exchange Commission or other regulatory relief, the Fund is
generally precluded from effecting certain principal transactions with
affiliated brokers, and its ability to utilize affiliated brokers for agency
transactions is subject to restrictions. This could limit the Fund's ability to
engage in securities transactions and take advantage of market opportunities. In
addition, until the underwriting syndicate is broken in connection with the
initial public offering of the Common Shares, the Fund will be precluded from
effecting principal transactions with brokers who are members of the syndicate.
Anti-Takeover Provisions. The Fund's Declaration of Trust and By-Laws
include provisions that could limit the ability of other entities or persons to
acquire control of the Fund or convert the Fund to open-end status. See "Certain
Provisions in the Declaration of Trust and By-Laws."
Market Disruption Risk. The terrorist attacks in the United States on
September 11, 2001 had a disruptive effect on the securities markets. The
ongoing U.S. military and related action in Iraq and events in the Middle East,
as well as the continuing threat of terrorist attacks, could have significant
adverse effects on the U.S. economy, the stock market and world economies and
markets generally. Below-investment grade debt securities tend to be more
volatile than higher-rated fixed-income securities so that these events and any
actions resulting from them may have a greater impact on the prices and
volatility of below-investment grade securities than on higher-rated
fixed-income securities. A similar disruption of financial markets or other
terrorist attacks could adversely affect Fund service providers and/or the
- 47 -
Fund's operations as well as interest rates, secondary trading, credit risk,
inflation and other factors relating to the Fund's shares. The Fund cannot
predict the effects of similar events in the future on the U.S. and world
economies or the value of the assets of the Fund.
THE FUND'S INVESTMENTS
INVESTMENT OBJECTIVES AND POLICIES
The Fund's primary investment objective is to seek a high level of
current income. The Fund seeks attractive total return as a secondary objective.
There can be no assurance that the Fund's investment objectives will be
achieved.
The Fund's investment objectives and the investment restrictions noted
in the SAI which are considered fundamental may not be changed without approval
by holders of a majority of the outstanding voting securities of the Fund, as
defined in the 1940 Act, which includes the holders of the Common Shares and
preferred shares of the Fund voting together as a single class (including the
holders of the Preferred Shares), and the holders of the outstanding preferred
shares (including the holders of the Preferred Shares) voting as a single class.
The remainder of the Fund's investment policies, including its investment
strategy, are considered non-fundamental and may be changed by the Board of
Trustees without shareholder approval, provided that shareholders receive at
least 60 days' prior written notice of any such change adopted by the Board of
Trustees. As defined in the 1940 Act, when used with respect to particular
shares of the Fund, a "majority of the outstanding" voting securities means (i)
67% or more of the shares present at a meeting, if the holders of more than 50%
of the shares are present or represented by proxy, or (ii) more than 50% of the
shares, whichever is less.
INVESTMENT PHILOSOPHY AND PROCESS
Gallatin employs a value-oriented management style with the goal of
buying companies at bargain prices. By doing so, Gallatin hopes to enhance
long-term total return while seeking to limit downside risk. Gallatin's
definition of an attractive company is one that is characterized by the
following attributes: (i) possesses sustainable competitive advantages that
allow for pricing flexibility; (ii) typically generates cash flow beyond what is
needed to maintain solid performance; and (iii) is led by senior managers who
effectively allocate corporate capital to the benefit of shareholders.
Gallatin's equity investment philosophy emphasizes stock selection over
macroeconomic and market factors. This stock selection is based first on
intensive corporate analysis to identify those companies with characteristics
that typically produce outstanding long-term return on invested capital. Those
characteristics include competitive advantage within the markets they serve,
free cash flow generation, and management ability to allocate capital for the
benefit of shareholders. The second phase of the process is to identify those
stock price levels which will allow for companies identified in the first phase
of analysis to produce attractive returns to equity investors. These price
levels are derived from a number of valuation techniques, chief of which is
private market value analysis, including sum-of-the-parts analysis. Private
- 48 -
market values are determined by analysis of transactions involving comparable
companies, utilizing the metrics common to that industry.
Those companies which meet the investment criteria of both phases are
candidates for inclusion in the Fund's portfolio. Stocks are sold when
significant changes are identified within the two primary phases of analysis:
corporate attributes and valuations. A meaningful deterioration in the key
attributes described above or a meaningful increase in the stock price relative
to key metrics are likely to result in a stock's sale.
Specialty finance and other financial companies of the type
contemplated for investment by the Fund (e.g., BDCs) generally do not build
competitive advantages in the classic sense, inasmuch as their business activity
consists not in selling products or services to customers, but in identifying
attractive investment opportunities. Thus, Gallatin's analysis of the corporate
attributes of these companies depends more on the evaluation of the investment
and capital allocation acumen of management than ordinarily might be the case
with operating companies.
PORTFOLIO COMPOSITION
The Fund's portfolio will be composed principally of the following
investments. A more detailed description of the Fund's investment policies and
restrictions and more detailed information about the Fund's portfolio
investments are contained in the SAI.
Under normal market conditions, the Fund will seek to achieve its
investment objectives by investing at least 80% of its Managed Assets in a
portfolio of securities of specialty finance and other financial companies that
the Sub-Adviser believes offer attractive opportunities for income and capital
appreciation. Under normal market conditions, the Fund will invest at least 25%
of its total assets in securities of companies within industries in the
financial sector. The concentration of the Fund's assets in a group of
industries is likely to present more risks than a fund that is broadly
diversified over several industries or groups of industries.
Specialty Finance Companies. Specialty finance companies provide
capital or financing to businesses and consumers within specified market
segments. These companies are distinguished by their market specializations
which allow them to focus on the specific financial needs of their clients.
Specialty finance companies often engage in asset-based and other forms of
non-traditional financing activities. While they generally compete against
financial companies with broad product lines and, often, greater financial
resources, specialty finance companies seek competitive advantage by focusing
their attention on market niches, which may provide them with deeper knowledge
of their target market and its needs. Specialty finance companies include
mortgage specialists to certain consumers, equipment leasing specialists to
certain industries and equity or debt-capital providers to certain small
businesses. Specialty finance companies often utilize tax-efficient or other
non-traditional structures, such as BDCs and REITs. The Fund is not limited with
respect to its investments in securities issued by specific categories of
specialty finance and other financial companies. However, based on current
market conditions and assumptions, the Sub-Adviser currently anticipates that
investments in BDCs and REITs will each initially represent approximately 25% to
- 49 -
50% of the Fund's Managed Assets. These percentages are expected to vary over
time as market conditions change.
Business Development Companies. BDCs are a type of closed-end fund
regulated under the 1940 Act, whose shares are typically listed for trading on a
U.S. securities exchange. BDCs are publicly-traded funds that typically invest
in and lend to small and medium-sized private and certain public companies that
may not have access to public equity markets for capital raising. BDCs invest in
such diverse industries as healthcare, chemical and manufacturing, technology
and service companies. BDCs are unique in that at least 70% of their investments
must be made in private U.S. businesses, and BDCs are required to make available
significant managerial assistance to their portfolio companies. Unlike
corporations, BDCs are not taxed on income distributed to their shareholders
provided they comply with the applicable requirements of the Internal Revenue
Code. BDCs, which are required to distribute substantially all of their income
to investors in order to not be subject to entity level taxation, often offer a
yield advantage over other types of securities. The Fund intends to invest
primarily in BDC shares which are trading in the secondary market on a U.S.
securities exchange but may, in certain circumstances, invest in an initial
public offering of BDC shares or invest in certain debt instruments issued by
BDCs. The Fund will indirectly bear its proportionate share of any management
and other expenses, and of any performance based or incentive fees, charged by
the BDCs in which it invests, in addition to the expenses paid by the Fund.
REITs and Other Mortgage-Related and Asset-Backed Securities. REITs are
financial vehicles that pool investors' capital to invest primarily in
income-producing real estate or real estate-related loans or interests. REIT
shares are typically listed for trading in the secondary market on a U.S.
securities exchange. REITs can generally be classified as "Mortgage REITs,"
"Equity REITs" and "Hybrid REITs." Mortgage REITs, which invest the majority of
their assets in real estate mortgages, derive their income primarily from
interest payments. The Fund intends to focus its Mortgage REIT investments in
companies that invest primarily in prime-rated and commercial mortgage
securities. Equity REITs, which invest the majority of their assets directly in
real property, derive their income primarily from rents, royalties and lease
payments. Equity REITs can also realize capital gains by selling properties that
have appreciated in value. Some REITs which are classified as Equity REITs
provide specialized financing solutions to their clients in the form of
sale-lease back transactions and triple net lease financing. Hybrid REITs
combine the characteristics of both Equity REITs and Mortgage REITs. Debt
securities issued by REITs are, for the most part, general and unsecured
obligations and are subject generally to risks associated with REITs.
Distributions received by the Fund from REITs may consist of dividends, capital
gains and/or return of capital. REITs are not taxed on income distributed to
their shareholders provided they comply with the applicable requirements of the
Internal Revenue Code. REITs, which are required to distribute substantially all
of their income to investors in order to not be subject to entity level
taxation, often offer a yield advantage over other types of securities. Many of
these distributions, however, will not generally qualify for favorable treatment
as qualified dividend income. The Fund is not limited with respect to the
specific types of REITs in which it invests and intends to invest primarily in
REIT shares which are trading in the secondary market on a U.S. securities
exchange but may, in certain circumstances, invest in an initial public offering
of REIT shares or invest in certain debt instruments issued by REITs. The Fund
will indirectly bear its proportionate share of any management and other
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operating expenses charged by the REITs in which it invests, in addition to the
expenses paid by the Fund. Other mortgage-related securities in which the Fund
may invest include debt instruments which provide periodic payments consisting
of interest and/or principal that are derived from or related to payments of
interest and/or principal on underlying mortgages. Additional payments on
mortgage-related securities may be made out of unscheduled prepayments of
principal resulting from the sale of the underlying property or from refinancing
or foreclosure, net of fees or costs that may be incurred.
The Fund may invest in commercial mortgage-related securities issued by
corporations. These are securities that represent an interest in, or are secured
by, mortgage loans secured by commercial property, such as industrial and
warehouse properties, office buildings, retail space and shopping malls,
multifamily properties and cooperative apartments, hotels and motels, nursing
homes, hospitals, and senior living centers. They may pay fixed or adjustable
rates of interest. The commercial mortgage loans that underlie commercial
mortgage-related securities have certain distinct risk characteristics.
Commercial mortgage loans generally lack standardized terms, which may
complicate their structure. Commercial properties themselves tend to be unique
and difficult to value. Commercial mortgage loans tend to have shorter
maturities than residential mortgage loans, and may not be fully amortizing,
meaning that they may have a significant principal balance, or "balloon"
payment, due on maturity. In addition, commercial properties, particularly
industrial and warehouse properties, are subject to environmental risks and the
burdens and costs of compliance with environmental laws and regulations.
Other mortgage-related securities in which the Fund may invest include
mortgage pass-through securities, collateralized mortgage obligations ("CMOs"),
mortgage dollar rolls, CMO residuals (other than residual interests in real
estate mortgage investment conduits), stripped mortgage-backed securities
("SMBSs") and other securities that directly or indirectly represent a
participation in, or are secured by and payable from, mortgage loans on real
property.
The Fund may invest in other types of asset-backed securities that are
offered in the marketplace. Other asset-backed securities may be collateralized
by the fees earned by service providers. The value of asset-backed securities
may be substantially dependent on the servicing of the underlying asset pools
and are therefore subject to risks associated with the negligence of, or
defalcation by, their servicers. In certain circumstances, the mishandling of
related documentation may also affect the rights of the security holders in and
to the underlying collateral. The insolvency of entities that generate
receivables or that utilize the underlying assets may result in added costs and
delays in addition to losses associated with a decline in the value of the
underlying assets.
Financial Companies. The principal industry groups of financial
companies include banks, savings institutions, brokerage firms, investment
management companies, insurance companies, holding companies of the foregoing,
and companies that provide related services to such companies. Banks and savings
institutions provide services to customers such as demand, savings and time
deposit accounts and a variety of lending and related services. Brokerage firms
provide services to customers in connection with the purchase and sale of
securities. Investment management companies provide investment advisory and
related services to retail customers, high net-worth individuals and
- 51 -
institutions. Insurance companies provide a wide range of commercial, life,
health, disability, personal property and casualty insurance products and
services to businesses, governmental units, associations and individuals.
PORTFOLIO CONTENTS
Equity Securities. Equity securities in which the Fund may invest
include, but are not limited to, common stocks, preferred stocks and convertible
preferred securities. Such securities may include common stocks of REITs and
utilities that either are required to and/or customarily distribute a large
percentage of their current earnings as dividends. Common stock represents an
equity ownership interest in a corporation, providing voting rights and
entitling the holder to a share of the company's success through dividends
and/or capital appreciation. In the event of liquidation, common stockholders
have rights to a company's remaining assets after bond holders, other debt
holders, and preferred stockholders have been paid in full. Typically, common
stockholders are entitled to one vote per share to elect the company's board of
directors (although the number of votes is not always directly proportional to
the number of shares owned). Common stockholders also receive voting rights
regarding other company matters such as mergers and certain important company
policies, such as issuing securities to management. In addition to voting
rights, common stockholders sometimes enjoy what are called "preemptive rights."
Preemptive rights allow common stockholders to maintain their proportional
ownership in the company in the event that the company issues another offering
of stock. This means that common stockholders with preemptive rights have the
right but not the obligation to purchase as many new shares of the stock as it
would take to maintain their proportional ownership in the company.
Preferred Stock. Preferred stock represents an equity ownership
interest in a corporation, but generally entitles the holder to receive, in
preference to the holders of other stocks such as common stocks, dividends and a
fixed share of the proceeds resulting from liquidation of the company. Some
preferred stock also entitles their holders to receive additional liquidation
proceeds on the same basis as holders of a company's common stock. Some
preferred stock offers a fixed rate of return with no maturity date. Because
those preferred stocks never mature, they act like long-term bonds, can be more
volatile than other types of preferred stock and may have heightened sensitivity
to changes in interest rates. Other preferred stock has a variable dividend,
generally determined on a quarterly or other periodic basis, either according to
a formula based upon a specified premium or discount to the yield on particular
U.S. Treasury securities or based on an auction process, involving bids
submitted by holders and prospective purchasers of such stocks. Because
preferred stock represents an equity ownership interest in a company, its value
usually will react more strongly than bonds and other debt instruments to actual
or perceived changes in a company's financial condition or prospects or to
fluctuations in the equity markets. Preferred stockholders generally have no
voting rights or their voting rights are limited to certain extraordinary
transactions or events. Certain of the preferred stocks in which the Fund may
invest may be convertible preferred stocks, which have characteristics similar
to convertible securities as described below in "Portfolio Contents--Convertible
Securities."
- 52 -
Trust Preferred Securities. Trust preferred securities are limited-life
preferred securities that are typically issued by corporations, generally in the
form of interest-bearing notes or preferred securities issued by an affiliated
business trust of a corporation whose only assets are generally in the form of
beneficial interests in subordinated debentures issued by the corporation, or
similarly structured securities. The maturity and dividend rate of the trust
preferred securities are structured to match the maturity and coupon interest
rate of the underlying subordinated debentures owned by the affiliated trust.
Trust preferred securities usually mature on the stated maturity date of the
subordinated debentures and may be redeemed or liquidated prior to the stated
maturity date of such instruments for any reason on or after their stated call
date or upon the occurrence of certain extraordinary circumstances at any time.
Distributions from trust preferred securities will not generally qualify for
favorable treatment as qualified dividend income.
Convertible Securities. Convertible securities include bonds,
debentures, notes, preferred stocks and other securities that entitle the holder
to acquire common stock or other equity securities of the same or a different
issuer. Convertible securities have general characteristics similar to both debt
and equity securities. A convertible security generally entitles the holder to
receive interest or preferred dividends paid or accrued until the convertible
security matures or is redeemed, converted or exchanged. Before conversion,
convertible securities have characteristics similar to non-convertible debt
obligations. Convertible securities rank senior to common stock in a
corporation's capital structure and, therefore, generally entail less risk than
the corporation's common stock, although the extent to which such risk is
reduced depends in large measure upon the degree to which the convertible
security sells above its value as a debt obligation. A convertible security may
be subject to redemption at the option of the issuer at a predetermined price.
If a convertible security held by the Fund is called for redemption, the Fund
would be required to permit the issuer to redeem the security and convert it to
underlying common stock, or would sell the convertible security to a third
party, which may have an adverse effect on the Fund's ability to achieve its
investment objectives. The price of a convertible security often reflects
variations in the price of the underlying common stock in a way that
non-convertible debt may not. The value of a convertible security is a function
of: (i) its yield in comparison to the yields of other securities of comparable
maturity and quality that do not have a conversion privilege; and (ii) its worth
if converted into the underlying common stock.
Infrastructure Trust Interests. Infrastructure trusts are statutory
trusts structured to own operating companies which own infrastructure assets.
Infrastructure trusts are typically classified as grantor trusts for U.S.
federal income tax purposes and, as such, are not taxed at the trust level.
Infrastructure trusts, which are required to distribute substantially all of
their income to investors in order to not be subject to entity level taxation,
often offer a yield advantage over other types of securities. Investors in
infrastructure trusts will generally be treated as the beneficial owner of a pro
rata portion of the interests of the operating companies held by the
infrastructure trusts. Beneficial owners of shares of an infrastructure trust
will be required to take into account their allocable share of the trust's
income, gain, loss, deduction and other items for U.S. federal income tax
purposes. Infrastructure assets can be broadly divided into four categories: (i)
assets that are natural or near-natural monopolies and are regulated in the
level of revenue earned or charges imposed, and include certain power and gas
transmission, generation and distribution assets, as well as certain
water/waste-water treatment facilities and incumbent local exchange carriers;
- 53 -
(ii) assets that depend on a form of user pay system for their main revenue
source (e.g., toll roads, airports, railways, ports and certain parking lots);
(iii) assets that provide basic social services to the community (e.g., schools,
hospitals and correction facilities); and (iv) assets that compete in a market
for the sale of a product or service and are therefore exposed to market risks
(e.g., electricity generation facilities, solid waste disposal facilities, city
and local carparks, and certain communication asset classes).
Income Trust Interests. Income trusts in which the Fund may invest are
generally equity investments and include investment trusts, royalty/energy
trusts, and business trusts. These trusts typically earn income through the
acquisition of equity and debt instruments, royalty interest or real properties.
An income trust can receive interest, royalty or lease payments from an
operating entity carrying on a business, as well as dividends and a return of
capital. The income is passed on to investors through monthly or quarterly
distributions. Income trusts are generally structured to own debt and equity of
an underlying entity that carries on an active business (typically natural
resource or energy related), or a royalty in revenues generated by the assets
thereof. The income trust structure was developed to facilitate distributions to
investors on a tax-efficient basis. The projected life of distributions and the
sustainability of distribution levels tend to vary with the nature of the
business underlying an income trust. The variety of businesses upon which income
trusts have been created is broad, both in the nature of the underlying industry
and assets and in geographic location.
o U.S. Royalty Trusts. Income trusts in the United States,
typically referred to as "U.S. royalty trusts," passively manage net
working interests and royalties in mature oil and gas producing
properties in the United States. Unit holders generally receive most of
the cash flows from these investments in the form of distributions. The
U.S. royalty trusts do not acquire new properties, operate the existing
properties within the trust, hedge production, or issue new equity or
debt.
o Canadian Income Trusts. Income trusts in Canada, typically
referred to as Canadian oil and gas trusts or "Canadian income trusts,"
engage in the acquisition, development and production of natural gas
and crude oil. These trusts generally seek to establish, maintain or
expand their reserves through development drilling activities and/or
acquisitions of producing companies or proven oil and gas reserves.
Such investments and acquisitions are funded through internally
generated cash-flow, the issuance of debt and additional equity.
Successfully replacing reserves enables Canadian income trusts to
offset natural production declines and maintain cash distribution
levels. Unlike oil and gas exploration and production companies,
Canadian income trusts generally do not engage in exploration
activities that require substantial capital expenditures and carry a
greater risk of drilling unproductive wells, or dry holes. To mitigate
commodity price risks, many Canadian income trusts regularly engage in
oil and gas hedging strategies. Under current Canadian tax laws, a
Canadian income trust generally can reduce its taxable income to zero
by paying (or making payable) all of its taxable income (including net
realized capital gains) to unit holders, thus avoiding a layer of
taxation associated with corporate entities.
- 54 -
Master Limited Partnership Interests. MLPs are limited partnerships or
limited liability companies that are taxed as partnerships and whose interests
(limited partnership units or limited liability company units) are traded on
securities exchanges like shares of common stock. An MLP consists of a general
partner and limited partners. The general partner manages the partnership, has
an ownership stake in the partnership and is eligible to receive an incentive
distribution. The limited partners provide capital to the partnership, have a
limited (if any) role in the operation and management of the partnership and
receive cash distributions. MLPs, which are required to distribute substantially
all of their income to investors in order to not be subject to entity level
taxation, often offer a yield advantage over other types of securities.
Currently, most MLPs operate in the energy, natural resources or real estate
sectors. The Fund will not invest more than 20% of its Managed Assets in MLPs.
Investment Grade Debt Securities. The Fund may invest in investment
grade bonds of varying maturities issued by governments, corporations and other
business entities. Bonds are fixed or variable rate debt obligations, including
bills, notes, debentures, money market instruments and similar instruments and
securities. Bonds generally are used by corporations as well as by governments
and other issuers to borrow money from investors. The issuer pays the investor a
fixed or variable rate of interest and normally must repay the amount borrowed
on or before maturity. Certain bonds are "perpetual" in that they have no
maturity date.
Non-Investment Grade Debt Securities. The Fund may invest in fixed
income securities of below-investment grade quality. Generally, such lower
quality debt securities offer a higher current yield than is offered by higher
quality debt securities, but also (i) will likely have some quality and
protective characteristics that, in the judgment of the rating agencies, are
outweighed by large uncertainties or major risk exposures to adverse conditions
and (ii) are predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal in accordance with the terms of the obligation.
Foreign Securities. The Fund may invest a significant portion of its
Managed Assets in securities of foreign issuers, including income trusts. The
Fund's investments in foreign issuers may include investments in equity and/or
fixed-income securities of such issuers. Foreign securities include securities
issued or guaranteed by companies organized under the laws of countries other
than the United States, securities issued or guaranteed by foreign national,
provincial, state, municipal or other governments with taxing authority or by
their agencies or instrumentalities and debt obligations of supra-national
governmental entities such as the World Bank or European Union. These securities
may be U.S. dollar-denominated or non-U.S. dollar-denominated. Foreign
securities also include U.S. dollar-denominated debt obligations, such as
"Yankee Dollar" obligations, of foreign issuers and of supranational government
entities. Yankee Dollar obligations are U.S. dollar-denominated obligations
issued in the U.S. capital markets by foreign corporations, banks and
governments. Foreign securities also may be traded on foreign securities
exchanges or in over-the-counter capital markets.
The Fund's investment in foreign issuers may include investments in
ADRs, GDRs or EDRs or other depositary receipts. Such depositary receipts
represent common stock deposited with a custodian in a depositary. They are
issued by a bank or a trust company to evidence ownership of underlying
- 55 -
securities issued by a foreign corporation. These instruments may not
necessarily be denominated in the same currency as the securities into which
they may be converted.
Mortgage-Backed Securities. Mortgage-backed securities represent direct
or indirect participations in, or are secured by and payable from, mortgage
loans secured by real property and include single- and multi-class pass-through
securities and collateralized mortgage obligations. U.S. government
mortgage-backed securities include mortgage-backed securities issued or
guaranteed as to the payment of principal and interest (but not as to market
value) by the Government National Mortgage Association (also known as Ginnie
Mae), the Federal National Mortgage Association (also known as Fannie Mae), the
Federal Home Loan Mortgage Corporation (also known as Freddie Mac) or other
government-sponsored enterprises. Other mortgage-backed securities are issued by
private issuers. Private issuers are generally originators of and investors in
mortgage loans, including savings associations, mortgage bankers, commercial
banks, investment bankers and special purpose entities. Payments of principal
and interest (but not the market value) of such private mortgage-backed
securities may be supported by pools of mortgage loans or other mortgage-backed
securities that are guaranteed, directly or indirectly, by the U.S. government
or one of its agencies or instrumentalities, or they may be issued without any
government guarantee of the underlying mortgage assets but with some form of
non-government credit enhancement.
Non-governmental mortgage-backed securities may offer higher yields
than those issued by government entities, but may also be subject to greater
price changes than governmental issues.
Some mortgage-backed securities, such as collateralized mortgage
obligations, make payments of both principal and interest at a variety of
intervals; others make semi-annual interest payments at a predetermined rate and
repay principal at maturity (like a typical bond). Stripped mortgage-backed
securities are created when the interest and principal components of a
mortgage-backed security are separated and sold as individual securities. In the
case of a stripped mortgage-backed security, the holder of the principal-only,
or "PO," security receives the principal payments made by the underlying
mortgage, while the holder of the interest-only, or "IO," security receives
interest payments from the same underlying mortgage.
Mortgage-backed securities are based on different types of mortgages
including those on commercial real estate or residential properties. These
securities often have stated maturities of up to thirty years when they are
issued, depending upon the length of the mortgages underlying the securities. In
practice, however, unscheduled or early payments of principal and interest on
the underlying mortgages may make the securities' effective maturity shorter
than this, and the prevailing interest rates may be higher or lower than the
current yield of the Fund's portfolio at the time the Fund receives the
pre-payments for reinvestment.
Residential mortgage-backed securities represent direct or indirect
participations in, or are secured by and payable from, pools of assets which
include all types of residential mortgage products.
- 56 -
Asset-Backed Securities. Asset-backed securities represent direct or
indirect participations in, or are secured by and payable from, pools of assets
such as, among other things, motor vehicle installment sales contracts,
installment loan contracts, leases of various types of real and personal
property, and receivables from revolving credit (credit card) agreements or a
combination of the foregoing. These assets are securitized through the use of
trusts and special purpose corporations. Credit enhancements, such as various
forms of cash collateral accounts or letters of credit, may support payments of
principal and interest on asset-backed securities. Although these securities may
be supported by letters of credit or other credit enhancements, payment of
interest and principal ultimately depends upon individuals paying the underlying
loans or accounts, which payment may be adversely affected by general downturns
in the economy. Asset-backed securities are subject to the same risk of
prepayment described above with respect to mortgage-backed securities. The risk
that recovery on repossessed collateral might be unavailable or inadequate to
support payments, however, is greater for asset-backed securities than for
mortgage-backed securities.
Loans. The Fund may invest a portion of its assets in loan
participations and other direct claims against a borrower. The Sub-Adviser
believes corporate loans to be high-yield debt instruments if the issuer has
outstanding debt securities rated below-investment grade or has no rated
securities. The corporate loans in which the Fund may invest primarily consist
of direct obligations of a borrower and may include debtor-in-possession
financings pursuant to Chapter 11 of the U.S. Bankruptcy Code, obligations of a
borrower issued in connection with a restructuring pursuant to Chapter 11 of the
U.S. Bankruptcy Code (a "bankruptcy reorganization proceeding"), leveraged
buy-out loans, leveraged recapitalization loans, receivables purchase
facilities, and privately placed notes. The Fund may invest in a corporate loan
at origination as a co-lender or by acquiring in the secondary market
participations in, assignments of or novations of a corporate loan. By
purchasing a participation, the Fund acquires some or all of the interest of a
bank or other lending institution in a loan to a corporate or government
borrower. The participations typically will result in the Fund having a
contractual relationship only with the lender, not the borrower. The Fund will
have the right to receive payments of principal, interest and any fees to which
it is entitled only from the lender selling the participation and only upon
receipt by the lender of the payments from the borrower. Many such loans are
secured, although some may be unsecured. Such loans may be in default at the
time of purchase. Loans that are fully secured offer the Fund more protection
than an unsecured loan in the event of non-payment of scheduled interest or
principal. However, there is no assurance that the liquidation of collateral
from a secured loan would satisfy the corporate borrower's obligation, or that
the collateral can be liquidated. Direct debt instruments may involve a risk of
loss in case of default or insolvency of the borrower and may offer less legal
protection to the Fund in the event of fraud or misrepresentation. In addition,
loan participations involve a risk of insolvency of the lending bank or other
financial intermediary. The markets in loans are not regulated by federal
securities laws or the Securities and Exchange Commission.
As in the case of other high-yield investments, such corporate loans
may be rated in the lower rating categories of the established rating services
(such as "Baa3" or lower by Moody's or "BBB-" or lower by S&P), or may be
unrated investments determined to be of comparable quality by the Sub-Adviser.
As in the case of other high-yield investments, such corporate loans can be
expected to provide higher yields than lower yielding, higher rated fixed income
- 57 -
securities, but may be subject to greater risk of loss of principal and income.
There are, however, some significant differences between corporate loans and
high-yield bonds. Corporate loan obligations are frequently secured by pledges
of liens and security interests in the assets of the borrower, and the holders
of corporate loans are frequently the beneficiaries of debt service
subordination provisions imposed on the borrower's bondholders. These
arrangements are designed to give corporate loan investors preferential
treatment over high-yield investors in the event of deterioration in the credit
quality of the issuer. Even when these arrangements exist, however, there can be
no assurance that the borrowers of the corporate loans will repay principal
and/or pay interest in full. Corporate loans generally bear interest at rates
set at a margin above a generally recognized base lending rate that may
fluctuate on a day-to-day basis, in the case of the prime rate of a U.S. bank,
or which may be adjusted on set dates, typically 30 days but generally not more
than one year, in the case of the London Interbank Offered Rate ("LIBOR").
Consequently, the value of corporate loans held by the Fund may be expected to
fluctuate significantly less than the value of other fixed rate high-yield
instruments as a result of changes in the interest rate environment; however,
the secondary dealer market for certain corporate loans may not be as well
developed as the secondary dealer market for high-yield bonds and, therefore,
presents increased market risk relating to liquidity and pricing concerns.
Distressed Securities. The Fund may invest up to 10% of its Managed
Assets in distressed securities. Distressed securities are securities issued by
a company in a bankruptcy reorganization proceeding; subject to some other form
of public or private debt restructuring; otherwise in default or in significant
risk of being in default as to the payment of interest or repayment of
principal; or trading at prices substantially below other below-investment grade
debt securities of companies in similar industries. These are securities
generally rated in the lower rating categories ("Ca" or lower by Moody's or "CC"
or lower by S&P) or, if unrated, are determined to be of comparable quality by
the Sub-Adviser. Distressed securities frequently do not produce current income.
Although distressed securities are particularly speculative investments, the
Sub-Adviser believes they provide the opportunity for enhanced income and/or
capital appreciation.
Collateralized Debt Obligations. A collateralized debt obligation
("CDO") is an asset-backed security whose underlying collateral is typically a
portfolio of bonds, bank loans, other structured finance securities and/or
synthetic instruments. Where the underlying collateral is a portfolio of bonds,
a CDO is referred to as a collateralized bond obligation ("CBO"). Where the
underlying collateral is a portfolio of bank loans, a CDO is referred to as a
collateralized loan obligation ("CLO"). CDOs may also be backed by a pool of
credit derivatives, including credit default swaps, forward contracts and
options. Investors in CDOs bear the credit risk of the underlying collateral.
Multiple tranches of securities are generally issued by CDOs, offering investors
various maturity and credit risk characteristics. Tranches are categorized as
senior, mezzanine, and subordinated-equity, according to their degree of risk.
If there are defaults or a CDO's collateral otherwise underperforms, scheduled
payments to senior tranches take precedence over those of mezzanine or
subordinated-equity tranches, and scheduled payments to mezzanine tranches take
precedence over those to subordinated-equity tranches. CDOs are subject to the
same risk of prepayment described with respect to asset-backed and
mortgage-related securities described above.
- 58 -
Credit Default Swaps. The Fund may invest in credit default swap
transactions for hedging or investment purposes. The "buyer" in a credit default
contract is obligated to pay the "seller" a periodic stream of payments over the
term of the contract, provided that no event of default on an underlying
reference obligation has occurred. If an event of default occurs, the seller
must pay the buyer the full notional value, or "par value," of the reference
obligation. The Fund may be either the buyer or seller in a credit default swap
transaction. If the Fund is a buyer and no event of default occurs, the Fund
will have made a series of periodic payments and recover nothing of monetary
value. However, if an event of default occurs, the Fund (if the buyer) will
receive the full notional value of the reference obligation either through a
cash payment in exchange for the asset or a cash payment in addition to owning
the reference asset. As a seller, the Fund receives a fixed rate of income
throughout the term of the contract, which typically is between six months and
five years, provided that there is no event of default. The Fund currently
intends to segregate assets on the Fund's records in the form of cash, cash
equivalents or liquid securities in an amount equal to the full notional value
of the credit default swaps of which it is the seller. If such assets are not
fully segregated on the Fund's records by the Fund, the use of credit default
swap transactions could then be considered leverage. If an event of default
occurs, the seller must pay the buyer the full notional value of the reference
obligation through either physical settlement or cash settlement.
Illiquid and Restricted Securities. The Fund may invest in securities
that, at the time of investment, are illiquid (determined using the Securities
and Exchange Commission's standard applicable to investment companies, i.e.,
securities that cannot be disposed of by the Fund within seven days in the
ordinary course of business at approximately the amount at which the Fund has
valued the securities). Investments currently considered to be illiquid include,
among others, repurchase agreements not entitling the holder to repayment of
principal and payment of interest within seven days, non-government stripped
fixed-rate mortgage-backed securities, and over-the-counter options. In the
absence of readily available market quotations, a committee appointed by the
Fund's Board of Trustees will price illiquid investments at a fair value as
determined in good faith. Valuing illiquid securities typically requires greater
judgment than valuing securities for which there is an active trading market.
The market price of illiquid securities generally is more volatile than that of
more liquid securities, which may adversely affect the price that the Fund pays
for or recovers upon the sale of illiquid securities. Investment of the Fund's
assets in illiquid securities may restrict the Fund's ability to take advantage
of market opportunities. The risks associated with an investment in illiquid
securities may be particularly acute in situations in which the Fund's
operations require cash and could result in the Fund borrowing to meet its
short-term needs or incurring losses on the sale of illiquid securities.
The Fund may invest in restricted securities, which are securities that
may not be sold to the public without an effective registration statement under
the Securities Act. The restriction on public sale may make it more difficult to
value such securities, limit the Fund's ability to dispose of them and lower the
amount the Fund could realize upon their sale. Before they are registered,
restricted securities may be sold only in a privately negotiated transaction or
pursuant to an exemption from registration. In recognition of the increased size
and liquidity of the institutional market for unregistered securities and the
importance of institutional investors in the formation of capital, the
Securities and Exchange Commission has adopted Rule 144A under the Securities
Act. Rule 144A is designed to facilitate efficient trading among institutional
investors by permitting the sale of certain unregistered securities to qualified
institutional buyers. To the extent privately placed securities held by the Fund
qualify under Rule 144A and an institutional market develops for those
- 59 -
securities, the Fund likely will be able to dispose of any such securities
without registering them under the Securities Act. To the extent that
institutional buyers become, for a time, uninterested in purchasing these
securities, investing in Rule 144A securities could increase the level of the
Fund's illiquidity.
Other Securities. New financial products continue to be developed and
the Fund may invest in any products that may be developed to the extent
consistent with its investment objectives and the regulatory and federal tax
requirements applicable to investment companies.
Short-Term Debt Securities; Temporary Defensive Position; Invest-Up
Period. During the periods in which the net proceeds of the offerings of the
Common Shares and Preferred Shares are being invested, or during periods in
which the Adviser or Sub-Adviser determines that it is temporarily unable to
follow the Fund's investment strategy or that it is impractical to do so, the
Fund may deviate from its investment strategy and invest all or any portion of
its Managed Assets in cash or cash equivalents. The Adviser's or Sub-Adviser's
determination that it is temporarily unable to follow the Fund's investment
strategy or that it is impractical to do so will generally occur only in
situations in which a market disruption event has occurred and where trading in
the securities selected through application of the Fund's investment strategy is
extremely limited or absent. In such a case, the Fund may be adversely affected
and the Fund may not pursue or achieve its investment objectives. For a further
description of these temporary investments, see the SAI under "Investment
Policies and Techniques."
INVESTMENT PRACTICES
Strategic Transactions. The Fund may, but is not required to, use
various Strategic Transactions to seek to: (i) reduce interest rate risks
arising from any use of leverage; (ii) facilitate portfolio management; (iii)
mitigate risks, including interest rate, currency and credit risks; and/or (iv)
earn income. Strategic Transactions are generally accepted under modern
portfolio management theory and are regularly used by many mutual funds and
other institutional investors. Although the Sub-Adviser seeks to use such
practices to further the Fund's investment objectives, no assurance can be given
that the Sub-Adviser will engage in any of these practices or that these
practices will achieve the desired result.
The Fund may purchase and sell derivative instruments such as
exchange-listed and over-the-counter put and call options on securities,
currencies, equity, fixed-income, currency and/or interest rate indices and
other financial instruments, purchase and sell financial futures contracts and
options thereon and enter into various interest rate and currency transactions
such as swaps, caps, floors, collars or credit transactions, total rate of
return swap transactions, credit default swaps and other credit derivative
instruments. The Fund also may purchase derivative instruments that combine
features of these instruments. The Fund generally seeks to use Strategic
Transactions as a portfolio management or hedging technique to seek to protect
against possible adverse changes in the market value of securities held in or to
be purchased for the Fund's portfolio, protect the value of the Fund's
portfolio, facilitate the sale of certain securities for investment purposes,
manage the effective interest rate and currency exposure of the Fund, protect
- 60 -
against changes in currency exchange rates, manage the effective maturity or
duration of the Fund's portfolio or establish positions in the derivatives
markets as a substitute for purchasing or selling particular securities. The
Fund may use derivatives for non-hedging purposes to enhance potential gain.
Strategic Transactions have risks, including the imperfect correlation
between the value of such instruments and the underlying assets, the possible
default of the other party to the transactions or illiquidity of the derivative
investments. Furthermore, the ability to successfully use Strategic Transactions
depends on the Sub-Adviser's ability to predict pertinent market movements,
which cannot be assured. Thus, the use of Strategic Transactions may result in
losses greater than if they had not been used, may require the Fund to sell or
purchase portfolio securities at inopportune times or for prices other than
current market values, may limit the amount of appreciation the Fund can realize
on an investment, or may cause the Fund to hold a security that it might
otherwise sell. Additionally, amounts paid by the Fund as premiums and cash,
cash equivalents or other assets held in margin accounts with respect to
Strategic Transactions are not otherwise available to the Fund for investment
purposes. See "Risks-- Derivatives Risk" in this Prospectus and "Other
Investment Policies and Techniques" in the SAI for further information on
Strategic Transactions and their risks.
Lending of Portfolio Securities. To generate additional income, the
Fund may lend portfolio securities in an amount up to 33-1/3% of its Managed
Assets to broker-dealers, major banks or other recognized domestic institutional
borrows of securities. Any such loan must be continuously secured by collateral
in cash or cash equivalents maintained on a current basis in an amount at least
equal to the market value of the securities loaned by the Fund. The Fund would
continue to receive the equivalent of the interest or dividends paid by the
issuer on the securities loaned, and would also receive an additional return
that may be in the form of a fixed fee or a percentage of the collateral. The
Fund may pay reasonable fees to persons unaffiliated with the Fund for services
in arranging these loans. The Fund would have the right to call the loan and
obtain the securities loaned at any time on notice of not more than five
business days. The Fund would not have the right to vote the securities during
the existence of the loan but would call the loan to permit voting of the
securities, if, in the Sub-Adviser's judgment, a material event requiring a
stockholder vote would otherwise occur before the loan was repaid. In the event
of bankruptcy or other default of the borrower, the Fund could experience both
delays in liquidating the loan collateral or recovering the loaned securities
and/or incur losses, including possible decline in the value of the collateral
or in the value of the securities loaned during the period while the Fund seeks
to enforce its rights thereto, possible subnormal levels of income and lack of
access to income during this period and expenses of enforcing its rights. As
with other extensions of credit, there are risks of delay in the recovery or
even loss of rights in the collateral should a borrower default or fail
financially. The Fund intends to engage in lending portfolio securities only
when such lending is fully secured by investment grade collateral held by an
independent agent.
Portfolio Turnover. The Fund's annual portfolio turnover rate may vary
greatly from year to year. Although the Fund cannot accurately predict its
annual portfolio turnover rate, it is not expected to exceed 50% under normal
circumstances. Portfolio turnover rate is not considered a limiting factor in
the execution of investment decisions for the Fund. There are no limits on the
- 61 -
rate of portfolio turnover, and investments may be sold without regard to length
of time held when the Fund's investment strategy so dictates. A higher portfolio
turnover rate results in correspondingly greater brokerage commissions and other
transactional expenses that are borne by the Fund. High portfolio turnover may
result in the realization of net short-term capital gains by the Fund. See
"Federal Tax Matters."
DESCRIPTION OF PREFERRED SHARES
The following is a brief description of the terms of the Preferred
Shares. This description does not purport to be complete and is subject to and
qualified in its entirety by reference to the more detailed description of the
Preferred Shares in the Statement of Terms, which is attached as Appendix C to
the SAI. Capitalized terms not otherwise defined in this description shall have
the meaning as defined in the Statement of Terms.
GENERAL
The Fund's Declaration of Trust authorizes the issuance of an unlimited
number of preferred shares, in one or more series, with rights as determined by
the Board of Trustees. Such shares may be issued by action of the Board of
Trustees without shareholder approval. The Board of Trustees has classified
_____ shares of beneficial interest as Series __ Preferred Shares and ____
shares of beneficial interest as Series ____ Preferred Shares, and has
authorized the issuance of those Preferred Shares. If the assets of the Fund
increase, the Fund may offer additional preferred shares to maintain the
leverage ratio of the Fund.
The Preferred Shares will have a liquidation preference of $25,000 per
share plus an amount equal to accumulated but unpaid distributions (whether or
not earned or declared). Preferred Shares will rank on parity with shares of any
other class or series of preferred stock of the Fund as to the payment of
periodic dividends or distributions, including distribution of assets upon
liquidation. All Preferred Shares carry one vote per share on all matters on
which such shares are entitled to be voted. Preferred Shares will, when issued,
be fully paid and non-assessable and have no preemptive, exchange, conversion or
cumulative voting rights.
Holders of Preferred Shares will not receive certificates representing
their ownership interest in such shares. DTC will initially act as Securities
Depository with respect to the Preferred Shares. Distributions will be paid
through DTC on each Distribution Payment Date. The Distribution Payment Date
will normally be the first business day after the Rate Period ends. DTC, in
accordance with its current procedures, is expected to distribute amounts
received from the Auction Agent in same-day funds on each Distribution Payment
Date to Agent Members (members of DTC that will act on behalf of existing or
potential Preferred Shareholders) ("Agent Members"). These Agent Members are in
turn expected to pay these distributions to the persons for whom they are acting
as agents. The current Broker-Dealer has indicated that distribution payments
will be available in same-day funds on each Distribution Payment Date to
customers that use a Broker-Dealer or a Broker-Dealer's designee as Agent
Member.
- 62 -
Except in an auction, the Fund will have the right (to the extent
permitted by applicable law) to purchase or otherwise acquire any of the
Preferred Shares, so long as the Fund is current in the payment of distributions
on the Preferred Shares and on any other shares ranking on a parity with the
Preferred Shares with respect to the payment of distributions or upon
liquidation.
DISTRIBUTIONS AND RATE PERIODS
General. Holders of Preferred Shares will be entitled to receive cash
distributions, when, as and if authorized by the Board of Trustees and declared
by the Fund, out of funds legally available therefor, on the initial
Distribution Payment Date with respect to the initial Rate Period for such
series and, thereafter, on each Distribution Payment Date with respect to a
subsequent Rate Period (generally a period of seven days for the Series ___
Preferred Shares and 28 days for the Series ___ Preferred Shares, subject to
certain exceptions) at the rate per annum equal to the Applicable Rate for each
Rate Period. Distributions so declared and payable shall be paid in accordance
with the Declaration of Trust, By-Laws and Statement of Terms, to the extent
permitted under applicable law and to the extent available and in preference to
and priority over any distribution declared and payable on the Common Shares.
Distributions shall be treated for federal income tax purposes as payable from
the Fund's earnings and profits allocable to the Preferred Shares.
On the Business Day next preceding each Distribution Payment Date, the
Fund is required to deposit with the Paying Agent sufficient funds for the
payment of distributions. The Fund does not intend to establish any reserves for
the payment of distributions. All moneys paid to the Paying Agent for the
payment of distributions will be held in trust for the payment of such
distributions to each Holder. Each distribution will be paid by the Paying Agent
to the Holder as its name appears on the Fund's share ledger or share records,
which Holder(s) is expected to be the nominee of the Securities Depository. The
Securities Depository will credit the accounts of the Agent Members of the
Beneficial Owners in accordance with the Securities Depository's normal
procedures. The Securities Depository's current procedures provide for it to
distribute distributions in same-day funds to Agent Members who are in turn
expected to distribute such distributions to the persons for whom they are
acting as agents. The Agent Member of a Beneficial Owner will be responsible for
holding or disbursing such payments on the applicable Distribution Payment Date
to such Distributions Owner in accordance with the instructions of such
Beneficial Owner.
Distributions in arrears for any past Rate Period may be declared and
paid at any time, without reference to any regular Distribution Payment Date, to
the Holder(s) as its name appears on the Fund's share ledger or share records on
such date, not exceeding 15 days preceding the payment date thereof, as may be
fixed by the Board of Trustees. Any distribution payment shall first be credited
against the earliest accumulated but unpaid distributions. No interest will be
payable in respect of any distribution payment or payments which may be in
arrears. See ODefault PeriodO below.
The amount of distributions per share payable (if declared) on each
Distribution Payment Date of each Rate Period (or in respect of distributions on
another date in connection with a redemption during such Rate Period) will be
computed by multiplying the Applicable Rate (or the Default Rate) for such Rate
- 63 -
Period (or a portion thereof) by a fraction, the numerator of which will be the
number of days in such Rate Period (or portion thereof) that such share was
outstanding and for which the Applicable Rate or the Default Rate was applicable
and the denominator of which will be 360, multiplying the amount so obtained by
$25,000 per share, and rounding the amount so obtained to the nearest cent.
Determination of Distribution Rate. The distribution rate for the
initial Rate Period (i.e., the period from and including the Original Issue Date
to and including the initial Auction Date) and the initial Distribution Payment
Date for each series of Preferred Shares are set forth in the Summary section of
this Prospectus under the caption ODistributions and Rate Periods.O For each
subsequent Rate Period, subject to certain exceptions, the distribution rate
will be the Applicable Rate that the Auction Agent advises the Fund has resulted
from an auction.
The initial Rate Period for the Series ___ Preferred Shares will be
____ days and for the Series ___ Preferred Shares will be ____ days. After the
initial Rate Period, each subsequent Rate Period for each series of Preferred
Shares generally will be a seven day Rate Period in the case of Series ___
Preferred Shares and a 28 day Rate Period in the case of Series ___ Preferred
Shares (a seven day Rate Period with respect to the Series ___ Preferred Shares
and a 28 day Rate Period with respect to Series ___ Preferred Shares being
referred to herein as a OStandard Rate PeriodO); provided, however, that prior
to any auction, the Fund may elect, subject to certain limitations described
herein, upon giving notice to holders thereof, a Special Rate Period.
A Special Rate Period will not be effective unless, among other things,
Sufficient Clearing Bids exist at the auction held on the Auction Date
immediately preceding the first day of such Special Rate Period (that is, in
general, the number of shares subject to Buy Orders by Potential Holders is at
least equal to the number of shares subject to Sell Orders by Existing Holders).
Distributions will accumulate at the Applicable Rate from the Original
Issue Date and shall be payable on each subsequent Distribution Payment Date.
For Rate Periods of less than 30 days, Distribution Payment Dates shall occur on
the first Business Day following the last day of such Rate Period and, if
greater than 30 days, then on a monthly basis on the first Business Day of each
month within such Rate Period and on the Business Day following the last day of
such Rate Period. Distributions will be paid through the Securities Depository
on each Distribution Payment Date. Thus, following the initial Distribution
Payment Date for the Preferred Shares, distributions generally will be payable
(in the case of Rate Periods which are not Special Rate Periods) on each
succeeding ________ in the case of the Series ___ Preferred Shares, and fourth
_________ in the case of Series ___ Preferred Shares.
Except during a Default Period as described below, the Applicable Rate
resulting from an auction will not be greater than the Maximum Rate, which is
equal to the Applicable Percentage of the Reference Rate, subject to upward but
not downward adjustment in the discretion of the Board of Trustees after
consultation with the Broker-Dealers. The Applicable Percentage will be
determined based on the lower of the credit ratings assigned on that date to
that series of Preferred Shares by Moody's and Fitch, as follows:
- 64 -
MOODY'S FITCH APPLICABLE
CREDIT RATING CREDIT RATING PERCENTAGE
Aa3 or above AA- or above 200%
Aa3 to A1 A- to A+ 250%
Baa3 to Baa1 BBB- to BBB+ 275%
Below Baa3 Below BBB- 300%
The Reference Rate is the greater of (1) the applicable AA Composite
Commercial Paper Rate (for a Rate Period of fewer than 184 days) or the
applicable Treasury Index Rate (for a Rate Period of 184 days or more), or (2)
the applicable LIBOR. For Standard Rate Periods or shorter periods only, the
Applicable Rate resulting from an auction will not be less than the Minimum
Rate, which is 70% of the applicable AA Composite Commercial Paper Rate. No
Minimum Rate is specified for auctions with respect to Rate Periods of more than
the Standard Rate Period.
The Maximum Rate for each series of Preferred Shares will apply
automatically following an auction for such shares in which Sufficient Clearing
Bids have not been made (other than because all shares of Preferred Shares were
subject to Submitted Hold Orders). If an auction for any subsequent Rate Period
is not held for any reason, including because there is no Auction Agent or
Broker-Dealer, then the Applicable Rate on the Preferred Shares for any such
Rate Period shall be the Maximum Rate (except for circumstances in which the
Distribution Rate is the Default Rate, as described below).
The All Hold Rate will apply automatically following an auction in
which all of the outstanding Preferred Shares are subject to (or are deemed to
be subject to) Submitted Hold Orders. The All Hold Rate is 80% of the applicable
AA Composite Commercial Paper Rate.
Prior to each auction, the Broker-Dealers will notify Holders of the
term of the next succeeding Rate Period as soon as practicable after the
Broker-Dealers have been so advised by the Fund. After each auction, on the
Auction Date, the Broker-Dealers will notify Holders of the Applicable Rate for
the next succeeding Rate Period and of the Auction Date of the next succeeding
auction.
Designation of Rate Period. The Fund will designate the duration of
subsequent Rate Periods for each series of Preferred Shares; provided, however,
that no such designation is necessary for a Standard Rate Period and, provided
further, that any designation of a Special Rate Period shall be effective only
if (1) notice thereof shall have been given as provided herein, (2) any failure
to pay in the timely manner to the Auction Agent the full amount of any
distribution on, or the redemption price of, such series of Preferred Shares
shall have been cured as set forth under ODefault Period,O (3) Sufficient
Clearing Bids shall have existed in an auction held on the Auction Date
immediately preceding the first day of such proposed Special Rate Period, (4) if
the Fund shall have mailed a Notice of Redemption with respect to any Preferred
Shares, as described under ORedemptionO below, the Redemption Price with respect
to such Preferred Shares shall have been deposited with the Paying Agent, and
(5) the Fund has confirmed that, as of the Auction Date next preceding the first
day of such Special Rate Period, the Fund has Eligible Assets with an aggregate
- 65 -
Discounted Value at least equal to the Preferred Shares Basic Maintenance Amount
and the Fund has consulted with the Broker-Dealers and has provided notice of
such designation and otherwise complied with Rating Agency Guidelines.
Designation of a Special Rate Period. If the Fund proposes to designate
any Special Rate Period, not fewer than two (2) Business Days nor more than 30
Business Days prior to the first day of such Special Rate Period, notice shall
be (1) made by press release and (2) communicated by the Fund by telephonic or
other means to the Auction Agent and confirmed in writing promptly thereafter.
Each such notice shall state (A) that the Fund proposes to exercise its option
to designate a succeeding Special Rate Period, specifying the first and last
days thereof and (B) that the Fund will, by 3:00 p.m. New York City time, on the
second Business Day next preceding the first day of such Special Rate Period,
notify the Auction Agent, who will promptly notify the Broker-Dealers, of either
(x) the Fund's determination, subject to certain conditions, to proceed with
such Special Rate Period, subject to the terms of any Specific Redemption
Provisions, or (y) the Fund's determination not to proceed with such Special
Rate Period in which latter event the succeeding Rate Period shall be a Standard
Rate Period.
No later than 3:00 p.m., New York City time, on the second Business Day
next preceding the first day of any proposed Special Rate Period, the Fund will
deliver to the Auction Agent, who will promptly deliver to the Broker-Dealers
and Existing Holders, either:
(1) a notice stating (A) that the Fund has determined to designate the
next succeeding Rate Period as a Special Rate Period, specifying the first and
last days thereof and (B) the terms of any Specific Redemption Provisions; or
(2) a notice stating that the Fund has determined not to exercise its
option to designate a Special Rate Period.
If the Fund fails to deliver either such notice above with respect to
any designation of any proposed Special Rate Period to the Auction Agent and the
Auction Agent is unable to make the confirmation described above by 3:00 p.m.,
New York City time, on the second Business Day next preceding the first day of
such proposed Special Rate Period, the Fund shall be deemed to have delivered a
notice to the Auction Agent with respect to such Rate Period to the effect set
forth in clause (2) above, thereby resulting in a Standard Rate Period.
Default Period. Subject to cure provisions, a ODefault PeriodO with
respect to a particular series of Preferred Shares will commence on any date on
which, when required to do so, the Fund fails to deposit irrevocably in trust in
same-day funds, with the Paying Agent by 12:00 noon, New York City time, (A) the
full amount of any declared distribution on that series payable on the
Distribution Payment Date (a ODistribution DefaultO), or (B) the full amount of
any redemption price (the ORedemption PriceO) payable on the date fixed for
redemption (the ORedemption DateO) (a ORedemption DefaultO, and together with a
Distribution Default, hereinafter referred to as ODefaultO).
Subject to cure provisions, a Default Period with respect to a
Distribution Default or a Redemption Default shall end on the Business Day on
which, by 12:00 noon, New York City time, all unpaid distributions and any
unpaid Redemption Price, respectively, shall have been deposited irrevocably in
- 66 -
trust in same-day funds with the Paying Agent. In the case of a Distribution
Default, the Applicable Rate for each Rate Period commencing during a Default
Period will be equal to the Default Rate, and each subsequent Rate Period
commencing after the beginning of a Default Period shall be a Standard Rate
Period; provided, however, that the commencement of a Default Period will not by
itself cause the commencement of a new Rate Period.
No auction shall be held during a Default Period with respect to a
Distribution Default applicable to that series of Preferred Shares. No Default
Period with respect to a Distribution Default or Redemption Default shall be
deemed to commence if the amount of any distribution or any Redemption Price due
(if such default is not solely due to the Fund's willful failure) is deposited
irrevocably in trust, in same-day funds with the Paying Agent by 12:00 noon, New
York City time, within three Business Days after the applicable Distribution
Payment Date or Redemption Date, together with an amount equal to the Default
Rate applied to the amount of such nonpayment based on the actual number of days
comprising such period divided by 360 for each series. The Default Rate shall be
equal to the Reference Rate multiplied by three.
Distribution Restrictions. While any of the Preferred Shares are
outstanding, the Fund generally may not pay or set apart for payment, any
dividend or other distribution in respect of the Common Shares (other than in
additional Common Shares or rights to purchase Common Shares) or repurchase any
of the Common Shares (except by conversion into or exchange for shares of the
Fund ranking junior to the Preferred Shares as to the payment of dividends and
other distributions, including the distribution of assets upon liquidation)
unless each of the following conditions has been satisfied:
o In the case of the Moody's coverage requirements, immediately
after such transaction, the aggregate Moody's discounted value
(i.e., the aggregate value of the Fund's portfolio discounted
according to Moody's criteria) would be equal to or greater
than the Preferred Shares Basic Maintenance Amount (i.e., the
amount necessary to pay all outstanding obligations of the
Fund with respect to the Preferred Shares, any preferred stock
outstanding, expenses for the next 90 days and any other
liabilities of the Fund) (see "--Rating Agency Guidelines and
Asset Coverage" below);
o In the case of Fitch's coverage requirements, immediately
after such transaction, the aggregate Fitch discounted value
(i.e., the aggregate value of the Fund's portfolio discounted
according to Fitch criteria) would be equal to or greater than
the Preferred Shares Basic Maintenance Amount;
o Immediately after the transaction, the Fund would have
eligible portfolio holdings with an aggregated discounted
value at least equal to the asset coverage requirements, if
any, under any borrowings;
o Immediately after such transaction, the 1940 Act Preferred
Shares Asset Coverage (as defined in this Prospectus under
"--Rating Agency Guidelines and Asset Coverage" below) is met;
- 67 -
o Full cumulative distributions on the Preferred Shares due on
or prior to the date of the transaction have been declared and
paid or shall have been declared and sufficient funds for the
payment thereof are reasonably expected by the Fund to be
available for payment on the date payment is due to the
Auction Agent; and
o The Fund has redeemed the full number of Preferred Shares
required to be redeemed by any provision for mandatory
redemption contained in the Declaration of Trust or the
Statement of Terms.
The Fund generally will not declare, pay or set apart for payment any
distribution on any of its shares ranking as to the payment of distributions on
a parity with Preferred Shares unless the Fund has declared and paid or
contemporaneously declares and pays full cumulative distributions on the
Preferred Shares through the most recent distribution payment date. However,
when the Fund has not paid distributions in full on the Preferred Shares through
the most recent distribution payment date or upon any shares of the Fund
ranking, as to the payment of distributions, on a parity with Preferred Shares
through their most recent respective distribution payment dates, the amount of
distributions declared per share on Preferred Shares and such other class or
series of shares will in all cases bear to each other the same ratio that
accumulated distributions per share on the Preferred Shares and such other class
or series of shares bear to each other.
REDEMPTION
Optional Redemption. To the extent permitted under the 1940 Act and
Massachusetts law, the Fund may, at its option, redeem Preferred Shares of
either or both series having a Rate Period of one year or less, in whole or in
part, out of funds legally available therefor, on any Distribution Payment Date
upon not less than 15 calendar days' and not more than 40 calendar days', prior
notice. This optional redemption is not available during the initial Rate Period
or during other limited circumstances. The optional redemption price per share
shall be equal to the liquidation preference per share, plus an amount equal to
accumulated but unpaid distributions thereon (whether or not earned or declared)
to the date fixed for redemption. Preferred Shares of either or both series
having a Rate Period of more than one year are redeemable at the option of the
Fund, in whole or in part, out of funds legally available therefor, prior to the
end of the relevant Rate Period, upon not less than 15 calendar days' and not
more than 40 calendar days', prior notice, subject to any Specific Redemption
Provisions, which may include the payment of redemption premiums in the sole
discretion of the Board of Trustees. The Fund shall not effect any optional
redemption unless after giving effect thereto (1) the Fund has available on such
date fixed for the redemption certain Deposit Securities with maturity or tender
dates not later than the day preceding the applicable redemption date and having
a value not less than the amount (including any applicable premium) due to
Holders of Preferred Shares by reason of the redemption of Preferred Shares on
such date fixed for the redemption, and (2) the Fund would have Eligible Assets
with an aggregate Discounted Value at least equal to the Preferred Shares Basic
Maintenance Amount.
The Fund also reserve the right to repurchase Preferred Shares in
market or other transactions from time to time in accordance with applicable law
- 68 -
and at a price that may be more or less than the liquidation preference of the
Preferred Shares, but are under no obligation to do so.
Mandatory Redemption. If the Fund fails to maintain Eligible Assets
with an aggregate Discounted Value at least equal to the Preferred Shares Basic
Maintenance Amount as of any Valuation Date or, fail to satisfy the 1940 Act
Preferred Shares Asset Coverage as of the last Business Day of any month, and
such failure is not cured within ten (10) Business Days following such Valuation
Date in the case of a failure to maintain the Preferred Shares Basic Maintenance
Amount or on the last Business Day of the following month in the case of a
failure to maintain the 1940 Act Preferred Shares Asset Coverage (each an OAsset
Coverage Cure DateO), the Preferred Shares will be subject to mandatory
redemption out of funds legally available therefor. See the Statement of Terms,
attached as Appendix C to the SAI, for a complete listing of circumstances in
which the Fund must redeem Preferred Shares.
The number of Preferred Shares to be redeemed under these circumstances
will be equal to the lesser of (1) the minimum number of Preferred Shares the
redemption of which, if deemed to have occurred immediately prior to the opening
of business on the relevant Asset Coverage Cure Date, would result in the Fund
having Eligible Assets with an aggregate Discounted Value at least equal to the
Preferred Shares Basic Maintenance Amount or sufficient to satisfy the 1940 Act
Preferred Shares Asset Coverage, as the case may be, in either case as of the
relevant Asset Coverage Cure Date (provided that, if there is no such minimum
number of shares the redemption of which would have such result, all Preferred
Shares then outstanding will be redeemed), and (2) the maximum number of
Preferred Shares that can be redeemed out of funds expected to be available
therefor on the Mandatory Redemption Date (as defined below) at the Mandatory
Redemption Price (as defined below).
The Fund will allocate the number of shares required to be redeemed to
satisfy the Preferred Shares Basic Maintenance Amount or the 1940 Act Preferred
Shares Asset Coverage, as the case may be, pro rata among the Holders of each
series of Preferred Shares in proportion to the number of shares they hold, by
lot or by such other method as the Fund shall deem fair and equitable, subject
to any mandatory redemption provisions.
The Fund required to effect such a mandatory redemption not later than
40 days after the Asset Coverage Cure Date, as the case may be (the "Mandatory
Redemption Date"), except that if the Fund does not have funds legally available
for the redemption of, or is not otherwise legally permitted to redeem, all of
the required number of Preferred Shares that are subject to mandatory
redemption, or the Fund otherwise is unable to effect such redemption on or
prior to such Mandatory Redemption Date, the Fund will redeem those Preferred
Shares on the earliest practicable date on which such funds are available, upon
notice to record owners of shares of Preferred Shares and the Paying Agent. The
Fund's ability to make a mandatory redemption may be limited by the provisions
of the 1940 Act or Massachusetts law.
The redemption price per share in the event of any mandatory redemption
will be $25,000 per share, plus an amount equal to accumulated but unpaid
distributions (whether or not earned or declared) to the date fixed for
redemption, plus (in the case of a Rate Period of more than one year only) a
redemption premium, if any, determined by the Board of Trustees in its sole
- 69 -
discretion after consultation with the Broker-Dealers and set forth in any
applicable Specific Redemption Provisions (the "Mandatory Redemption Price").
Redemption Procedure. Pursuant to Rule 23c-2 under the 1940 Act, the
Fund will file a notice of the Fund's intention to redeem with the SEC so as to
provide at least the minimum notice required by such rule or any successor
provision (notice currently must be filed with the SEC generally at least 30
days prior to the redemption date). The Fund shall deliver a notice of
redemption to the Auction Agent containing the information described below one
Business Day prior to the giving of notice to Holders in the case of an optional
redemption and on or prior to the 30th day preceding the Mandatory Redemption
Date in the case of a mandatory redemption. The Auction Agent will use its
reasonable efforts to provide notice to each Holder of Preferred Shares called
for redemption by electronic means not later than the close of business on the
Business Day immediately following the Business Day on which the Auction Agent
determines the shares to be redeemed (or, during a Default Period with respect
to such shares, not later than the close of business on the Business Day
immediately following the day on which the Auction Agent receives notice of
redemption from the Fund). Such notice will be confirmed promptly in writing not
later than the close of business on the third Business Day preceding the
redemption date by providing the notice to each Holder of record of Preferred
Shares called for redemption, the Paying Agent (if different from the Auction
Agent) and the Securities Depository ("Notice of Redemption"). The Notice of
Redemption will be addressed to the registered owners of the Preferred Shares at
their addresses appearing on the books or records of the Fund. Such notice will
set forth (1) the redemption date, (2) the number and identity of Preferred
Shares to be redeemed, (3) the redemption price (specifying the amount of
accumulated distributions to be included therein and the amount of the
redemption premium, if any), (4) that distributions on the shares to be redeemed
will cease to accumulate on such redemption date, and (5) the 1940 Act provision
under which redemption shall be made. No defect in the Notice of Redemption or
in the transmittal or mailing thereof will affect the validity of the redemption
proceedings, except as required by applicable law.
If less than all of the shares of a series of Preferred Shares are
redeemed on any date, the shares per Holder to be redeemed on such date will be
selected by the Fund on a pro rata basis in proportion to the number of shares
held by such Holder, by lot or by such other method as is determined by the Fund
to be fair and equitable, subject to the terms of any Specific Redemption
Provisions. Preferred Shares may be subject to mandatory redemption as described
herein notwithstanding the terms of any Specific Redemption Provisions. The
Auction Agent will give notice to the Securities Depository, whose nominee will
be the record Holder of all of the Preferred Shares, and the Securities
Depository will determine the number of shares to be redeemed from the account
of the Agent Member of each Beneficial Owner. Each Agent Member will determine
the number of shares to be redeemed from the account of each Beneficial Owner
for which it acts as agent. An Agent Member may select for redemption shares
from the accounts of some Beneficial Owners without selecting for redemption any
shares from the accounts of other Beneficial Owners. In this case, in selecting
the Preferred Shares to be redeemed, the Agent Member will select by lot or by
other fair and equitable method. Notwithstanding the foregoing, if neither the
Securities Depository nor its nominee is the record Holder of all of the shares,
the particular shares to be redeemed shall be selected by the Fund by lot, on a
- 70 -
pro rata basis between each series or by such other method as the Fund shall
deem fair and equitable, as contemplated above.
If Notice of Redemption has been given, then upon the deposit of funds
with the Paying Agent sufficient to effect such redemption, distributions on
such shares will cease to accumulate and such shares will be no longer deemed to
be outstanding for any purpose and all rights of the Holders of the shares so
called for redemption will cease and terminate, except the right of the Holders
of such shares to receive the redemption price, but without any interest or
additional amount. The Fund shall be entitled to receive from the Paying Agent,
promptly after the date fixed for redemption, any cash deposited with the Paying
Agent in excess of (1) the aggregate redemption price of the Preferred Shares
called for redemption on such date and (2) such other amounts, if any, to which
Holders of Preferred Shares called for redemption may be entitled. The Fund will
be entitled to receive, from time to time after the date fixed for redemption,
from the Paying Agent the interest, if any, earned on such funds deposited with
the Paying Agent and the owners of Preferred Shares so redeemed will have no
claim to any such interest. Any funds so deposited that are unclaimed two years
after such redemption date will be paid, to the extent permitted by law, by the
Paying Agent to the Fund upon the Fund's request. Subsequent to such payment,
Holders of Preferred Shares called for redemption may look only to the Fund for
payment.
So long as any Preferred Shares are held of record by the nominee of
the Securities Depository, the redemption price for such shares will be paid on
the redemption date to the nominee of the Securities Depository. The Securities
Depository's normal procedures provide for it to distribute the amount of the
redemption price to Agent Members who, in turn, are expected to distribute such
funds to the persons for whom they are acting as agent. Notwithstanding the
provisions for redemption described above, no Preferred Shares may be redeemed
unless all distributions in arrears on the outstanding Preferred Shares, and any
shares ranking on a parity with the Preferred Shares with respect to the payment
of distributions or upon liquidation, have been or are being contemporaneously
paid or set aside for payment, except in connection with the liquidation of the
Fund, in which case all Preferred Shares and all shares ranking in parity with
the Preferred Shares must receive proportionate amounts. At any time the Fund
may purchase or acquire all the outstanding Preferred Shares pursuant to the
successful completion of an otherwise lawful purchase or exchange offer made on
the same terms to, and accepted by, Holders of all outstanding Preferred Shares.
Except for the provisions described above, nothing contained in the
Statement of Terms limits any legal right of ours to purchase or otherwise
acquire any Preferred Shares outside of an Auction at any price, whether higher
or lower than the price that would be paid in connection with an optional or
mandatory redemption, so long as, at the time of any such purchase, there is no
arrearage in the payment of distributions on, or the mandatory or optional
redemption price with respect to, any Preferred Shares for which Notice of
Redemption has been given and the Fund is in compliance with the 1940 Act
Preferred Shares Asset Coverage and have Eligible Assets with an aggregate
Discounted Value at least equal to the Preferred Shares Basic Maintenance Amount
after giving effect to such purchase or acquisition on the date thereof. Any
shares purchased, redeemed or otherwise acquired by the Fund shall be returned
to the status of authorized but unissued shares. If less than all outstanding
- 71 -
Preferred Shares are redeemed or otherwise acquired by the Fund, the Fund shall
give notice of such transaction to the Auction Agent, in accordance with the
procedures agreed upon by the Board of Trustees.
RATING AGENCY GUIDELINES AND ASSET COVERAGE
Preferred Shares Basic Maintenance Amount. The Fund is required under
Moody's and Fitch guidelines to maintain assets having in the aggregate a
discounted value at least equal to the Preferred Shares Basic Maintenance
Amount. The discounted value of an asset (other than cash and cash equivalents)
is a specified percentage of its full value; this discounting is intended to
provide increased assurance of adequate asset coverage in the face of expected
or unexpected fluctuation in the value of the assets. Moody's and Fitch have
each established separate guidelines for determining discounted value. To the
extent any particular portfolio holding does not satisfy the applicable Rating
Agency's Guidelines, all or a portion of such holding's value will not be
included in the calculation of discounted value (as defined by such rating
agency). The Moody's and Fitch guidelines impose certain diversification
requirements on the Fund's portfolio. Other than as needed to meet the asset
coverage tests, the Moody's and Fitch guidelines do not impose any absolute
limitations on the percentage of the Fund's assets that may be invested in
holdings not eligible for inclusion in the calculation of the discounted value
of the Fund's portfolio. The amount of ineligible assets included in the Fund's
portfolio at any time depends upon the rating, diversification and other
characteristics of the assets included in the portfolio. The Preferred Shares
Basic Maintenance Amount includes the sum of (a) the aggregate liquidation
preference of Preferred Shares then outstanding and (b) certain accrued and
projected distribution and other payment obligations of the Fund.
The Fund may, but are not required to, adopt any modifications to the
guidelines that may hereafter be established by Moody's or Fitch. Failure to
adopt any such modifications, however, may result in a change in the ratings
described above or a withdrawal of ratings altogether. In addition, any rating
agency providing a rating for Preferred Shares may, at any time, change or
withdraw such rating. The Board of Trustees may, without shareholder approval,
amend, alter or repeal any or all of the definitions and related provisions that
have been adopted by the Fund pursuant to the rating agency guidelines in the
event the Fund receives confirmation from Moody's or Fitch, or both, as
appropriate, that any such amendment, alteration or repeal would not impair the
ratings then assigned by Moody's and Fitch to Preferred Shares.
As described by Moody's and Fitch, a preferred stock rating is an
assessment of the capacity and willingness of an issuer to pay preferred stock
obligations. The ratings on the Preferred Shares are not recommendations to
purchase, hold or sell those shares, inasmuch as the ratings do not comment as
to market price or suitability for a particular investor. The Rating Agency
Guidelines described above also do not address the likelihood that an owner of
Preferred Shares will be able to sell such shares in an auction or otherwise.
The ratings are based on current information furnished to Moody's and Fitch by
the Fund, the Adviser and the Sub-Adviser and information obtained from other
sources. The ratings may be changed, suspended or withdrawn as a result of
changes in, or the unavailability of, such information. The Common Shares have
not been rated by a rating agency.
- 72 -
A rating agency's guidelines will apply to Preferred Shares only so
long as such rating agency is rating such shares. The Fund will pay certain fees
to Moody's and Fitch for rating Preferred Shares.
1940 Act Preferred Shares Asset Coverage. The Fund is also required
under the 1940 Act to maintain the 1940 Act Preferred Shares Asset Coverage. The
Fund's 1940 Act Preferred Shares Asset Coverage is tested as of the last
business day of each month in which any senior equity securities are outstanding
and in connection with the declaration of any distribution on, or repurchase of,
any Common Shares or Preferred Shares. The minimum required 1940 Act Preferred
Shares Asset Coverage amount of 200% may be increased or decreased if the 1940
Act is amended. Based on the composition of the portfolio of the Fund and market
conditions as of __________, 2007, the 1940 Act Preferred Shares Asset Coverage,
assuming the issuance on that date of all Preferred Shares offered hereby and
giving effect to the deduction of related sales load and related offering costs
estimated at $___________ and the application of the net proceeds as described
under "Use of Proceeds," would have been computed as follows:
Value of Fund assets less liabilities not constituting
senior securities
$[ ]
= ________ = [ ]%
Senior securities representing indebtedness plus
liquidation value of the Preferred Shares $[ ]
The Board of Trustees may amend the definition of Maximum Rate to
increase the percentage amount by which the Reference Rate is multiplied to
determine the Maximum Rate without the vote or consent of the Preferred
Shareholders or of any other of shareholders, provided that immediately
following any such increase the Fund could meet the Preferred Shares Basic
Maintenance Amount Test.
Mandatory Redemption. In the event the Fund does not timely cure a
failure to maintain (a) a discounted value of the Fund's portfolio at least
equal to the Preferred Shares Basic Maintenance Amount in accordance with the
requirements of the rating agency or agencies then rating Preferred Shares, or
(b) the 1940 Act Preferred Shares Asset Coverage, the Fund will be required to
redeem Preferred Shares as described under "Redemption--Mandatory Redemption"
above.
VOTING RIGHTS
Except as otherwise provided in this prospectus and in the SAI, in the
Declaration of Trust, By-Laws and the Statement of Terms or as otherwise
required by law, holders of preferred shares, including Preferred Shares, will
have equal voting rights with holders of Common Shares and holders of any other
outstanding preferred shares of the Fund (one vote per share) and will vote
together with holders of Common Shares and holders of any other preferred shares
of the Fund as a single class.
- 73 -
Holders of outstanding preferred shares, including Preferred Shares,
voting as a separate class, are entitled at all times to elect two of the Fund's
trustees. The remaining trustees normally are elected by holders of Common
Shares and preferred shares, including Preferred Shares, voting together as a
single class. If at any time distributions (whether or not earned or declared)
on outstanding preferred shares, including Preferred Shares, shall be due and
unpaid in an amount equal to two full years' distributions thereon, and
sufficient cash or specified securities shall not have been deposited with the
Auction Agent for the payment of such distributions, then, as the sole remedy of
holders of outstanding preferred shares, the number of trustees constituting the
Board of Trustees shall be increased and holders of preferred shares shall be
entitled to elect additional trustees such that the trustees elected solely by
preferred shareholders will constitute a majority of the trustees. If the Fund
thereafter shall pay, or declare and set apart for payment, in full,
distributions payable on all outstanding preferred shares, the voting rights
stated in the preceding sentence shall cease, and the terms of office of all of
the additional trustees so elected by the preferred shareholders (but not of the
trustees with respect to whose election the holders of Common Shares were
entitled to vote or the two trustees the preferred shareholders have the right
to elect in any event), will terminate automatically.
So long as any Preferred Shares are outstanding, the Fund will not,
without the affirmative vote or consent of holders of sixty-six and two-thirds
(66 2/3%) of each class of shares outstanding, authorize the Fund's conversion
from a closed-end to an open-end investment company; provided, however, that
such votes shall require a majority shareholder vote if the action in question
has previously been approved by the affirmative vote of two-thirds of the
trustees. So long as any Preferred Shares are outstanding, the Fund will not,
among other items, without the affirmative vote or consent of the holders of at
least a majority of the Preferred Shares outstanding at such time (voting
together as a separate class):
(a) authorize, create or issue, or increase the authorized or
issued amount of, any class or series of shares ranking prior to or on
a parity with the Preferred Shares with respect to payment of
distributions or distributions of assets on dissolution, liquidation or
winding up the affairs of the Fund, or authorize, create or issue
additional shares of any series of Preferred Shares, unless, in the
case of preferred shares on a parity with the Preferred Shares or the
creation and issuance of additional shares of any series of Preferred
Shares, the Fund obtains confirmation from Moody's (if Moody's is then
rating the Preferred Shares), Fitch (if Fitch is then rating the
Preferred Shares) or any substitute rating agency (if any such
substitute rating agency is then rating the Preferred Shares) that the
issuance of such a class, series or shares would not impair the rating
then assigned by such rating agency to the Preferred Shares and the
Fund continues to comply with Section 13 of the 1940 Act, the 1940 Act
Preferred Shares Asset Coverage requirements and the Preferred Shares
Basic Maintenance Amount requirements, in which case the vote or
consent of the holders of the Preferred Shares is not required;
(b) amend, alter or repeal the provisions of the Declaration
of Trust, By-Laws or the Statement of Terms by merger, consolidation or
otherwise, so as to adversely affect any preference, right or power of
the Preferred Shares or Preferred Shareholders; provided, however, that
(i) none of the actions permitted by the exception to (a) above will be
deemed to affect such preferences, rights or powers, (ii) a division of
Preferred Shares will be deemed to affect such preferences, rights or
powers only if the terms of such division adversely affect the
- 74 -
Preferred Shareholders and (iii) the authorization, creation and
issuance of classes or series of shares ranking junior to the Preferred
Shares with respect to the payment of distributions of assets upon
dissolution, liquidation or winding up of the affairs of the Fund will
be deemed to affect such preferences, rights or powers only if Moody's
or Fitch is then rating the Preferred Shares and such issuance would,
at the time thereof, cause the Fund not to satisfy the 1940 Act
Preferred Shares Asset Coverage or the Preferred Shares Basic
Maintenance Amount; or
(c) approve any reorganization (as such term is used in the
1940 Act) adversely affecting the Preferred Shares within the meaning
of Section 18(a)(2)(D) of the 1940 Act, provided, however, that a vote
of two-thirds of the Preferred Shares is required if the reorganization
has not been approved by two-thirds of the Trustees.
So long as any Preferred Shares are outstanding, the Fund shall not,
without the affirmative vote or consent of the holders of at least a majority of
the Preferred Shares outstanding at the time, in person or by proxy, either in
writing or at a meeting, voting as a separate class, file a voluntary
application for relief under federal bankruptcy law or any similar application
under state law for so long as the Fund is solvent and does not foresee becoming
insolvent.
The Fund will not approve any of the actions set forth in (a) or (b)
above that require a shareholder vote which adversely affects the rights
expressly set forth in the Statement of Terms of a holder of shares of preferred
shares differently than those of a holder of shares of any other series of
preferred shares without the affirmative vote or consent of the holders of at
least a majority of the shares of each series adversely affected. Even with such
a vote, some of the actions set forth in (a) or (b) above may not be permitted
under the 1940 Act. Under the 1940 Act, the affirmative vote of the holders of a
majority of the outstanding Preferred Shares, voting together as a single class,
will be required to approve any plan of reorganization (including bankruptcy
proceedings) adversely affecting such shares or any action requiring a vote of
security holders under Section 13(a) of the 1940 Act. Under the 1940 Act, the
vote of a majority of the outstanding Preferred Shares means the affirmative
vote of the lesser of (i) 67% or more of the outstanding Preferred Shares
present at a meeting of Preferred Shareholders or represented by proxy if the
holders of more than 50% of the outstanding Preferred Shares are present or
represented by proxy or (ii) more than 50% of the outstanding Preferred Shares.
The Declaration of Trust of the Fund, however, requires a higher percentage vote
under certain circumstances. See "Certain Provisions under the Declaration of
Trust and By-Laws" below. To the extent permitted by Massachusetts law, the
Declaration of Trust, By-Laws and the Statement of Terms, no vote of holders of
Common Shares, either separately or together with holders of Preferred Shares as
a single class, is necessary to take the actions contemplated by (a) and (b)
above.
The foregoing voting provisions will not apply with respect to
Preferred Shares if, at or prior to the time when a vote is required, such
shares shall have been (i) redeemed or (ii) called for redemption and sufficient
funds shall have been deposited in trust to effect such redemption.
- 75 -
THE AUCTION
ROLE OF AUCTION AGENT
Statement of Terms. The Statement of Terms provides that, except as
otherwise described herein, the Applicable Rate for the shares of each series of
Preferred Shares for each Rate Period after the initial Rate Period shall be
equal to the rate per annum that the Auction Agent advises has resulted on the
Business Day preceding the first day of such subsequent Rate Period (an "Auction
Date") from implementation of the auction procedures (the "Auction Procedures"),
in which persons determine to hold or offer to sell or, based on distribution
rates bid by them, offer to purchase or sell shares. Each periodic
implementation of the Auction Procedures is referred to herein as an "Auction."
See the Statement of Terms, attached as Appendix C to the SAI, for a more
complete description of the auction process.
Auction Agency Agreement. The Auction Agency Agreement between the Fund
and the Auction Agent (currently, [____________]) (the "Auction Agency
Agreement") provides, among other things, that the Auction Agent will follow the
Auction Procedures for purposes of determining the Applicable Rate for each
series of Preferred Shares so long as the Applicable Rate for the Preferred
Shares is to be based on the results of an auction. The Auction Agent acts as a
non-fiduciary agent for the Fund in connection with auctions. In the absence of
bad faith or gross negligence on its part, the Auction Agent will not be liable
for any action taken, suffered, or omitted or for any error of judgment made by
it in the performance of its duties under the Auction Agency Agreement and will
not be liable for any error of judgment made in good faith unless the Auction
Agent will have been grossly negligent in ascertaining the pertinent facts.
The Auction Agent may terminate the Auction Agency Agreement upon
notice to the Fund on a date no earlier than 60 days after the notice. If the
Auction Agent should resign, the Fund will use its best efforts to enter into an
agreement with a successor Auction Agent containing substantially the same terms
and conditions as the Auction Agency Agreement. The Fund may remove the Auction
Agent provided that prior to such removal the Fund shall have entered into such
an agreement with a successor Auction Agent.
AUCTION PROCEDURES
The following is a brief discussion of the procedures to be used in
conducting Auctions. Separate Auctions will be conducted for each series of
Preferred Shares. This summary is qualified by reference to the Statement of
Terms set forth in Appendix C to the SAI.
Auction Date. An Auction to determine the Applicable Rate for the
shares of each series of Preferred Shares offered hereby for each Rate Period
(other than the initial Rate Period therefore) will be held on the first
Business Day (as hereinafter defined) preceding the first day of such Rate
Period, which first day is also a Distribution Payment Date for the preceding
Rate Period. "Business Day" means a day on which the New York Stock Exchange is
open for trading and which is not a Saturday, Sunday or other day on which banks
in the City of New York are authorized or obligated by law to close. Auctions
for shares of Series ___ Preferred Shares for Rate Periods after the initial
Rate Period normally will be held every ________ after the preceding
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Distribution Payment Date, and each subsequent Rate Period normally will begin
on the following ________ (also a Distribution Payment Date). Auctions for
shares of Series ___ Preferred Shares for Rate Periods after the initial Rate
Period normally will be held every fourth _____ after the preceding Distribution
Payment Date, and each subsequent Rate Period normally will begin on the
following _______ (also a Distribution Payment Date). The Auction Date and the
first day of the related Rate Period (both of which must be Business Days) need
not be consecutive calendar days. For example, in most cases, if the ________
that normally would be an Auction Date for Series ___ Preferred Shares is not a
Business Day, then such Auction Date will be the preceding ________ and the
first day of the related Rate Period will continue to be the following ________.
Beneficial Owners. Prior to the Broker-Dealer Deadline on each Auction
Date for each series of Preferred Shares, each customer of a Broker-Dealer who
is listed on the records of that Broker-Dealer (or, if applicable, the Auction
Agent) as a holder of Preferred Shares (a "Beneficial Owner") may submit orders
("Orders") with respect to Preferred Shares to that Broker-Dealer as follows:
o Hold Order--indicating its desire to hold Preferred Shares
without regard to the Applicable Rate for Preferred Shares for the next
Rate Period thereof.
o Bid--indicating its desire to sell Preferred Shares, if any, held
by such Beneficial Owner which such Beneficial Owner offers to sell if
the Applicable Rate for Preferred Shares for the next succeeding Rate
Period of Preferred Shares shall be less than the rate per annum
specified by such Beneficial Owner (also known as a hold-at-rate
order).
o Sell Order--indicating its desire to sell the number of Preferred
Shares, if any, held by such Beneficial Owner which such Beneficial
Owner offers to sell without regard to the Applicable Rate for
Preferred Shares for the next succeeding Rate Period of Preferred
Shares.
Orders submitted (or the failure to do so) by Beneficial Owners under
certain circumstances will have the effects described below. A Beneficial Owner
of Preferred Shares that submits a Bid with respect to Preferred Shares to its
Broker-Dealer having a rate higher than the Maximum Rate for Preferred Shares on
the Auction Date therefore will be treated as having submitted a Sell Order with
respect to such Preferred Shares.
A Beneficial Owner of Preferred Shares that fails to submit an Order
with respect to such Preferred Shares to its Broker-Dealer will be deemed to
have submitted a Hold Order with respect to such Preferred Shares; provided,
however, that if a Beneficial Owner of Preferred Shares fails to submit an Order
with respect to such Preferred Shares to its Broker-Dealer for an Auction
relating to a Special Rate Period of more than seven days in the case of Series
__ Preferred Shares and 28 days in the case of Series ____ Preferred Shares,
such Beneficial Owner will be deemed to have submitted a Sell Order with respect
to such Preferred Shares. A Sell Order shall constitute an irrevocable offer to
sell the Preferred Shares subject thereto. In an Auction, a Beneficial Owner may
submit different types of Orders with respect to Preferred Shares then held by
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such Beneficial Owner, as well as Bids for additional Preferred Shares. A
Beneficial Owner that offers to become the Beneficial Owner of additional
Preferred Shares is, for purposes of such offer, a Potential Beneficial Owner as
discussed below.
Potential Beneficial Owners. A customer of a Broker-Dealer that is not
a Beneficial Owner of Preferred Shares but that wishes to purchase Preferred
Shares, or that is a Beneficial Owner of Preferred Shares that wishes to
purchase additional Preferred Shares (in each case, a "Potential Beneficial
Owner"), may submit Bids to its Broker-Dealer in which it offers to purchase
shares at $25,000 per share specified in such Bid if the Applicable Rate for
Preferred Shares determined on such Auction Date shall be higher than the rate
specified in such Bid. A Bid placed by a Potential Beneficial Owner of Preferred
Shares specifying a rate higher than the Maximum Rate for Preferred Shares on
the Auction Date therefore will not be accepted.
The Auction Process. Each Broker-Dealer shall submit in writing, which
shall include a writing delivered via e-mail other electronic means, to the
Auction Agent, prior to the Submission Deadline on each Auction Date, all Orders
for Preferred Shares subject to an Auction on such Auction Date accepted by such
Broker-Dealer, designating itself (unless otherwise permitted by the Fund) as an
Existing Holder in respect of Preferred Shares subject to Orders submitted or
deemed submitted to it by Beneficial Owners and as a Potential Holder in respect
of Preferred Shares subject to Orders submitted to it by Potential Beneficial
Owners. However, neither the Fund nor the Auction Agent will be responsible for
a Broker-Dealer's failure to comply with the foregoing. Any Order placed with
the Auction Agent by a Broker-Dealer as or on behalf of an Existing Holder or a
Potential Holder will be treated in the same manner as an Order placed with a
Broker-Dealer by a Beneficial Owner or Potential Beneficial Owner. Similarly,
any failure by a Broker-Dealer to submit to the Auction Agent an Order in
respect of Preferred Shares held by it or customers who are Beneficial Owners
will be treated in the same manner as a Beneficial Owner's failure to submit to
its Broker-Dealer an Order in respect of Preferred Shares held by it. A
Broker-Dealer may also submit Orders to the Auction Agent for its own account as
an Existing Holder or Potential Holder, provided it is not an affiliate of the
Fund.
If Sufficient Clearing Bids for a series of Preferred Shares exist
(that is, the number of Preferred Shares subject to Submitted Bids of Potential
Holders specifying one or more rates between the Minimum Rate (for Standard Rate
Periods or shorter periods, only) and the Maximum Rate (for all Rate Periods)
for Preferred Shares exceeds or is equal to the number of Preferred Shares
subject to Sell Submitted Orders, the Applicable Rate for Preferred Shares for
the next succeeding Rate Period thereof will be the lowest rate specified in the
Submitted Bids which, taking into account such rate and all lower rates bid by
Broker-Dealers as or on behalf of Existing Holders and Potential Holders, would
result in Existing Holders and Potential Holders owning the Preferred Shares
available for purchase in the Auction (such rate, the "Winning Bid Rate"). If
Sufficient Clearing Bids for Preferred Shares do not exist (other than because
all of the outstanding Preferred Shares are subject to Submitted Hold Orders),
the Rate Period next following the Auction automatically will be a 7-day period
in the case of the Series ___ Preferred Shares and a 28-day period in the case
of the Series ___ Preferred Shares, and the Applicable Rate for all Preferred
Shares for the next succeeding Rate Period thereof will be equal to the Maximum
Rate for Preferred Shares. In such event, Holders of Preferred Shares that have
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submitted or are deemed to have submitted Sell Orders may not be able to sell in
such Auction all Preferred Shares subject to such Sell Orders. In any particular
Auction, if all outstanding Preferred Shares are the subject of Submitted Hold
Orders, the Applicable Rate of Preferred Shares for the next succeeding Auction
Period will be the All Hold Rate (such a situation is called an "All Hold
Auction").
The Auction Procedures include a pro rata allocation of Preferred
Shares for purchase and sale, which may result in an Existing Holder continuing
to hold or selling, or a Potential Holder purchasing, a number of Preferred
Shares that is less than the number of Preferred Shares specified in its Order.
To the extent the allocation procedures have that result, Broker-Dealers that
have designated themselves as Existing Holders or Potential Holders in respect
of customer Orders will be required to make appropriate pro rata allocations
among their respective customers.
Settlement of purchases and sales will be made on the next Business Day
(also a Distribution Payment Date) after the Auction Date through the Securities
Depository. Purchasers will make payment through their Agent Members in same-day
funds to the Securities Depository against delivery to their respective Agent
Members. The Securities Depository will make payment to the sellers' Agent
Members in accordance with the Securities Depository's normal procedures, which
now provide for payment against delivery by their Agent Members in same-day
funds.
CERTAIN CONSIDERATIONS AFFECTING AUCTION RATE SECURITIES
Role of Broker-Dealers. _______________ (the "Broker-Dealers") have
been appointed by the issuers or obligors of various auction rate securities to
serve as a dealer in the auctions for those securities and are paid by the
issuers or obligors for their services. The Broker-Dealers receive Broker-Dealer
fees from such issuers or obligors at an agreed upon annual rate that is applied
to the principal amount of securities sold or successfully placed through them
in such auctions.
The Broker-Dealers are designated in the Broker-Dealer Agreements as
the Broker-Dealers to contact Existing Holders and Potential Holders and solicit
Bids for the Preferred Shares. The Broker-Dealers will receive Broker-Dealer
Fees from the Fund with respect to the Preferred Shares sold or successfully
placed through them in Auctions. The Broker-Dealers may share a portion of such
fees with other dealers that submit Orders through them that are filled in the
Auction.
Bidding by Broker-Dealers. A Broker-Dealer (provided it is not an
affiliate of the Fund) is permitted, but not obligated, to submit Orders in
Auctions for its own account either as a buyer or seller. If a Broker-Dealer
submits an Order for its own account, it would have an advantage over other
Bidders because a Broker-Dealer would have knowledge of the other Orders placed
through it in that Auction and thus could determine the rate and size of its
Order so as to increase the likelihood that (i) its Order will be accepted in
the Auction and (ii) the Auction will clear at a particular rate. For this
reason, and because a Broker-Dealer is appointed and paid by the Fund to serve
as a Broker-Dealer in the auction, a Broker-Dealer's interests in serving as a
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Broker-Dealer in an Auction may differ from those of Existing Holders and
Potential Holders who participate in Auctions. See "Role of Broker-Dealers." A
Broker-Dealer would not have knowledge of Orders submitted to the Auction Agent
by any other firm that is, or may in the future be, appointed to accept Orders
pursuant to a Broker-Dealer Agreement.
The Broker-Dealers are the only Broker-Dealers appointed by the Fund to
serve as a Broker-Dealer in the Auction, and as long as that remains the case,
they will be the only Broker-Dealers that submit Orders to the Auction Agent in
that Auction. As a result, in such circumstances, the Broker-Dealers may discern
the clearing rate before the Orders are submitted to the Auction Agent and set
the clearing rate with their Respective Orders.
A Broker-Dealer may place one or more Bids in an Auction for its own
account to acquire securities for its inventory, to prevent an Auction Failure
(which occurs if there are insufficient clearing bids and results in the auction
rate being set at the Maximum Rate) or to prevent auctions from clearing at a
rate that the Broker-Dealer believes does not reflect the market for the
Preferred Shares. A Broker-Dealer may place such Bids even after obtaining
knowledge of some or all of the other Orders submitted through it. When bidding
in an Auction for its own account, a Broker-Dealer also may Bid inside or
outside the range of rates that it posts in its Price Talk (as defined herein).
See "Price Talk." A Broker-Dealer also may encourage bidding by others in
auctions, including to prevent an Auction Failure or to prevent an Auction from
clearing at a rate that a Broker-Dealer believes does not reflect the market for
the Preferred Shares. A Broker-Dealer may encourage such Bids even after
obtaining knowledge of some or all of the other Orders submitted through it.
Bids by a Broker-Dealer or by those it may encourage to place Bids are
likely to affect (i) the Applicable Rate including preventing the Applicable
Rate from being set at the Maximum Rate or otherwise causing Potential
Beneficial Owners to receive a lower rate than they might have received had a
Broker-Dealer not Bid (or not encouraged others to Bid) and (ii) the allocation
of the Preferred Shares being auctioned, including displacing some Potential
Beneficial Owners who may have their Bids rejected or receive fewer Preferred
Shares than they would have received if a Broker-Dealer had not Bid (or
encouraged others to Bid). Because of these practices, the fact that an Auction
clears successfully does not mean that an investment in the Preferred Shares
involves no significant liquidity or credit risk. A Broker-Dealer is not
obligated to continue to place such Bids (or to continue to encourage other
Bidders to do so) in any particular Auction to prevent an Auction Failure or an
Auction from clearing at a rate a Broker-Dealer believes does not reflect the
market for the Preferred Shares. Investors should not assume that a
Broker-Dealer will place Bids or encourage others to do so or that Auction
Failures will not occur. Investors should also be aware that Bids by a
Broker-Dealer (or by those it may encourage to place Bids) may cause lower
Applicable Rates to occur.
The statements herein regarding Bidding by a Broker-Dealer apply only
to a Broker-Dealer's auction desk and any other business units of a
Broker-Dealer that are not separated from the auction desk by an information
barrier designed to limit inappropriate dissemination of bidding information. In
any particular Auction, if an All Hold Auction results because all outstanding
Preferred Shares of a series are the subject of Submitted Hold Orders, then the
Applicable Rate for the next succeeding Auction Period will be the All Hold
Rate. If a Broker-Dealer holds any Preferred Shares for its own account on an
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Auction Date, the Broker-Dealer may, but is not obligated to, submit a Sell
Order into the Auction with respect to such shares, which would prevent that
Auction from being an All Hold Auction. A Broker-Dealer may, but is not
obligated to, submit Bids for its own account in that same Auction, as set forth
above.
Price Talk. Before the start of an Auction, a Broker-Dealer, in its
discretion, may make available to its customers who are Existing Holders and
Potential Holders a Broker-Dealer's good faith judgment of the range of likely
clearing rates for the Auction based on market and other information. This is
known as "Price Talk." Price Talk is not a guaranty that the Applicable Rate
established through the Auction will be within the Price Talk, and Existing
Holders and Potential Holders are free to use it or ignore it. A Broker-Dealer
occasionally may update and change the Price Talk based on changes in the Fund's
credit quality or macroeconomic factors that are likely to result in a change in
interest rate levels, such as an announcement by the Federal Reserve Board of a
change in the Federal Funds rate or an announcement by the Bureau of Labor
Statistics of unemployment numbers. Potential Holders should confirm with a
Broker-Dealer the manner by which such Broker-Dealer will communicate Price Talk
and any changes to Price Talk.
"All-or-Nothing" Bids. The Broker-Dealers will not accept
"all-or-nothing" Bids (i.e., Bids whereby the bidder proposes to reject an
allocation smaller than the entire quantity Bid) or any other type of Bid that
allows the Bidder to avoid Auction Procedures that require the pro rata
allocation of Preferred Shares where there are not sufficient Sell Orders to
fill all Bids at the Winning Bid Rate.
No Assurances Regarding Auction Outcomes. The Broker-Dealers provide no
assurance as to the outcome of any Auction. The Broker-Dealers also do not
provide any assurance that any Bid will be successful, in whole or in part, or
that the Auction will clear at a rate that a bidder considers acceptable. Bids
may be only partially filled, or not filled at all, and the Applicable Rate on
any Preferred Shares purchased or retained in the Auction may be lower than the
market rate for similar investments.
The Broker-Dealers will not agree before an Auction to buy Preferred
Shares from, or sell Preferred Shares to, a customer after the Auction.
Deadlines. Each particular Auction has a formal deadline by which all
Bids must be submitted by the Broker-Dealers to the Auction Agent. This deadline
is called the "Submission Deadline." To provide sufficient time to process and
submit customer Bids to the Auction Agent before the Submission Deadline, each
Broker-Dealer imposes an earlier deadline for all customers, called the
"Broker-Dealer Deadline," by which bidders must submit Bids to a Broker-Dealer.
The Broker-Dealer Deadline is subject to change by a Broker-Dealer. Potential
Beneficial Owners should consult with their Broker-Dealer as to its
Broker-Dealer Deadline. A Broker-Dealer may allow for correction of clerical
errors after the Broker-Dealer Deadline and prior to the Submission Deadline and
may change Bids it has submitted for its own account at any time until the
Submission Deadline. A Broker-Dealer may submit Bids for its own account at any
time until the Submission Deadline. The Auction Procedures provide that until
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one hour after the Auction Agent completes the dissemination of the results of
an Auction, new Orders can be submitted to the Auction Agent if such Orders were
received by a Broker-Dealer or generated by a Broker-Dealer for its own account
prior to the Submission Deadline and the failure to submit such Orders prior to
the Submission Deadline was the result of force majeure, a technological failure
or a clerical error. In addition, until one hour after the Auction Agent
completes dissemination of the results of an Auction a Broker-Dealer may modify
or withdraw an Order submitted to the Auction Agent prior to the Submission
Deadline if a Broker-Dealer determines that such Order contained a clerical
error. In the event of such a submission, modification or withdrawal, the
Auction Agent will rerun the Auction, if necessary, taking into account such
submission, modification or withdrawal.
Existing Holder's Ability to Resell Preferred Shares May Be Limited. An
Existing Holder may sell, transfer or dispose of a Preferred Share (i) in an
Auction, only pursuant to a Bid or Sell Order in accordance with the Auction
Procedures, or (ii) outside an Auction, only to or through a Broker-Dealer.
Existing Holders will be able to sell all of the Preferred Shares that are the
subject of their Submitted Sell Orders only if there are bidders willing to
purchase all those shares in the Auction. If Sufficient Clearing Bids have not
been made, Existing Holders that have submitted Sell Orders will not be able to
sell in the Auction all, and may not be able to sell any, of the Preferred
Shares subject to such Submitted Sell Orders. As discussed above (See "Bidding
by Broker-Dealers"), a Broker-Dealer may submit a Bid in an Auction to avoid an
Auction Failure, but it is not obligated to do so. There may not always be
enough bidders to prevent an Auction Failure in the absence of bidding by a
Broker-Dealer in the Auction for its own account or encouraging others to Bid.
Therefore, Auction Failures are possible, especially if the Fund's credit were
to deteriorate, if a market disruption were to occur or if, for any reason, a
Broker-Dealer were unable or unwilling to Bid.
Between Auctions, there can be no assurance that a secondary market for
the Preferred Shares will develop or, if it does develop, that it will provide
Existing Holders the ability to resell the Preferred Shares on the terms or at
the times desired by an Existing Holder. A Broker-Dealer, in its own discretion,
may decide to buy or sell the Preferred Shares in the secondary market for its
own account from or to investors at any time and at any price, including at
prices equivalent to, below, or above par for the Preferred Shares. However, a
Broker-Dealer is not obligated to make a market in the Preferred Shares and may
discontinue trading in the Preferred Shares without notice for any reason at any
time. Existing Holders who resell between Auctions may receive an amount less
than par, depending on market conditions.
If an Existing Holder purchased Preferred Shares through a dealer which
is not a Broker-Dealer for the Preferred Shares, such Existing Holder's ability
to sell its Preferred Shares may be affected by the continued ability of its
dealer to transact trades for the Preferred Shares through a Broker-Dealer.
The ability to resell the Preferred Shares of any series will depend on
various factors affecting the market for the Preferred Shares, including news
relating to the Fund, the attractiveness of alternative investments, investor
demand for short term securities, the perceived risk of owning the Preferred
Shares (whether related to credit, liquidity or any other risk), the tax or
accounting treatment accorded the Preferred Shares (including U.S. generally
accepted accounting principles as they apply to the accounting treatment of
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auction rate securities), reactions of market participants to regulatory actions
(such as those described in "Securities and Exchange Commission Settlements"
below) or press reports, financial reporting cycles and market conditions
generally. Demand for the Preferred Shares may change without warning, and
declines in demand may be short-lived or continue for longer periods.
Resignation of the Auction Agent or a Broker-Dealer Could Impact the
Ability to Hold Auctions. The Auction Agent Agreement provides that the Auction
Agent may resign from its duties as Auction Agent by giving the Fund at least 60
days' notice and does not require, as a condition to the effectiveness of such
resignation, that a replacement Auction Agent be in place. The Broker-Dealer
Agreements provide that a Broker-Dealer thereunder may resign upon five days'
notice and does not require, as a condition to the effectiveness of such
resignation, that a replacement Broker-Dealer be in place. For any Auction
Period during which there is no duly appointed Broker-Dealer, it will not be
possible to hold Auctions for the Preferred Shares, with the result that the
distribution rate on the Preferred Shares will be determined as described in the
Statement of Terms.
Securities and Exchange Commission Settlements. On May 31, 2006, the
SEC announced that it had settled its investigation of 15 firms, including
[__________________] (the "Settling Broker-Dealers"), that participate in the
auction rate securities market regarding their respective practices and
procedures in this market. The Securities and Exchange Commission alleged in the
settlement that the firms had managed auctions for auction rate securities in
which they participated in ways that were not adequately disclosed or that did
not conform to disclosed auction procedures. As part of the settlement, the
Settling Broker-Dealers agreed to pay a civil penalty. In addition, each
Settling Broker-Dealer, without admitting or denying the Securities and Exchange
Commission's allegations, agreed to provide to customers written descriptions of
its material auction practices and procedures, and to implement procedures
reasonably designed to detect and prevent any failures by that Settling
Broker-Dealer to conduct the auction process in accordance with disclosed
procedures. No assurance can be provided as to how the settlement may affect the
market for auction rate securities generally or the Preferred Shares.
In addition on January 9, 2007, the Securities and Exchange Commission
announced that it had settled its investigation of three banks, including
[__________________] (the "Settling Auction Agents"), that participate as
auction agents in the auction rate securities market, regarding their respective
practices and procedures in this market. The Securities and Exchange Commission
alleged in the settlement that the Settling Auction Agents allowed
broker-dealers in auctions to submit bids or revise bids after the submission
deadlines and allowed broker-dealers to intervene in auctions in ways that
affected the rates paid on the auction rate securities. As part of the
settlement, the Settling Auction Agents agreed to pay civil penalties. In
addition, each Settling Auction Agent, without admitting or denying the
Securities and Exchange Commission's allegations, agreed to provide to
broker-dealers and issuers written descriptions of its material auction
practices and procedures and to implement procedures reasonably designed to
detect and prevent any failures by that Settling Auction Agent to conduct the
auction process in accordance with disclosed procedures. No assurance can be
offered as to how the settlement may affect the market for auction rate
securities generally or the Preferred Shares.
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DESCRIPTION OF BORROWINGS
The Fund's Declaration of Trust authorizes the Fund, without prior
approval of holders of Common and Preferred Shares, to borrow money. In this
connection, the Fund may issue notes or other evidence of indebtedness
(including bank borrowings or commercial paper) and may secure any such
borrowings by mortgaging, pledging or otherwise subjecting as security the
Fund's assets. In connection with such borrowing, the Fund may be required to
maintain minimum average balances with the lender or to pay a commitment or
other fee to maintain a line of credit. Any such requirements will increase the
cost of borrowing over the stated interest rate. Under the requirements of the
1940 Act, the Fund, immediately after any such borrowings, must have an "asset
coverage" of at least 300% (33-1/3% of Managed Assets after borrowings). With
respect to such borrowing, asset coverage means the ratio which the value of the
total assets of the Fund, less all liabilities and indebtedness not represented
by senior securities (as defined in the 1940 Act), bears to the aggregate amount
of such borrowing represented by senior securities issued by the Fund.
The rights of lenders to the Fund to receive interest on and repayment
of principal of any such borrowings will be senior to those of the Preferred
Shareholders, and the terms of any such borrowings may contain provisions which
limit certain activities of the Fund, including the payment of distributions to
Preferred Shareholders in certain circumstances. Further, the 1940 Act does (in
certain circumstances) grant to the lenders to the Fund certain voting rights in
the event of default in the payment of interest on or repayment of principal. In
the event that such provisions would impair the Fund's status as a regulated
investment company under the Code, the Fund intends to repay the borrowings. Any
borrowing will likely be ranked senior or equal to all other existing and future
borrowings of the Fund.
Certain types of borrowings may result in the Fund being subject to
covenants in credit agreements relating to asset coverage and portfolio
composition requirements. The Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more rating agencies, which may
issue ratings for the short-term corporate debt securities or preferred shares
issued by the Fund. These guidelines may impose asset coverage or portfolio
composition requirements that are more stringent than those imposed by the 1940
Act. It is not anticipated that these covenants or guidelines will impede the
Sub-Adviser from managing the Fund's portfolio in accordance with the Fund's
investment objectives and policies.
Under the 1940 Act, the Fund is not permitted to issue preferred shares
unless immediately after such issuance the value of the Fund's Managed Assets is
at least 200% of the liquidation value of the outstanding preferred shares
(i.e., the liquidation value may not exceed 50% of the Fund's Managed Assets).
In addition, the Fund is not permitted to declare any cash dividend or other
distribution on its Common Shares unless, at the time of such declaration, the
value of the Fund's Managed Assets is at least 200% of such liquidation value.
The Fund intends, to the extent possible, to purchase or redeem preferred shares
from time to time to the extent necessary in order to maintain coverage of any
outstanding preferred shares of at least 200%.
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The Fund may also borrow money as a temporary measure for extraordinary
or emergency purposes, including the payment of dividends and the settlement of
securities transactions which otherwise might require untimely dispositions of
Fund securities.
DESCRIPTION OF COMMON SHARES
The Declaration of Trust authorizes the issuance of an unlimited number
of Common Shares. The Common Shares have a par value of $.01 per share. As of
_______, 2007, there are [ ] Common Shares outstanding. The Board of Trustees
may determine to issue additional Common Shares without shareholder approval.
All Common Shares have equal rights to the payment of dividends and the
distribution of assets upon liquidation. The Common Shares are fully paid and
non-assessable, and have no pre-emptive or conversion rights or rights to
cumulative voting.
If Preferred Shares are outstanding, Common Shareholders will not be
entitled to receive any distributions from the Fund unless all accrued and
payable distributions on Preferred Shares have been paid, and unless asset
coverage, as defined in the 1940 Act, with respect to Preferred Shares is at
least 200% after giving effect to the distributions. Similarly, if borrowings
are outstanding, the Fund may not pay distributions to common or preferred
shareholders unless asset coverage, as defined in the 1940 Act, with respect to
outstanding borrowings is at least 300% after giving effect to the
distributions.
The Fund's Common Shares are traded on the NYSE under the symbol "FGB."
The Fund intends to hold annual meetings of shareholders.
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
General supervision of the duties performed by the Adviser and the
Sub-Adviser is the responsibility of the Board of Trustees. There are five
Trustees of the Fund, one of whom is an "interested person" (as defined in the
1940 Act) and four of whom are not "interested persons." The names and business
addresses of the Trustees and officers of the Fund and their principal
occupations and other affiliations during the past five years are set forth
under "Management of the Fund" in the SAI.
INVESTMENT ADVISER
First Trust Advisors, 1001 Warrenville Road, Suite 300, Lisle, Illinois
60532, is the investment adviser to the Fund and is responsible for selecting,
with the approval of the Board of Trustees, and supervising the Sub-Adviser.
First Trust Advisors serves as investment adviser or portfolio supervisor to
investment portfolios with approximately $32.57 billion in assets which it
managed or supervised as of May 31, 2007.
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First Trust Advisors is also responsible for the ongoing monitoring of
the Fund's investment portfolio, managing the Fund's business affairs and
providing certain clerical, bookkeeping and other administrative services.
First Trust Advisors, a registered investment adviser, is an Illinois
limited partnership formed in 1991 and an investment adviser registered with the
Securities and Exchange Commission under the Investment Advisers Act of 1940
(the "Advisers Act"). First Trust Advisors is a limited partnership with one
limited partner, Grace Partners of DuPage L.P. ("Grace Partners"), and one
general partner, The Charger Corporation. Grace Partners is a limited
partnership with one general partner, The Charger Corporation, and a number of
limited partners. Grace Partners' and The Charger Corporation's primary business
is investment advisory and broker-dealer services through their interests. The
Charger Corporation is an Illinois corporation controlled by the Robert Donald
Van Kampen family. First Trust Advisors is controlled by Grace Partners and The
Charger Corporation.
For additional information concerning First Trust Advisors, including a
description of the services provided, see the SAI.
SUB-ADVISER
Gallatin, a registered investment adviser, is the Sub-Adviser to the
Fund. Gallatin provides asset management and advisory services to high net worth
individuals and institutional investors. Gallatin, organized in 2005, is a
wholly-owned subsidiary of A.G. Edwards, Inc. The majority of Gallatin's
investment personnel previously comprised A.G. Edwards & Sons, Inc.'s Asset
Management Department and the investment team has largely worked together since
1994. Its 13 managers and analysts count more than 180 years of aggregate
investment experience.
Gallatin has approximately $10.3 billion of assets under management as
of May 31, 2007. Of these, approximately $3.1 billion are managed in equity and
investment grade fixed income portfolios. Gallatin also manages approximately
$7.2 billion in portfolios of selected exchange-traded funds ("ETFs") that are
guided by proprietary asset allocation models. These models are driven by the
firm's analysis of cyclical changes within the economy and financial markets
combined with quantitative modeling. Gallatin's advisory arm also employs
investment manager analysts who provide careful selection and monitoring of
mutual funds, unit investment trusts, ETFs and separate account managers.
On May 31, 2007, Wachovia Corp. announced that it had reached an
agreement in principle with A.G. Edwards, Inc. under which Wachovia Corp. will
acquire A.G. Edwards, Inc. Gallatin is a wholly-owned subsidiary of A.G.
Edwards, Inc. Subject to certain regulatory approvals and the approval by the
shareholders of A.G. Edwards, Inc., the Acquisition is expected to be completed
in the fourth quarter of 2007. Depending on the structure and terms of the
Acquisition, the Acquisition, if completed, may result in a change of control of
Gallatin which would constitute an assignment, as that term is defined in the
Investment Company Act of 1940, as amended, of the Sub-Advisory Agreement among
the Fund, Gallatin and First Trust Advisors L.P., the Fund's Adviser, thus
having the effect of automatically terminating the Sub-Advisory Agreement. In
the event of the automatic termination of the Sub-Advisory Agreement, it is
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expected that a new Sub-Advisory Agreement among the Fund, Gallatin and First
Trust Advisors L.P., pursuant to which Gallatin would continue to serve as the
Fund's Sub-Adviser following completion of the Acquisition, would be presented
to the Fund's Board of Trustees and the Fund's shareholders for their approval.
Gallatin will be responsible for the day-to-day management of the
Fund's portfolio utilizing a team of portfolio managers comprised of the
following Gallatin personnel:
MARK A. KELLER, CFA, SENIOR VICE PRESIDENT, CHIEF INVESTMENT OFFICER
Mark Keller serves as senior vice president and chief investment
officer for Gallatin. Since 1994 Mr. Keller has led the Asset Management program
for A.G. Edwards, Inc. and its affiliates and continues in this capacity now as
part of the wholly-owned subsidiary, Gallatin Asset Management. Mr. Keller also
chairs the A.G. Edwards & Sons, Inc. Investment Strategy Committee. Prior to
1994, he served for 15 years in A.G. Edwards & Sons, Inc.'s Securities Research
Department as an analyst covering a variety of industries. During his last five
years in Securities Research, Mr. Keller served as equity strategist and manager
of the firm's Focus List. He has been a CFA charterholder since 1984 and has a
B.A. from Wheaton College (Illinois).
DAVID B. MIYAZAKI, CFA, VICE PRESIDENT, EQUITY PORTFOLIO MANAGER
David Miyazaki serves as a portfolio manager for Gallatin where he
manages equity portfolios with a value discipline. He is also a member of the
A.G. Edwards & Sons, Inc. Investment Strategy Committee, working to establish
and maintain the firm's asset allocation recommendations. Prior to joining A.G.
Edwards & Sons, Inc. in 1999, Mr. Miyazaki managed a short-term interest rate
arbitrage portfolio while at Koch Industries from 1996 to 1999. He worked as an
analyst for Prudential Capital's private placement group from 1994 to 1996 and
traded mortgage-backed securities for a boutique firm in Dallas, Texas, from
1991 to 1993. Mr. Miyazaki has been a CFA charterholder since 1995. He graduated
from Texas Christian University with a B.A. in business administration.
DANIEL T. WINTER, CFA, VICE PRESIDENT, EQUITY PORTFOLIO MANAGER
Dan Winter serves as a portfolio manager for Gallatin where he manages
equity portfolios with a value discipline. He has served A.G. Edwards, Inc. and
its affiliates in an equity portfolio manager capacity since 1992, first for
A.G. Edwards Trust Co., then with A.G. Edwards & Sons, Inc.'s Asset Management
department and continues in this capacity now as part of the wholly-owned
subsidiary, Gallatin Asset Management. During his tenure with A.G. Edwards Trust
Co., Mr. Winter specialized in the management of a variety of portfolios,
including charitable remainder trusts, foundations, endowments, employee
benefits, and rabbi and personal trusts; in 1996 he formally joined the Asset
Management department. He also directs the daily trading for the equity
portfolios. Mr. Winter has been a CFA charterholder since 1995. He earned a B.A.
in business management with a finance concentration from Eckerd College (St.
Petersburg, Florida) and an M.B.A. from Saint Louis University.
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For additional information concerning Gallatin, including a description
of the services provided, and additional information about the Fund's portfolio
managers, including portfolio managers' compensation, other accounts managed by
the portfolio managers, and the portfolios managers' ownership of Fund shares,
see "Sub-Adviser" in the SAI.
INVESTMENT MANAGEMENT AGREEMENT
Pursuant to an investment management agreement between the Adviser and
the Fund, the Fund has agreed to pay a fee for the services and facilities
provided by the Adviser at the annual rate of 1.00% of Managed Assets.
For purposes of calculation of the management fee, the Fund's "Managed
Assets" means the average daily gross asset value of the Fund (including assets
attributable to the Fund's Preferred Shares, if any, and the principal amount of
borrowings, if any), minus the sum of the Fund's accrued and unpaid dividends on
any outstanding Preferred Shares and accrued liabilities (other than the
principal amount of any borrowings incurred, commercial paper or notes issued by
the Fund). For purposes of determining Managed Assets, the liquidation
preference of the Preferred Shares is not treated as a liability.
In addition to the management fee, the Fund pays all other costs and
expenses of its operations including the compensation of its Trustees (other
than those affiliated with the Adviser), custodian, transfer agency,
administrative, accounting and distribution disbursing expenses, legal fees,
leverage expenses, rating agency fees, listing fees and expenses, expenses of
the independent registered public accounting firm, expenses of repurchasing
Common Shares, expenses of preparing, printing and distributing Shareholder
reports, notices, proxy statements and reports to governmental agencies and
taxes, if any.
The Sub-Adviser receives a portfolio management fee at the annual rate
of 0.50% of Managed Assets, which is paid by the Adviser out of the Adviser's
management fee.
A discussion regarding the basis for the approval of the Investment
Management Agreement and Sub-Advisory Agreement by the Board of Trustees will be
available in the Fund's initial semi-annual report to shareholders, for the
period ending May 31, 2007.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS
Under Massachusetts law, shareholders, in certain circumstances, could
be held personally liable for the obligations of the Fund. However, the
Declaration of Trust contains an express disclaimer of shareholder liability for
debts or obligations of the Fund and requires that notice of such limited
liability be given in each agreement, obligation or instrument entered into or
executed by the Fund or the Board of Trustees. The Declaration of Trust further
provides for indemnification out of the assets and property of the Fund for all
loss and expense of any shareholder held personally liable for the obligations
of the Fund. In addition, the Fund will assume the defense of any claim against
a shareholder for personal liability at the request of the shareholder. Thus,
the risk of a shareholder incurring financial loss on account of shareholder
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liability is limited to circumstances in which the Fund would be unable to meet
its obligations. The Fund believes that the likelihood of such circumstances is
remote.
The Declaration of Trust requires a shareholder vote only on those
matters where the 1940 Act or the Fund's listing with an exchange require a
shareholder vote, but otherwise permits the Trustees to take actions without
seeking the consent of shareholders. For example, the Declaration of Trust gives
the Trustees broad authority to approve reorganizations between the Fund and
another entity, such as another closed-end fund, and the sale of all or
substantially all of its assets without shareholder approval if the 1940 Act
would not require such approval. Notwithstanding the foregoing, the Declaration
of Trust permits the Trustees to establish separate voting powers of the
Preferred Shares. See "Description of Preferred Shares -- Voting Rights" above.
The Declaration of Trust further provides that the Trustees may amend
the Declaration of Trust in any respect without shareholder approval. The
Declaration of Trust, however, prohibits amendments that impair the exemption
from personal liability granted in the Declaration of Trust to persons who are
or have been shareholders, Trustees, officers or, employees of the Fund or that
limit the rights to indemnification or insurance provided in the Declaration of
Trust with respect to actions or omissions of persons entitled to
indemnification under the Declaration of Trust prior to the amendment. The
Declaration of Trust and By-Laws include provisions that could limit the ability
of other entities or persons to acquire control of the Fund or to convert the
Fund to open-end status. The number of Trustees is currently five, but by action
of two-thirds of the Trustees, the Board may from time to time be increased or
decreased. The Board of Trustees is divided into three classes of trustees
serving staggered three-year terms, with the terms of one class expiring at each
annual meeting of shareholders. Subject to applicable provisions of the 1940
Act, vacancies on the Board of Trustees may be filled by a majority action of
the remaining Trustees. Such provisions may work to delay a change in the
majority of the Board of Trustees. The provisions of the Declaration of Trust
relating to the election and removal of Trustees may be amended only by a vote
of two-thirds of the Trustees then in office.
Generally, the Declaration of Trust requires a vote by holders of at
least two-thirds of the Common Shares and preferred shares, if any, voting
together as a single class, except as described below and in the Declaration of
Trust, to authorize:
(1) a conversion of the Fund from a closed-end to an open-end
investment company; (2) a merger or consolidation of the Fund with any
corporation, association, trust or other organization, including a series or
class of such other organization (in the limited circumstances where a vote by
shareholders is otherwise required under the Declaration of Trust); (3) a sale,
lease or exchange of all or substantially all of the Fund's assets (in the
limited circumstances where a vote by shareholders is otherwise required under
the Declaration); (4) in certain circumstances, a termination of the Fund; (5) a
removal of Trustees by Common shareholders; or (6) certain transactions in which
a Principal Shareholder (as defined in the Declaration of Trust) is a party to
the transaction. However, with respect to (1) above, if there are preferred
shares outstanding, the affirmative vote of the holders of two-thirds of the
preferred shares voting as a separate class shall also be required. With respect
to (2) above, except as otherwise may be required, if the transaction
constitutes a plan of reorganization which adversely affects preferred shares,
if any, then an affirmative vote of two-thirds of the preferred shares,
including the Preferred Shares, voting together as a separate class is required
as well. With respect to (1) through (3), if such transaction has already been
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authorized by the affirmative vote of two-thirds of the Trustees, then the
affirmative vote of the majority of the outstanding voting securities, as
defined in the 1940 Act (a "Majority Shareholder Vote"), is required, provided
that when only a particular class is affected (or, in the case of removing a
Trustee, when the Trustee has been elected by only one class), only the required
vote of the particular class will be required. Such affirmative vote or consent
shall be in addition to the vote or consent of the holders of the Fund's shares
otherwise required by law or any agreement between the Fund and any national
securities exchange. See the SAI under "Certain Provisions in the Declaration of
Trust and By-Laws."
The provisions of the Declaration of Trust described above could have
the effect of depriving the shareholders of opportunities to sell their Common
Shares at a premium over the then current market price of the Common Shares by
discouraging a third party from seeking to obtain control of the Fund in a
tender offer or similar transaction. The overall effect of these provisions is
to render more difficult the accomplishment of a merger or the assumption of
control by a third party. They provide, however, the advantage of potentially
requiring persons seeking control of the Fund to negotiate with its management
regarding the price to be paid and facilitating the continuity of the Fund's
investment objectives and policies. The Board of Trustees of the Fund has
considered the foregoing anti-takeover provisions and concluded that they are in
the best interests of the Fund.
The Declaration of Trust also provides that prior to bringing a
derivative action, a demand must first be made on the Trustees by three
unrelated shareholders that hold shares representing at least 5% of the voting
power of the Fund or affected class. The Declaration of Trust 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 shareholders may not proceed with the derivative
action unless the shareholders are 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. If a
demand is rejected, the complaining shareholders 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 of Trust, the
shareholders bringing the action may be responsible for the Fund's costs,
including attorney's fee. The Declaration of Trust also includes a forum
selection clause requiring that any shareholder litigation be brought in certain
courts in Illinois and further provides that any shareholder bringing an action
against the Fund waive the right to trial by jury to the fullest extent
permitted by law.
Reference should be made to the Declaration of Trust on file with the
Securities and Exchange Commission for the full text of these provisions.
REPURCHASE OF FUND SHARES
The Fund is a closed-end investment company and therefore shareholders
do not have the right to cause the Fund to redeem their Common Shares. The Fund
may repurchase Common Shares on the open market in accordance with the 1940 Act
and the rules and regulations thereunder, but the Fund is under no obligation to
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do so. Any determination to repurchase Common Shares would reduce the asset
coverage for the Preferred Shares and might make it necessary or desirable for
the Fund to redeem Preferred Shares. As described above in "Description of
Preferred Shares--Distributions and Rate Periods--Distribution Restrictions,"
the repurchase of Common Shares may be restricted or prohibited at times when
there exists accumulated and unpaid distributions on the Preferred Shares.
FEDERAL TAX MATTERS
This section summarizes some of the main U.S. federal income tax
consequences of owning and disposing of Preferred Shares. 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 broker/dealer, or other investor with
special circumstances. In addition, this section does not describe your state,
local or foreign tax consequences.
This federal income tax summary is based in part on the advice of
counsel to the Fund. The Internal Revenue Service could disagree with any
conclusions set forth in this section. In addition, the Fund's counsel was not
asked to review, and has not reached a conclusion with respect to, the federal
income tax treatment of the assets held by 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.
The Fund intends to qualify annually and to elect to be treated as a
regulated investment company ("RIC") under the Code and to comply with
applicable distribution requirements so that it will not pay federal income tax
on income and capital gains distributed to its Preferred Shareholders.
The Preferred Shares will constitute stock, and distributions by the
Fund with respect to the Preferred Shares (other than distributions in
redemption of Preferred Shares that are treated as exchanges of stock under
Section 302(b) of the Code) will constitute dividends to the extent of the
Fund's current and accumulated earnings and profits as calculated for federal
income tax purposes. It is possible, however, that the Internal Revenue Service
might take a contrary position, asserting, for example, that the Preferred
Shares constitute debt. If this position were upheld, the discussion of the
treatment of distributions below would not apply. Instead, distributions to you
would constitute interest, whether or not they exceeded the Fund's earnings and
profits, would be included in full in your income, and would be taxed as
ordinary income. The Fund's counsel believes that such a position, if asserted
by the Internal Revenue Service, would be unlikely to be upheld by a competent
court.
To qualify for the favorable U.S. federal income tax treatment
generally accorded to RICs, 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, other income derived
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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 value of the Fund's total assets is
represented by cash and cash items (including receivables), U.S. government
securities, the securities of other RICs 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, 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 (c) 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.
The IRS currently requires that a RIC that has two or more classes of
stock disregard disproportionate allocations between such classes of each type
of its income (such as ordinary income and capital gains) and instead allocate
to each such class proportionate amounts of each type of its income based upon
the percentage of total dividends distributed to each class for the taxable
year. Accordingly, the Fund intends each taxable year to allocate capital gain
dividends for tax purposes among the Common Shares and the Preferred Shares in
proportion to the total dividends paid to each class during or with respect to
such year. In order to satisfy both the 1940 Act requirement that capital gains
dividends be distributed only once (or, under certain circumstances, twice) per
year and the federal income tax requirements, the Fund may under certain
circumstances be forced to retain capital gains and pay tax on those retained
gains at the Fund level, all without the benefit of deemed gain distributions
and deemed tax credits to the Fund's shareholders; in addition, the Fund's
shareholders may be treated as having received ordinary income dividends in
respect of the retained capital gains. In short, compliance with both the 1940
Act and the RIC federal income tax requirements may result in double taxation of
gains that the Fund has to retain and pay tax on, or alternatively, the Fund may
accelerate capital losses and defer capital gains, even if this would be
contrary to the Fund's otherwise desired investment objectives, in an attempt to
minimize the net capital gains that could become subject to double taxation.
In addition, also because of the 1940 Act limitations on when capital
gain dividends may be distributed, shareholders who hold Shares on the
ex-dividend date for a capital gains dividend will be entitled to a capital
gains dividend, but shareholders who hold shares at other times during the year
(but not on the capital gains ex-dividend date) would not be entitled to a
capital gains dividend.
As a RIC, 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
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loss), if any, that it distributes to its shareholders. The Fund intends to
distribute to its shareholders, at least annually, substantially all of its
investment company taxable income and net capital gain. If the Fund retains any
net capital gain or investment company taxable income, it will generally be
subject to federal income tax at regular corporate rates on the amount retained.
In addition, amounts not distributed on a timely basis in accordance with a
calendar year distribution requirement are subject to a nondeductible 4% excise
tax unless, generally, the Fund distributes during each calendar year an amount
equal to the sum of (1) at least 98% of its ordinary income (not taking into
account any capital gains or losses) for the calendar year, (2) at least 98% 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. 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. These distributions will be taxable to
Preferred Shareholders in the calendar year in which the distributions are
declared, rather than the calendar year in which the distributions are received.
If the Fund failed to qualify as a RIC or failed to satisfy the 90%
distribution requirement in any taxable year, the Fund would be taxed as an
ordinary corporation on its taxable income (even if such income were distributed
to its shareholders) and all distributions out of earnings and profits would be
taxed to Preferred Shareholders as dividend income, which, in general and
subject to limitations under the Code, under current law would constitute
qualified dividend income in the case of individual Preferred Shareholders and
would be eligible for the corporate dividends received deduction.
DISTRIBUTIONS
Distributions paid out of the Fund's investment company taxable income
(computed without regard to deduction for distributions paid) generally are
taxable to a Preferred Shareholder as ordinary income to the extent of the
Fund's earnings and profits. However, certain ordinary income distributions that
are specifically designated by the Fund may constitute qualified dividend income
eligible for taxation at capital gains tax rates. In particular, a portion of
the ordinary income distributions received by an individual shareholder from a
RIC such as the Fund are generally taxed at the same rates that apply to net
capital gain (generally, a maximum rate of 15%), provided certain holding period
requirements are satisfied and provided the distributions are attributable to
qualified dividend income received by the Fund itself. Dividends received by the
Fund from REITs and foreign corporations are treated as qualified dividend
income only in certain circumstances. Distributions paid out of the Fund's
investment company taxable income that are not attributable to qualified
dividend income received by the Fund itself are not taxed to individual
Preferred Shareholders at the same rates that apply to net capital gain but are
generally taxed at the Preferred Shareholder's higher ordinary tax rate.
These special rules relating to the taxation of ordinary income
dividends from RICs generally apply to taxable years beginning before January 1,
2011.
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Distributions of net capital gain (the excess of net long-term capital
gain over net short-term capital loss), if any, properly designated as capital
gain dividends are taxable to a shareholder as long-term capital gains,
regardless of how long the shareholder has held Fund shares. 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 tax basis in his or her shares. To the extent that
the amount of any 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.
Preferred Shareholders will be notified annually as to the U.S. federal
income tax status of distributions.
DIVIDENDS RECEIVED DEDUCTION
A corporation that owns shares will generally be entitled to the 70%
dividends received deduction with respect to a portion of the dividends received
from the Fund.
SALE OF FUND SHARES
Upon the sale or other disposition of shares of the Fund, which a
shareholder holds as a capital asset, 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 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 this 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 net capital gain received by the shareholder with respect to
the shares.
NATURE OF THE FUND'S INVESTMENTS
Certain of the Fund's investment practices may be subject to special
and complex federal income tax provisions that may, among other things, (1)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (2) convert lower taxed long-term capital gain into higher taxed
short-term capital gain or ordinary income, (3) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited), (4)
cause the Fund to recognize income or gain without a corresponding receipt of
cash, (5) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur and (6) adversely alter the characterization of
certain complex financial transactions. The Fund will monitor its transactions,
will make the appropriate tax elections and take appropriate actions in order to
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mitigate the effect of these rules and prevent disqualification of the Fund from
being taxed as a regulated investment company (including disposing of certain
investments to generate cash or borrowing cash to satisfy its distribution
requirements).
INVESTMENT IN SECURITIES OF UNCERTAIN TAX CHARACTER
The Fund may invest in preferred securities or other securities the
U.S. federal income tax treatment of which may not be clear or may be subject to
recharacterization by the Internal Revenue Service. To the extent the tax
treatment of such securities or the income from such securities differs from the
tax treatment expected by the Fund, it could affect the timing or character of
income recognized by the Fund, requiring the Fund to purchase or sell
securities, or otherwise change its portfolio, in order to comply with the tax
rules applicable to regulated investment companies under the Code.
BACKUP WITHHOLDING
The Fund may be required to withhold U.S. federal income tax from all
taxable distributions and sale proceeds payable to shareholders who fail to
provide the Fund with their correct taxpayer identification number or to make
required certifications, or who have been notified by the Internal Revenue
Service that they are subject to backup withholding. The withholding percentage
is 28% until 2011, when the percentage will revert to 31% unless amended by
Congress. Corporate shareholders and certain other shareholders specified in the
Code generally are exempt from 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, for United States federal income
tax purposes, 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.
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 U.S. tax of 30% (or lower treaty rate), which tax is generally
withheld from such distributions, subject to certain exceptions described below.
Distributions of capital gain dividends and any amounts retained by the
Fund which are designated as undistributed capital gains will not be subject to
U.S. tax at the rate of 30% (or lower treaty rate) unless the non-U.S.
shareholder is a nonresident alien individual and is physically present in the
United States for 183 or more days during the taxable year and meets certain
other requirements. However, this 30% tax (or lower rate under an applicable
treaty) on capital gains of nonresident alien individuals who are physically
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present in the United States for 183 or more days only applies in exceptional
cases because any individual present in the United States for 183 or more 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. 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 183 or more days during the taxable year and meets certain other
requirements. In the case of dividends with respect to taxable years of the Fund
beginning after 2004 and prior to 2008, distributions from the Fund that are
properly designated by the Fund as short-term capital gain dividends
attributable to certain short-term capital gains recognized by the Fund are
subject to similar rules.
In the case of dividends with respect to taxable years of the Fund
beginning after 2004 and prior to 2008, distributions from the Fund that are
properly designated by the Fund as interest-related dividends attributable to
certain interest received by the Fund may not be subject to U.S. federal income
tax when received by certain non-U.S. shareholders, provided the Fund makes
certain elections and certain conditions are met.
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 designated 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.
ALTERNATIVE MINIMUM TAX
As with any taxable investment, investors may be subject to the federal
alternative minimum tax on their income (including taxable income from the
fund), depending on their individual circumstances.
UNDERWRITING
The Underwriters named below, acting through A.G. Edwards & Sons, Inc.,
as lead manager and ___________ as their representatives (including A.G. Edwards
- 96 -
& Sons, Inc., the "Representatives"), have severally agreed, subject to the
terms and conditions of the underwriting agreement with the Fund, First Trust
Advisors and Gallatin Asset Management (the "Underwriting Agreement"), to
purchase from the Fund the number of Preferred Shares set forth below opposite
their respective names.
UNDERWRITER NUMBER OF NUMBER OF
SHARES SHARES
SERIES [ ] SERIES [ ]
A.G. Edwards & Sons, Inc. ......................
[_________].....................................
Total .....................................
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions, including the absence of any
materially adverse change in the Fund's business and the receipt of certain
certificates, opinions and letters from the Fund and the Fund's attorneys and
independent registered public accounting firm. The nature of the Underwriters'
obligation is such that they are committed to purchase all Preferred Shares
offered hereby if they purchase any Preferred Shares.
The Representatives have advised the Fund that the Underwriters propose
to offer some Preferred Shares directly to investors at the offering price of
$25,000 per Preferred Share, and may offer some Preferred Shares to certain
dealers at the offering price less a concession not in excess of $[ ] per
Preferred Share, and such dealers may reallow a concession not in excess of $[ ]
per Preferred Share on sales to certain other dealers. The sales load the Fund
will pay of $250.00 per share is equal to 1.00% of the initial offering price.
Preferred Shares are offered by the Underwriters, subject to prior sale, when,
as and if delivered to and accepted by the Underwriters, and subject to their
right to reject orders in whole or in part.
The Fund, First Trust Advisors and Gallatin Asset Management have each
agreed to indemnify the Underwriters for or to contribute to the losses arising
out of certain liabilities, including liabilities under the Securities Act.
The Fund anticipates that the Representatives and certain other
Underwriters may from time to time act as brokers or dealers in connection with
the execution of portfolio transactions after they have ceased to be an
Underwriter and, subject to certain restrictions, may so act while they are
Underwriters.
The Fund anticipates that the Underwriters or their respective
affiliates may, from time to time, act in Auctions as a Broker-Dealers and
receive fees as set forth under "The Auction" and in the SAI under "Additional
Information Concerning Auctions for Preferred Shares." The Underwriters are
active underwriters of, and dealers in securities and act as market makers in a
number of such securities, and therefore can be expected to engage in portfolio
transactions with, and perform services for, the Fund.
In connection with this offering, the Underwriters or selected dealers
may distribute prospectuses electronically.
The settlement date for the purchase of Preferred Shares will be
, 2007 as agreed upon by the Underwriters, the Fund, First Trust
Advisors and Gallatin Asset Management pursuant to Rule 15c6-1 under the
Securities Exchange Act of 1934, as amended.
- 97 -
On May 31, 2007, Wachovia Corp. announced that it had reached an
agreement in principle with A.G. Edwards, Inc. under which Wachovia Corp. will
acquire A.G. Edwards, Inc. A.G. Edwards & Sons, Inc. is a wholly-owned
subsidiary of A.G. Edwards, Inc.
Gallatin Asset Management, Inc., a wholly-owned subsidiary of A.G.
Edwards, Inc., also serves as the Fund's Sub-Adviser and receives compensation
for its services. See "Risks--Certain Affiliations" and "Management of the
Fund."
The address of the lead managing underwriter is A.G. Edwards & Sons,
Inc., One North Jefferson Avenue, St. Louis, Missouri 63108.
CORPORATE FINANCE SERVICES AND CONSULTING AGREEMENT
First Trust Advisors (and not the Fund) has entered into a Corporate
Finance Services and Consulting Agreement with A.G. Edwards & Sons, Inc. and has
agreed to pay from its own assets a Service Fee to A.G. Edwards & Sons, Inc.
This Service Fee will be payable quarterly at the annual rate of 0.15% of the
Fund's average daily net assets and will be payable only so long as the
Investment Management Agreement remains in effect between the Fund and First
Trust Advisors or any successor in interest or affiliate of First Trust
Advisors, as and to the extent that such Investment Management Agreement is
renewed or continued periodically in accordance with the 1940 Act. Pursuant to
the Corporate Finance Services and Consulting Agreement, A.G. Edwards & Sons,
Inc. will: (i) provide relevant information, studies or reports regarding
closed-end investment companies with similar investment objectives and/or
strategies as the Fund as well as general trends in the closed-end investment
company and asset management industries, and consult with representatives of
First Trust Advisors in connection therewith; (ii) at the request of First Trust
Advisors, provide certain economic research and statistical information and
reports on behalf of First Trust Advisors or the Fund and consult with
representatives of First Trust Advisors or the Fund, and/or Trustees of the Fund
in connection therewith, which information and reports shall include: (a)
statistical and financial market information with respect to the Fund's market
performance; and (b) comparative information regarding the Fund and other
closed-end management investment companies with respect to (x) the NAV of their
respective shares (as made publicly available by the Fund and such investment
companies), (y) the respective market performance of the Fund and such other
companies, and (z) other relevant performance indicators; and (iii) provide
First Trust Advisors with such other services in connection with the Common
Shares relating to the trading price and market price thereof upon which First
Trust Advisors and A.G. Edwards & Sons, Inc. shall, from time to time, agree,
including after-market services designed to maintain the visibility of the Fund
in the market.
ADMINISTRATOR, CUSTODIAN, FUND ACCOUNTANT AND TRANSFER AGENTS
The custodian of the assets of the Fund is PFPC Trust Company, 8800
Tinicum Blvd., 3rd Floor, Philadelphia, Pennsylvania 19153. The Fund's transfer,
shareholder services and dividend paying agent with respect to the Common Shares
is PFPC Inc., 4400 Computer Dr., Westboro, Massachusetts 01581. Pursuant to an
Administration and Accounting Services Agreement, PFPC Inc. also provides
certain administrative and accounting services to the Fund, including
- 98 -
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. PFPC Trust
Company and PFPC Inc., are both members of The PNC Financial Services Group,
Inc. As compensation for these services, the Fund has agreed to pay PFPC Inc. an
annual fee, calculated daily and payable on a monthly basis, of 0.10% of the
Fund's average net assets, subject to decrease with respect to additional Fund
net assets. The Fund's transfer agent, registrar and distribution paying agent
with respect to the Preferred Shares is _________, _________.
LEGAL OPINIONS
Certain legal matters in connection with the Preferred Shares will be
passed upon for the Fund by Chapman and Cutler LLP, Chicago, Illinois, and for
the Underwriters by Skadden, Arps, Slate, Meagher & Flom LLP, Chicago, Illinois.
Chapman and Cutler LLP may rely as to certain matters of Massachusetts law on
the opinion of Bingham McCutchen LLP.
- 99 -
TABLE OF CONTENTS OF STATEMENT OF ADDITIONAL INFORMATION
Page
INVESTMENT OBJECTIVES...................................................................................1
INVESTMENT RESTRICTIONS.................................................................................1
INVESTMENT POLICIES AND TECHNIQUES......................................................................3
ADDITIONAL INFORMATION ABOUT THE FUND'S INVESTMENTS AND INVESTMENT RISKS................................6
OTHER INVESTMENT POLICIES AND TECHNIQUES...............................................................13
MANAGEMENT OF THE FUND.................................................................................19
INVESTMENT ADVISER.....................................................................................25
PROXY VOTING POLICIES AND PROCEDURES...................................................................27
SUB-ADVISER............................................................................................27
PORTFOLIO TRANSACTIONS AND BROKERAGE...................................................................31
DESCRIPTION OF SHARES..................................................................................33
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS OF THE PREFERRED SHARES.................................35
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS.............................................40
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND.................................................43
FEDERAL INCOME TAX MATTERS.............................................................................45
PERFORMANCE RELATED AND COMPARATIVE INFORMATION........................................................51
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM..........................................................54
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT...........................................54
ADDITIONAL INFORMATION.................................................................................54
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM................................................56
FINANCIAL STATEMENTS...................................................................................57
APPENDIX A -- DESCRIPTION OF RATINGS................................................................A-1
APPENDIX B -- GALLATIN ASSET MANAGEMENT, INC. PROXY VOTING GUIDELINES...............................B-1
APPENDIX C -- STATEMENT ESTABLISHING AND FIXING THE RIGHTS AND PREFERENCES OF
SERIES__ AUCTION PREFERRED SHARES AND SERIES __ AUCTION PREFERRED SHARES..............C-1
- 100 -
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN OR INCORPORATED BY
REFERENCE INTO THIS PROSPECTUS. THE FUND HAS NOT AUTHORIZED ANYONE TO PROVIDE
YOU WITH DIFFERENT INFORMATION. THE FUND IS NOT MAKING AN OFFER TO SELL THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED. YOU
SHOULD NOT ASSUME THAT THE INFORMATION IN THIS PROSPECTUS IS ACCURATE AS OF ANY
DATE OTHER THAN THE DATE ON THE COVER PAGE OF THIS PROSPECTUS.
TABLE OF CONTENTS
PAGE
Prospectus Summary................................................1
Financial Highlights.............................................25
The Fund.........................................................26
Use of Proceeds..................................................26
Capitalization...................................................27
Risks............................................................28
The Fund's Investments...........................................48
Description of Preferred Shares..................................62
The Auction......................................................76
Description of Borrowings........................................84
Description of Common Shares.....................................85
Management of The Fund...........................................85
Certain Provisions In The Declaration of Trust and By-Laws.......88
Repurchase of Fund Shares........................................90
Federal Tax Matters..............................................91
Underwriting.....................................................96
Corporate Finance Services And Consulting Agreement..............98
Administrator, Custodian, Fund Accountant and Transfer Agents....98
Legal Opinions...................................................99
Table of Contents of the Statement of Additional Information....100
FIRST TRUST/GALLATIN
SPECIALTY FINANCE &
FINANCIAL OPPORTUNITIES FUND
PREFERRED SHARES
____ SHARES, SERIES [ ]
_____SHARES, SERIES [ ]
PROSPECTUS
A.G. EDWARDS
, 2007
Back Cover
The information in this Statement of Additional Information is not complete and
may be changed. We may not sell securities until the registration statement
filed with the Securities and Exchange Commission is effective. This Statement
of Additional Information is not an offer to sell these securities and is not
soliciting an offer to buy these securities in any state where the offer or sale
is not permitted.
SUBJECT TO COMPLETION, DATED JUNE 13, 2007
FIRST TRUST/GALLATIN SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
AUCTION PREFERRED SHARES
Series _____
Series _____
STATEMENT OF ADDITIONAL INFORMATION
First Trust /Gallatin Specialty Finance and Financial Opportunities Fund
(the "Fund") is a recently organized, closed-end, non-diversified management
investment company.
This Statement of Additional Information relating to Series _ Auction
Preferred Shares and Series __ Auction Preferred Shares, each of beneficial
interest of the Fund (the "Preferred Shares"), is not a prospectus, but should
be read in conjunction with the Fund's Prospectus dated , 2007 (the
"Prospectus"). This Statement of Additional Information does not include all
information that a prospective investor should consider before purchasing
Preferred Shares. Investors should obtain and read the Prospectus prior to
purchasing such Shares. A copy of the Fund's Prospectus may be obtained without
charge by calling (800) 988-5891. You also may obtain a copy of the Prospectus
on the Securities and Exchange Commission's web site (http://www.sec.gov).
Capitalized terms used but not defined in this Statement of Additional
Information have the meanings ascribed to them in the Prospectus.
This Statement of Additional Information is dated _______, 2007.
TABLE OF CONTENTS
Page
INVESTMENT OBJECTIVES...................................................................................1
INVESTMENT RESTRICTIONS.................................................................................1
INVESTMENT POLICIES AND TECHNIQUES......................................................................3
ADDITIONAL INFORMATION ABOUT THE FUND'S INVESTMENTS AND INVESTMENT RISKS................................6
OTHER INVESTMENT POLICIES AND TECHNIQUES...............................................................13
MANAGEMENT OF THE FUND.................................................................................19
INVESTMENT ADVISER.....................................................................................25
PROXY VOTING POLICIES AND PROCEDURES...................................................................27
SUB-ADVISER............................................................................................27
PORTFOLIO TRANSACTIONS AND BROKERAGE...................................................................31
DESCRIPTION OF SHARES..................................................................................33
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS OF THE PREFERRED SHARES.................................35
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS.............................................40
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND.................................................43
FEDERAL INCOME TAX MATTERS.............................................................................45
PERFORMANCE RELATED AND COMPARATIVE INFORMATION........................................................51
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM..........................................................54
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT...........................................54
ADDITIONAL INFORMATION.................................................................................54
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM................................................56
FINANCIAL STATEMENTS...................................................................................57
APPENDIX A -- DESCRIPTION OF RATINGS................................................................A-1
APPENDIX B -- GALLATIN ASSET MANAGEMENT, INC. PROXY VOTING GUIDELINES...............................B-1
APPENDIX C -- STATEMENT ESTABLISHING AND FIXING THE RIGHTS AND PREFERENCES OF
SERIES__ AUCTION PREFERRED SHARES AND SERIES __ AUCTION PREFERRED SHARES..............C-1
INVESTMENT OBJECTIVES
Investment Objectives. The Fund's primary investment objective is to
seek a high level of current income. The Fund seeks attractive total return as a
secondary objective. There can be no assurance that the Fund's investment
objectives will be achieved.
The Fund will seek to achieve its investment objectives by investing at
least 80% of its Managed Assets in a portfolio of securities of specialty
finance and other financial companies that Gallatin Asset Management, Inc.
("Gallatin" or "Sub-Adviser") believes offer attractive opportunities for income
and capital appreciation. Under normal market conditions, the Fund will
concentrate its investments in securities of companies within industries in the
financial sector. The concentration of the Fund's assets in a group of
industries is likely to present more risks than a fund that is broadly
diversified over several industries.
Percentage limitations described in this Statement of Additional
Information are as of the time of investment by the Fund and may be exceeded on
a going-forward basis as a result of market value fluctuations of the Fund's
portfolio and other events.
The Common Shares may trade at a discount or premium to net asset value
("NAV"). An investment in the Fund may not be appropriate for all investors and
is not intended to be a complete investment program. No assurance can be given
that the Fund will achieve its investment objectives. For further discussion of
the Fund's portfolio composition and associated special risk considerations, see
"The Fund's Investments" and "Risks" in the Prospectus.
INVESTMENT RESTRICTIONS
The Fund's investment objectives and certain investment policies of the
Fund are described in the Prospectus. The Fund, as a fundamental policy, may
not:
1. Purchase any security if, as a result of the purchase, 25% or
more of the Fund's total assets (taken at current value) would be
invested in the securities of borrowers and other issuers having their
principal business activities in the same industry; provided, that this
limitation shall not apply with respect to securities of companies
within industries in the financial sector or obligations issued or
guaranteed by the U.S. government or by its agencies or
instrumentalities;
2. Borrow money, except as permitted by the Investment Company
Act of 1940, as amended (the "1940 Act"), the rules thereunder and
interpretations thereof or pursuant to a Securities and Exchange
Commission exemptive order;
3. Issue senior securities, as defined in the 1940 Act, other
than: (i) Preferred Shares which immediately after issuance will have
asset coverage of at least 200%; (ii) indebtedness which immediately
after issuance will have asset coverage of at least 300%; (iii) the
borrowings permitted by investment restriction 2 above; or (iv) pursuant
to a Securities and Exchange Commission exemptive order;
4. Make loans of funds or other assets, other than by entering
into repurchase agreements, lending portfolio securities and through the
purchase of debt securities in accordance with its investment
objectives, policies and limitations;
5. Act as underwriter of another issuer's securities, except to
the extent that the Fund may be deemed to be an underwriter within the
meaning of the Securities Act of 1933 in connection with the purchase
and sale of portfolio securities;
6. Purchase or sell real estate, but this shall not prevent the
Fund from investing in securities of companies that deal in real estate
or are engaged in the real estate business, including real estate
investment trusts, and securities secured by real estate or interests
therein and the Fund may hold and sell real estate or mortgages on real
estate acquired through default, liquidation, or other distributions of
an interest in real estate as a result of the Fund's ownership of such
securities; and
7. Purchase or sell physical commodities unless acquired as a
result of ownership of securities or other instruments (but this shall
not prevent the Fund from purchasing or selling options, futures
contracts or derivative instruments or from investing in securities or
other instruments backed by physical commodities).
Except as noted above, the foregoing fundamental investment policies,
together with the investment objectives of the Fund, cannot be changed without
approval by holders of a majority of the outstanding voting securities of the
Fund, as defined in the 1940 Act, which includes Common Shares and Preferred
Shares, if any, voting together as a single class, and of the holders of the
outstanding Preferred Shares voting as a single class. Under the 1940 Act a
"majority of the outstanding voting securities" means the vote of: (A) 67% or
more of the Fund's shares present at a meeting, if the holders of more than 50%
of the Fund's shares are present or represented by proxy; or (B) more than 50%
of the Fund's shares, whichever is less.
In addition to the foregoing investment policies, the Fund is also
subject to the following non-fundamental restrictions and policies, which may be
changed by the Board of Trustees. The Fund may not:
1. Sell securities short, unless the Fund owns or has the right
to obtain securities equivalent in kind and amount to the securities
sold at no added cost, and provided that transactions in options,
futures contracts, options on futures contracts, or other derivative
instruments are not deemed to constitute selling securities short; or
2. Purchase securities of listed companies for the purpose of
exercising control.
The foregoing restrictions and limitations will apply only at the time
of purchase of securities, and the percentage limitations will not be considered
-2-
violated unless an excess or deficiency occurs or exists immediately after and
as a result of an acquisition of securities, unless otherwise indicated.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objectives, policies, and techniques that are described in the Fund's
Prospectus.
PORTFOLIO COMPOSITION
Derivatives. The Fund may, but is not required to, use various
derivatives described below to reduce interest rate risk arising from any use of
financial leverage, facilitate portfolio management, mitigate risks, including
interest rate, currency and credit risks, and/or earn income. Such derivatives
are generally accepted under modern portfolio management practices and are
regularly used by closed-end management investment companies and other
institutional investors. Although the Sub-Adviser seeks to use the practices to
further the Fund's investment objectives, no assurance can be given that these
practices will achieve this result. The Fund may purchase and sell derivative
instruments such as exchange-listed and over-the-counter put and call options on
securities, financial futures, equity, fixed-income and interest rate indices,
credit default swaps, swap options, and other financial instruments. It may
purchase and sell financial futures contracts and options thereon. Moreover, the
Fund may enter into various interest rate transactions such as swaps, caps,
floors or collars and enter into various currency transactions such as currency
forward contracts, currency futures contracts, currency swaps or options on
currency or currency futures or enter into credit transactions, total rate of
return swap transactions, credit default swaps and other credit derivative
instruments. The Fund may also purchase derivative instruments that combine
features of several of these instruments. The Fund generally seeks to use
derivatives as a portfolio management or hedging technique to seek to protect
against possible adverse changes in the market value of securities held in or to
be purchased for the Fund's portfolio, protect the value of the Fund's
portfolio, facilitate the sale of certain securities for investment purposes,
manage the effective interest rate exposure of the Fund, protect against changes
in currency exchange rates, manage the effective maturity or duration of the
Fund's portfolio or establish positions in the derivatives markets as a
temporary substitute for purchasing or selling particular securities. The Fund
may use derivatives for non-hedging purposes to enhance potential gain.
Other Investment Companies. The Fund may invest in the securities of
other investment companies, including BDCs, to the extent that such investments
are consistent with the Fund's investment objectives and policies and
permissible under the 1940 Act, including any exemptive relief or no-action
guidance from the Securities and Exchange Commission. Generally, the provisions
of the 1940 Act limit the amount the Fund can invest in any one closed-end fund,
including BDCs, to 3% of the closed-end fund's total outstanding voting
securities. As a result, the Fund may hold a smaller position in a BDC than if
it were not subject to this restriction. To comply with the provisions of the
1940 Act, on any matter upon which BDC shareholders are solicited to vote, the
Sub-Adviser may be required to vote BDC shares in the same general proportion as
-3-
shares held by other shareholders of the BDC. These limitations do not apply to
the purchase of shares of any investment company in connection with a merger,
consolidation, reorganization or acquisition of substantially all the assets of
another investment company.
The Fund, as a holder of the securities of other investment companies,
will bear its pro rata portion of the other investment companies' expenses,
including advisory fees. These expenses are in addition to the direct expenses
of the Fund's own operations.
Short-Term Debt Securities; Temporary Defensive Position; Invest-Up
Period. During the periods in which the net proceeds of the offerings of the
Common Shares and Preferred Shares are being invested, the issuance of
additional preferred shares, if any, commercial paper or notes and/or borrowings
are being invested, or during periods in which First Trust Advisors L.P. ("First
Trust Advisors" or "Adviser") or the Sub-Adviser determines that it is
temporarily unable to follow the Fund's investment strategy or that it is
impractical to do so, the Fund may deviate from its investment strategy and
invest all or any portion of its Managed Assets in cash and cash equivalents.
The Adviser's or the Sub-Adviser's determination that it is temporarily unable
to follow the Fund's investment strategy or that it is impracticable to do so
will generally occur only in situations in which a market disruption event has
occurred and where trading in the securities selected through application of the
Fund's investment strategy is extremely limited or absent. In such a case, the
Fund may not pursue or achieve its investment objectives.
The cash and cash equivalents are defined to include, without
limitation, the following:
(1) U.S. Government securities, including bills, notes and bonds
differing as to maturity and rates of interest that are either issued or
guaranteed by the U.S. Treasury or by U.S. Government agencies or
instrumentalities. U.S. Government agency securities include securities
issued by: (a) the Federal Housing Administration, Farmers Home
Administration, Export-Import Bank of the United States, Small Business
Administration, and the Government National Mortgage Association, whose
securities are supported by the full faith and credit of the United
States; (b) the Federal Home Loan Banks, Federal Intermediate Credit
Banks, and the Tennessee Valley Authority, whose securities are
supported by the right of the agency to borrow from the U.S. Treasury;
(c) the Federal National Mortgage Association, whose securities are
supported by the discretionary authority of the U.S. Government to
purchase certain obligations of the agency or instrumentality; and (d)
the Student Loan Marketing Association, whose securities are supported
only by its credit. While the U.S. Government provides financial support
to such U.S. Government-sponsored agencies or instrumentalities, no
assurance can be given that it always will do so since it is not so
obligated by law. The U.S. government, its agencies and
instrumentalities do not guarantee the market value of their securities.
Consequently, the value of such securities may fluctuate.
(2) Certificates of deposit issued against funds deposited in a
bank or a savings and loan association. Such certificates are for a
definite period of time, earn a specified rate of return, and are
normally negotiable. The issuer of a certificate of deposit agrees to
pay the amount deposited plus interest to the bearer of the certificate
on the date specified thereon. Under current FDIC regulations, the
-4-
maximum insurance payable as to any one certificate of deposit is
$100,000; therefore, certificates of deposit purchased by the Fund may
not be fully insured.
(3) Repurchase agreements, which involve purchases of debt
securities. At the time the Fund purchases securities pursuant to a
repurchase agreement, it simultaneously agrees to resell and redeliver
such securities to the seller, who also simultaneously agrees to buy
back the securities at a fixed price and time. This assures a
predetermined yield for the Fund during its holding period, since the
resale price is always greater than the purchase price and reflects an
agreed-upon market rate. Such actions afford an opportunity for the Fund
to invest temporarily available cash. Pursuant to the Fund's policies
and procedures, the Fund may enter into repurchase agreements only with
respect to obligations of the U.S. Government, its agencies or
instrumentalities; certificates of deposit; or bankers' acceptances in
which the Fund may invest. Repurchase agreements may be considered loans
to the seller, collateralized by the underlying securities. The risk to
the Fund is limited to the ability of the seller to pay the agreed-upon
sum on the repurchase date; in the event of default, the repurchase
agreement provides that the Fund is entitled to sell the underlying
collateral. If the seller defaults under a repurchase agreement when the
value of the underlying collateral is less than the repurchase price,
the Fund could incur a loss of both principal and interest. The
Sub-Adviser monitors the value of the collateral at the time the action
is entered into and at all times during the term of the repurchase
agreement. The Sub-Adviser does so in an effort to determine that the
value of the collateral always equals or exceeds the agreed-upon
repurchase price to be paid to the Fund. If the seller were to be
subject to a federal bankruptcy proceeding, the ability of the Fund to
liquidate the collateral could be delayed or impaired because of certain
provisions of the bankruptcy laws.
(4) Commercial paper, which consists of short-term unsecured
promissory notes, including variable rate master demand notes issued by
corporations to finance their current operations. Master demand notes
are direct lending arrangements between the Fund and a corporation.
There is no secondary market for such notes. However, they are
redeemable by the Fund at any time. The Sub-Adviser will consider the
financial condition of the corporation (e.g., earning power, cash flow,
and other liquidity measures) and will continuously monitor the
corporation's ability to meet all its financial obligations, because the
Fund's liquidity might be impaired if the corporation were unable to pay
principal and interest on demand. Investments in commercial paper will
be limited to commercial paper rated in the highest categories by a
nationally recognized statistical rating organization and which mature
within one year of the date of purchase or carry a variable or floating
rate of interest.
(5) 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.
-5-
(6) 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.
(7) The Fund may invest in shares of money market funds in
accordance with the provisions of the 1940 Act.
ADDITIONAL INFORMATION ABOUT THE FUND'S INVESTMENTS AND INVESTMENT RISKS
DERIVATIVES RISK
The Fund may use various other investment management techniques that
also involve certain risks and special considerations, including utilizing
derivative instruments to generate income or for hedging and risk management
purposes. Derivative instruments the Fund may use include interest rate options,
futures, swaps, caps, floors, and collars, and other derivative transactions.
These strategic transactions will be entered into to generate income or to seek
to manage the risks of the Fund's portfolio securities, but may have the effect
of limiting the gains from favorable market movements.
A derivative is a financial instrument whose performance is derived at
least in part from the performance of an underlying index, security or asset.
The values of certain derivatives can be affected dramatically by even small
market movements, sometimes in ways that are difficult to predict. There are
many different types of derivatives, with many different uses. The Fund expects
to enter into these transactions primarily to seek to generate income or to
preserve a return on a particular investment or portion of its portfolio, and
also may enter into such transactions to seek to protect against decreases in
the anticipated rate of return on floating or variable rate financial
instruments the Fund owns or anticipates purchasing at a later date, or for
other risk management strategies such as managing the effective dollar-weighted
average duration of the Fund's portfolio. The Fund also may engage in hedging
transactions to seek to protect the value of its portfolio against declines in
NAV resulting from changes in interest rates, currencies or other market
changes. Market conditions will determine whether and in what circumstances the
Fund would employ any of the hedging and risk management techniques described
below. The successful utilization derivative transactions requires skills
different from those needed in the selection of the Fund's portfolio securities.
The Fund believes that the Sub-Adviser possesses the skills necessary for the
successful utilization of derivative transactions. The Fund will incur brokerage
and other costs in connection with its derivative transactions.
The Fund may enter into interest rate swaps or total rate of return
swaps or purchase or sell interest rate caps or floors. Interest rate swaps
involve the exchange by the Fund with another party of their respective
obligations to pay or receive interest, e.g., an obligation to make floating
rate payments for an obligation to make fixed rate payments.
-6-
The purchase of an interest rate cap entitles the purchaser, to the
extent that a specified index exceeds a predetermined interest rate, to receive
payments of interest at the difference of the index and the predetermined rate
on a notional principal amount (the reference amount with respect to which
interest obligations are determined although no actual exchange of principal
occurs) from the party selling the interest rate cap. The purchase of an
interest rate floor entitles the purchaser, to the extent that a specified index
falls below a predetermined interest rate, to receive payments of interest at
the difference of the index and the predetermined rate on a notional principal
amount from the party selling the interest rate floor.
In circumstances in which the Sub-Adviser anticipates that interest
rates will decline, the Fund might, for example, enter into an interest rate
swap as the floating rate payor or, alternatively, purchase an interest rate
floor. In the case of purchasing an interest rate floor, if interest rates
declined below the floor rate, the Fund would receive payments from its
counterparty which would wholly or partially offset the decrease in the payments
it would receive in respect of the portfolio assets being hedged. In the case
where the Fund purchases an interest rate swap, if the floating rate payments
fell below the level of the fixed rate payment set in the swap agreement, the
Fund's counterparty would pay the Fund amounts equal to interest computed at the
difference between the fixed and floating rates over the notional principal
amount. Such payments would offset or partially offset the decrease in the
payments the Fund would receive in respect of floating rate portfolio assets
being hedged.
The successful use of swaps, caps and floors to preserve the rate of
return on a portfolio of financial instruments depends on the Sub-Adviser's
ability to predict correctly the direction and extent of movements in interest
rates.
At the maturity of a forward contract to deliver a particular currency,
the Fund may either sell the portfolio security related to such contract and
make delivery of the currency, or it may retain the security and either acquire
the currency on the spot market or terminate its contractual obligation to
deliver the currency by purchasing an offsetting contract with the same currency
trader obligating it to purchase on the same maturity date the same amount of
the currency.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of a forward contract. Accordingly, it
may be necessary for the Fund to purchase additional currency on the spot market
(and bear the expense of such purchase) if the market value of the security is
less than the amount of currency that the Fund is obligated to deliver and if a
decision is made to sell the security and make delivery of the currency.
Conversely, it may be necessary to sell on the spot market some of the currency
received upon the sale of the portfolio security if its market value exceeds the
amount of currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
currency. Should forward contract prices decline during the period between the
Fund's entering into a forward contract for the sale of a currency and the date
it enters into an offsetting contract for the purchase of the currency, the Fund
-7-
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should forward
prices increase, the Fund will suffer a loss to the extent the price of the
currency it has agreed to purchase exceeds the price of the currency it has
agreed to sell. A default on the contract would deprive the Fund of unrealized
profits or force the Fund to cover its commitments for purchase or sale of
currency, if any, at the current market price.
Although the Fund believes that use of the derivative transactions
described above will benefit the Fund, if the Sub-Adviser's judgment about the
direction or extent of the movement in interest rates is incorrect, the Fund's
overall performance would be worse than if it had not entered into any such
transactions.
Because these derivative transactions designed to mitigate risk are
entered into for good-faith risk management purposes, the Sub-Adviser and the
Fund believe these hedging transactions do not constitute senior securities. The
Fund usually will enter into interest rate swaps on a net basis, i.e., where the
two parties make net payments with the Fund receiving or paying, as the case may
be, only the net amount of the two payments. The net amount of the excess, if
any, of the Fund's obligations over its entitlements with respect to each
interest rate swap will be accrued and an amount of cash, cash equivalents or
liquid securities having an aggregate market value at least equal to the accrued
excess will be segregated on the Fund's records. If the Fund enters into a swap
on other than a net basis, the Fund intends to segregate assets on the Fund's
records in the full amount of the Fund's obligations under each swap.
Accordingly, the Fund does not treat swaps as senior securities. The Fund may
enter into swaps, caps and floors with member banks of the Federal Reserve
System, members of the New York Stock Exchange or other entities determined by
the Sub-Adviser, pursuant to procedures adopted and reviewed on an ongoing basis
by the Board of Trustees, to be creditworthy. If a default occurs by the other
party to the transaction, the Fund will have contractual remedies pursuant to
the agreements related to the transaction but remedies may be subject to
bankruptcy and insolvency laws which could affect the Fund's rights as a
creditor. The swap market has grown substantially in recent years with a large
number of banks and financial services firms acting both as principals and as
agents utilizing standardized swap documentation. As a result, the swap market
has become relatively liquid. Caps and floors are more recent innovations and
they are less liquid than swaps. There can be no assurance, however, that the
Fund will be able to enter into interest rate swaps or to purchase interest rate
caps or floors at prices or on terms the Sub-Adviser believes are advantageous
to the Fund. In addition, although the terms of interest rate swaps, caps and
floors may provide for termination, there can be no assurance that the Fund will
be able to terminate an interest rate swap or to sell or offset interest rate
caps or floors that it has purchased.
The Fund also may engage in credit derivative transactions. Default risk
derivatives are linked to the price of reference securities or loans after a
default by the issuer or borrower, respectively. Market spread derivatives are
based on the risk that changes in market factors, such as credit spreads, can
cause a decline in the value of a security, loan or index. There are three basic
transactional forms for credit derivatives: swaps, options and structured
instruments. The use of credit derivatives is a highly specialized activity
which involves strategies and risks different from those associated with
ordinary portfolio security transactions. If the Sub-Adviser is incorrect in its
-8-
forecasts of default risks, market spreads or other applicable factors, the
investment performance of the Fund would diminish compared with what it would
have been if these techniques were not used. Moreover, even if the Sub-Adviser
is correct in its forecasts, there is a risk that a credit derivative position
may correlate imperfectly with the price of the asset or liability being hedged.
Credit Default Swap Transactions. The Fund may invest in credit default
swap transactions (as measured by the notional amounts of the swaps), including
credit linked notes (described below) for hedging and investment purposes. The
"buyer" in a credit default contract is obligated to pay the "seller" a periodic
stream of payments over the term of the contract, provided that no event of
default on an underlying reference obligation has occurred. If an event of
default occurs, the seller must pay the buyer the full notional value, or "par
value," of the reference obligation. Credit default swap transactions are either
"physical delivery" settled or "cash" settled. Physical delivery entails the
actual delivery of the reference asset to the seller in exchange for the payment
of the full par value of the reference asset. Cash settled entails a net cash
payment from the seller to the buyer based on the difference of the par value of
the reference asset and the current value of the reference asset that may have,
through default, lost some, most or all of its value. The Fund may be either the
buyer or seller in a credit default swap transaction. If the Fund is a buyer and
no event of default occurs, the Fund will have made a series of periodic
payments and recover nothing of monetary value. However, if an event of default
occurs, the Fund (if the buyer) will receive the full notional value of the
underlying reference obligation either through a cash payment in exchange for
the asset or a cash payment in addition to owning the reference asset. As a
seller, the Fund receives a fixed rate of income throughout the term of the
contract, which typically is between six months and five years, provided that
there is no event of default. The Fund currently intends to segregate assets on
the Fund's records in the form of cash, cash equivalents or liquid securities in
an amount equal to the full notional value of the credit default swaps of which
it is the seller. If such assets are not fully segregated on the Fund's records,
the use of credit default swap transactions could then be considered leverage.
If an event of default occurs, the seller must pay the buyer the full notional
value of the underlying reference obligation through either physical settlement
or cash settlement. Credit default swap transactions involve greater risks than
if the Fund had invested in the underlying reference obligation directly.
The Fund also may purchase credit default swap contracts in order to
hedge against the risk of default of debt securities it holds, in which case the
Fund would function as the counterparty referenced in the preceding paragraph.
This would involve the risk that the swap may expire worthless and would only
generate income in the event of an actual default by the issuer of the
underlying obligation (as opposed to a credit downgrade or other indication of
financial instability). It would also involve credit risk that the seller may
fail to satisfy its payment obligations to the Fund in the event of a default.
Risks and Special Considerations Concerning Derivatives. In addition to
the foregoing, the use of derivative instruments involves certain general risks
and considerations as described below.
(1) Market Risk. Market risk is the risk that the value of the
underlying assets may go up or down. Adverse movements in the value of
-9-
an underlying asset can expose the Fund to losses. Market risk is the
primary risk associated with derivative transactions. Derivative
instruments may include elements of leverage and, accordingly,
fluctuations in the value of the derivative instrument in relation to
the underlying asset may be magnified. The successful use of derivative
instruments depends upon a variety of factors, particularly the
Sub-Adviser's ability to predict correctly market movements or changes
in the relationships of such instruments to the Fund's portfolio
holdings, and there can be no assurance the Sub-Adviser's judgment in
this respect will be accurate. Consequently, the use of derivatives for
investment or hedging purposes might result in a poorer overall
performance for the Fund, whether or not adjusted for risk, than if the
Fund had not used derivatives.
(2) Credit Risk. Credit risk is the risk that a loss is sustained
as a result of the failure of a counterparty to comply with the terms of
a derivative instrument. The counterparty risk for exchange-traded
derivatives is generally less than for privately-negotiated or
over-the-counter derivatives, since generally a clearing agency, which
is the issuer or counterparty to each exchange-traded instrument,
provides a guarantee of performance. For privately-negotiated
instruments, there is no similar clearing agency guarantee. In all
transactions, the Fund will bear the risk that the counterparty will
default, and this could result in a loss of the expected benefit of the
derivative transactions and possibly other losses to the Fund. The Fund
will enter into transactions in derivative instruments only with
counterparties that the Sub-Adviser reasonably believes are capable of
performing under the contract.
(3) Correlation Risk. Correlation risk is the risk that there
might be an imperfect correlation, or even no correlation, between price
movements of a derivative instrument and price movements of investments
being hedged. When a derivative transaction is used to completely hedge
another position, changes in the market value of the combined position
(the derivative instrument plus the position being hedged) result from
an imperfect correlation between the price movements of the two
instruments. With a perfect hedge, the value of the combined position
remains unchanged with any change in the price of the underlying asset.
With an imperfect hedge, the value of the derivative instrument and its
hedge are not perfectly correlated. For example, if the value of a
derivative instrument used in a short hedge (such as buying a put option
or selling a futures contract) increased by less than the decline in
value of the hedged investments, the hedge would not be perfectly
correlated. This might occur due to factors unrelated to the value of
the investments being hedged, such as speculative or other pressures on
the markets in which these instruments are traded. In addition, the
Fund's success in using hedging instruments is subject to the
Sub-Adviser's ability to correctly predict changes in relationships of
such hedge instruments to the Fund's portfolio holdings, and there can
be no assurance that the Sub-Adviser's judgment in this respect will be
accurate. An imperfect correlation may prevent the Fund from achieving
the intended hedge or expose the Fund to a risk of loss.
(4) Liquidity Risk. Liquidity risk is the risk that a derivative
instrument cannot be sold, closed out, or replaced quickly at or very
close to its fundamental value. Generally, exchange contracts are liquid
-10-
because the exchange clearinghouse is the counterparty of every
contract. OTC transactions are less liquid than exchange-traded
derivatives since they often can only be closed out with the other party
to the transaction. The Fund might be required by applicable regulatory
requirements to maintain assets as "cover," maintain segregated accounts
and/or make margin payments when it takes positions in derivative
instruments involving obligations to third parties (i.e., instruments
other than purchase options). If the Fund is unable to close out its
positions in such instruments, it might be required to continue to
maintain such accounts or make such payments until the position expires,
matures, or is closed out. These requirements might impair the Fund's
ability to sell a security or make an investment at a time when it would
otherwise be favorable to do so, or require that the Fund sell a
portfolio security at a disadvantageous time. The Fund's ability to sell
or close out a position in an instrument prior to expiration or maturity
depends upon the existence of a liquid secondary market or, in the
absence of such a market, the ability and willingness of the
counterparty to enter into a transaction closing out the position. Due
to liquidity risk, there is no assurance that any derivatives position
can be sold or closed out at a time and price that is favorable to the
Fund.
(5) Legal Risk. Legal risk is the risk of loss caused by the
unenforceability of a party's obligations under the derivative. While a
party seeking price certainty agrees to surrender the potential upside
in exchange for downside protection, the party taking the risk is
looking for a positive payoff. Despite this voluntary assumption of
risk, a counterparty that has lost money in a derivative transaction may
try to avoid payment by exploiting various legal uncertainties about
certain derivative products.
(6) Systemic or "Interconnection" Risk. Systemic or
interconnection risk is the risk that a disruption in the financial
markets will cause difficulties for all market participants. In other
words, a disruption in one market will spill over into other markets,
perhaps creating a chain reaction. Much of the OTC derivatives market
takes place among the OTC dealers themselves, thus creating a large
interconnected web of financial obligations. This interconnectedness
raises the possibility that a default by one large dealer could create
losses for other dealers and destabilize the entire market for OTC
derivative instruments.
ILLIQUID/RESTRICTED SECURITIES
The Fund may invest in securities that, at the time of investment, are
illiquid (determined using the Securities and Exchange Commission's standard
applicable to investment companies, i.e., securities that cannot be disposed by
the Fund of within seven days in the ordinary course of business at
approximately the amount at which the Fund values the securities). The Fund may
also invest in restricted securities. The Sub-Adviser, under the supervision of
the Board of Trustees, will determine whether restricted securities are
illiquid. As a result, restricted securities may be more difficult to value and
the Fund may have difficulty disposing of such assets either in a timely manner
or for a reasonable price. In order to dispose of an unregistered security, the
Fund, where it has contractual rights to do so, may have to cause such security
to be registered. A considerable period may elapse between the time the decision
-11-
is made to sell the security and the time the security is registered in order
for the Fund could sell it. Contractual restrictions on the resale of securities
vary in length and scope and are generally the result of a negotiation between
the issuer and acquiror of the securities. The Fund would, in either case, bear
market risks during that period.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (the "Securities Act"),
securities which are otherwise not readily marketable and reverse repurchase
agreements having a maturity of longer than seven days. Securities that have not
been registered under the Securities Act are referred to as restricted
securities and are purchased directly from the issuer or in the secondary
market. Limitations on resale may have an adverse effect on the marketability of
portfolio securities and the Fund might be unable to dispose of restricted or
other illiquid securities promptly or at reasonable prices. The Fund might also
have to register the restricted securities to dispose of them resulting in
additional expense and delay. Adverse market conditions could impede the public
offering of securities.
Over time, a large institutional market has developed for certain
securities that are not registered under the Securities Act including repurchase
agreements, commercial paper, foreign securities, municipal securities,
convertible securities and corporate bonds and notes. Institutional investors
depend on an efficient institutional market in which the unregistered security
can be readily resold or on an issuer's ability to honor a demand for repayment.
The fact that there are contractual or legal restrictions on resale to the
general public or to certain institutions may not be indicative of the liquidity
of such investments.
RESTRICTIVE COVENANTS AND 1940 ACT RESTRICTIONS
With respect to a leverage borrowing program instituted by the Fund, the
credit agreements governing such a program (the "Credit Agreements") will likely
include usual and customary covenants for this type of transaction, including,
but not limited to, limits on the Fund's ability to: (i) issue preferred shares;
(ii) incur liens or pledge portfolio securities or investments; (iii) change its
investment objectives or fundamental investment restrictions without the
approval of lenders; (iv) make changes in any of its business objectives,
purposes or operations that could result in a material adverse effect; (v) make
any changes in its capital structure; (vi) amend the Fund documents in a manner
which could adversely affect the rights, interests or obligations of any of the
lenders; (vii) engage in any business other than the business currently engaged
in; (viii) create, incur, assume or permit to exist certain debt except for
certain specific types of debt; and (ix) permit any of its Employee Retirement
Income Security Act ("ERISA") affiliates to cause or permit to occur an event
that could result in the imposition of a lien under the Code or ERISA. In
addition, the Credit Agreements would not permit the Fund's asset coverage ratio
(as defined in the Credit Agreements) to fall below 300% at any time.
Under the requirements of the 1940 Act, the Fund must have asset
coverage of at least 300% immediately after any borrowing, including borrowing
under any leverage borrowing program the Fund implements. For this purpose,
asset coverage means the ratio which the value of the total assets of the Fund,
less liabilities and indebtedness not represented by senior securities, bears to
the aggregate amount of borrowings represented by senior securities issued by
the Fund. The Credit Agreements would limit the Fund's ability to pay dividends
-12-
or make other distributions on the Fund's Common Shares unless the Fund complies
with the Credit Agreements' 300% asset coverage test. In addition, the Credit
Agreements will not permit the Fund to declare dividends or other distributions
or purchase or redeem Common Shares or Preferred Shares: (i) at any time that
any event of default under the Credit Agreements has occurred and is continuing;
or (ii) if, after giving effect to such declaration, the Fund would not meet the
Credit Agreements' 300% asset coverage test set forth in the Credit Agreements.
OTHER INVESTMENT POLICIES AND TECHNIQUES
DERIVATIVE STRATEGIES
General Description of Derivative Strategies. The Fund may use
derivatives or other transactions to generate income, to hedge the Fund's
exposure to an increase in the price of a security prior to its anticipated
purchase or a decrease in the price of a security prior to its anticipated sale,
to seek to reduce interest rate risks arising from the use of any Financial
leverage by the Fund and to mitigate risks, including interest rate, currency
and credit risks. The specific derivative instruments to be used, or other
transactions to be entered into, for such investment or hedging purposes may
include exchange-listed and over-the-counter put and call options on currencies,
securities, fixed-income, currency and interest rate indices, and other
financial instruments, financial futures contracts and options thereon
(hereinafter referred to as "Futures" or "futures contracts"), interest rate and
currency transactions such as swaps, caps, floors or collars, credit
transactions, total rate of return swap transactions, credit default swaps or
other credit derivative instruments.
Derivative instruments on securities may be used to hedge against price
movements in one or more particular securities positions that the Fund owns or
intends to acquire. Such instruments may also be used to "lock-in" recognized
but unrealized gains in the value of portfolio securities. Derivative
strategies, if successful, can reduce the risk of loss by wholly or partially
offsetting the negative effect of unfavorable price movements in the investments
being hedged. However, derivative strategies can also reduce the opportunity for
gain by offsetting the positive effect of favorable price movements in the
hedged investments. The use of derivative instruments is subject to applicable
regulations of the Securities and Exchange Commission, the several options and
futures exchanges upon which they are traded, the CFTC and various state
regulatory authorities. In addition, the Fund's ability to use derivative
instruments may be limited by tax considerations.
General Limitations on Futures and Options Transactions. The Fund has
filed a notice of eligibility for exclusion from the definition of the term
"commodity pool operator" with the CFTC and the National Futures Association,
which regulate trading in the futures markets. Pursuant to Section 4.5 of the
regulations under the Commodity Exchange Act (the "CEA"), the Fund is not
subject to regulation as a commodity pool under the CEA.
Various exchanges and regulatory authorities have undertaken reviews of
options and Futures trading in light of market volatility. Among the possible
actions that have been presented are proposals to adopt new or more stringent
-13-
daily price fluctuation limits for Futures and options transactions and
proposals to increase the margin requirements for various types of futures
transactions.
Asset Coverage for Futures and Options Positions. The Fund will comply
with the regulatory requirements of the Securities and Exchange Commission and
the CFTC with respect to coverage of options and Futures positions by registered
investment companies and, if the guidelines so require, will set aside cash,
U.S. government securities, high grade liquid debt securities and/or other
liquid assets permitted by the Securities and Exchange Commission and CFTC in a
segregated account on the Fund's records in the amount prescribed. Securities
held in a segregated account cannot be sold while the Futures or options
position is outstanding, unless replaced with other permissible assets, and will
be marked-to-market daily.
Options. The Fund may purchase put and call options on stock or other
securities. A put option embodies the right of its purchaser to compel the
writer of the option to purchase from the option holder an underlying security
or its equivalent at a specified price at any time during the option period. In
contrast, a call option gives the purchaser the right to buy the underlying
security covered by the option or its equivalent from the writer of the option
at the stated exercise price.
As a holder of a put option, the Fund will have the right to sell the
securities underlying the option and as the holder of a call option, the Fund
will have the right to purchase the securities underlying the option, in each
case at their exercise price at any time prior to the option's expiration date.
The Fund may seek to terminate its option positions prior to their expiration by
entering into closing transactions. The ability of the Fund to enter into a
closing sale transaction depends on the existence of a liquid secondary market.
There can be no assurance that a closing purchase or sale transaction can be
effected when the Fund so desires.
Certain Considerations Regarding Options. The hours of trading for
options may not conform to the hours during which the underlying securities are
traded. To the extent that the options markets close before the markets for the
underlying securities, significant price and rate movements can take place in
the underlying markets that cannot be reflected in the options markets. The
purchase of options is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary portfolio
securities transactions. The purchase of options involves the risk that the
premium and transaction costs paid by the Fund in purchasing an option will be
lost as a result of unanticipated movements in prices of the securities on which
the option is based. Imperfect correlation between the options and securities
markets may detract from the effectiveness of attempted hedging. Options
transactions may result in significantly higher transaction costs and portfolio
turnover for the Fund.
Some, but not all, of the derivative instruments may be traded and
listed on an exchange. There is no assurance that a liquid secondary market on
an options exchange will exist for any particular option, or at any particular
time, and for some options no secondary market on an exchange or elsewhere may
exist. If the Fund is unable to effect a closing sale transaction with respect
-14-
to options on securities that it has purchased, it would have to exercise the
option in order to realize any profit and would incur transaction costs upon the
purchase and sale of the underlying securities.
Futures Contracts. The Fund may enter into securities-related futures
contracts, including security futures contracts as an anticipatory hedge. The
Fund's derivative investments may include sales of Futures as an offset against
the effect of expected declines in securities prices and purchases of Futures as
an offset against the effect of expected increases in securities prices. The
Fund will not enter into futures contracts which are prohibited under the CEA
and will, to the extent required by regulatory authorities, enter only into
futures contracts that are traded on exchanges and are standardized as to
maturity date and underlying financial instrument. A security futures contract
is a legally binding agreement between two parties to purchase or sell in the
future a specific quantity of shares of a security or of the component
securities of a narrow-based security index, at a certain price. A person who
buys a security futures contract enters into a contract to purchase an
underlying security and is said to be "long" the contract. A person who sells a
security futures contact enters into a contract to sell the underlying security
and is said to be "short" the contract. The price at which the contract trades
(the "contract price") is determined by relative buying and selling interest on
a regulated exchange.
Transaction costs are incurred when a futures contract is bought or sold
and margin deposits must be maintained. In order to enter into a security
futures contract, the Fund must deposit funds with its custodian in the name of
the futures commodities merchant equal to a specified percentage of the current
market value of the contract as a performance bond. Moreover, all security
futures contracts are marked-to-market at least daily, usually after the close
of trading. At that time, the account of each buyer and seller reflects the
amount of any gain or loss on the security futures contract based on the
contract price established at the end of the day for settlement purposes.
An open position, either a long or short position, is closed or
liquidated by entering into an offsetting transaction (i.e., an equal and
opposite transaction to the one that opened the position) prior to the contract
expiration. Traditionally, most futures contracts are liquidated prior to
expiration through an offsetting transaction and, thus, holders do not incur a
settlement obligation. If the offsetting purchase price is less than the
original sale price, a gain will be realized. Conversely, if the offsetting sale
price is more than the original purchase price, a gain will be realized; if it
is less, a loss will be realized. The transaction costs must also be included in
these calculations. There can be no assurance, however, that the Fund will be
able to enter into an offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is not able to enter into an
offsetting transaction, the Fund will continue to be required to maintain the
margin deposits on the futures contract and the Fund may not be able to realize
a gain in the value of its future position or prevent losses from mounting. This
inability to liquidate could occur, for example, if trading is halted due to
unusual trading activity in either the security futures contract or the
underlying security; if trading is halted due to recent news events involving
the issuer of the underlying security; if systems failures occur on an exchange
or at the firm carrying the position; or, if the position is on an illiquid
market. Even if the Fund can liquidate its position, it may be forced to do so
at a price that involves a large loss.
-15-
Under certain market conditions, it may also be difficult or impossible
to manage the risk from open security futures positions by entering into an
equivalent but opposite position in another contract month, on another market,
or in the underlying security. This inability to take positions to limit the
risk could occur, for example, if trading is halted across markets due to
unusual trading activity in the security futures contract or the underlying
security or due to recent news events involving the issuer of the underlying
security.
There can be no assurance that a liquid market will exist at a time when
the Fund seeks to close out a futures contract position. The Fund would continue
to be required to meet margin requirements until the position is closed,
possibly resulting in a decline in the Fund's NAV. 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.
Security futures contracts that are not liquidated prior to expiration
must be settled in accordance with the terms of the contract. Some security
futures contracts are settled by physical delivery of the underlying security.
At the expiration of a security futures contract that is settled through
physical delivery, a person who is long the contract must pay the final
settlement price set by the regulated exchange or the clearing organization and
take delivery of the underlying shares. Conversely, a person who is short the
contract must make delivery of the underlying shares in exchange for the final
settlement price. Settlement with physical delivery may involve additional
costs.
Other security futures contracts are settled through cash settlement. In
this case, the underlying security is not delivered. Instead, any positions in
such security futures contracts that are open at the end of the last trading day
are settled through a final cash payment based on a final settlement price
determined by the exchange or clearing organization. Once this payment is made,
neither party has any further obligations on the contract.
As noted above, margin is the amount of funds that must be deposited by
the Fund in order to initiate futures trading and to maintain the Fund's open
positions in futures contracts. A margin deposit is intended to ensure the
Fund's performance of the futures contract. The margin required for a particular
futures contract is set by the exchange on which the futures contract is traded
and may be significantly modified from time to time by the exchange during the
term of the futures contract.
If the price of an open futures contract changes (by increase in the
case of a sale or by decrease in the case of a purchase) so that the loss on the
futures contract reaches a point at which the margin on deposit does not satisfy
margin requirements, the broker will require an increase in the margin. However,
if the value of a position increases because of favorable price changes in the
futures contract so that the margin deposit exceeds the required margin, the
broker will pay the excess to the Fund. In computing daily NAV, the Fund will
mark to market the current value of its open futures contracts. The Fund expects
to earn interest income on its margin deposits.
-16-
Because of the low margin deposits required, futures contracts trading
involves an extremely high degree of leverage. As a result, a relatively small
price movement in a futures contract may result in immediate and substantial
loss, as well as gain, to the investor. For example, if at the time of purchase,
10% of the value of the futures contract is deposited as margin, a subsequent
10% decrease in the value of the futures contract would result in a total loss
of the margin deposit, before any deduction for the transaction costs, if the
account were then closed out. A 15% decrease would result in a loss equal to
150% of the original margin deposit, if the futures contracts were closed out.
Thus, a purchase or sale of a futures contract may result in losses in excess of
the amount initially invested in the futures contract. However, the Fund would
presumably have sustained comparable losses if, instead of the futures contract,
it had invested in the underlying financial instrument and sold it after the
decline.
In addition to the foregoing, imperfect correlation between the futures
contracts and the underlying securities may prevent the Fund from achieving the
intended hedge or expose the Fund to risk of loss. Under certain market
conditions, the prices of security futures contracts may not maintain their
customary or anticipated relationships to the prices of the underlying security
or index. These pricing disparities could occur, for example, when the market
for the security futures contract is illiquid, when the primary market for the
underlying security is closed, or when the reporting of transactions in the
underlying security has been delayed.
In addition, the value of a position in security futures contracts could
be affected if trading is halted in either the security futures contract or the
underlying security. In certain circumstances, regulated exchanges are required
by law to halt trading in security futures contracts. For example, trading on a
particular security futures contract must be halted if trading is halted on the
listed market for the underlying security as a result of pending news,
regulatory concerns, or market volatility. Similarly, trading of a security
futures contract on a narrow-based security index must be halted under
circumstances such as where trading is halted on securities accounting for at
least 50% of the market capitalization of the index. In addition, regulated
exchanges are required to halt trading in all security futures contracts for a
specified period of time when the Dow Jones Industrial Average ("DJIA")
experiences one-day declines of 10%, 20% and 30%. The regulated exchanges may
also have discretion under their rules to halt trading in other circumstances -
such as when the exchange determines that the halt would be advisable in
maintaining a fair and orderly market.
A trading halt, either by a regulated exchange that trades security
futures or an exchange trading the underlying security or instrument, could
prevent the Fund from liquidating a position in security futures contracts in a
timely manner, which could expose the Fund to a loss.
Each regulated exchange trading a security futures contract may also
open and close for trading at different times than other regulated exchanges
trading security futures contracts or markets trading the underlying security or
securities. Trading in security futures contracts prior to the opening or after
the close of the primary market for the underlying security may be less liquid
than trading during regular market hours.
Swap Agreements. The Fund may enter into swap agreements. A swap is a
financial instrument that typically involves the exchange of cash flows between
two parties on specified dates (settlement dates), where the cash flows are
based on agreed-upon prices, rates, indices, etc. The nominal amount on which
the cash flows are calculated is called the notional amount. Swaps are
individually negotiated and structured to include exposure to a variety of
different types of investments or market factors, such as interest rates,
commodity prices, non-U.S. currency rates, mortgage securities, corporate
borrowing rates, security prices, indexes or inflation rates.
Swap agreements may increase or decrease the overall volatility of the
investments of the Fund. The performance of swap agreements may be affected by a
-17-
change in the specific interest rate, currency, or other factors that determine
the amounts of payments due to and from the Fund. If a swap agreement calls for
payments by the Fund, the Fund must be prepared to make such payments when due.
In addition, if the counterparty's creditworthiness declines, the value of a
swap agreement would be likely to decline, potentially resulting in losses.
Generally, swap agreements have fixed maturity dates that are agreed
upon by the parties to the swap. The agreement can be terminated before the
maturity date only under limited circumstances, such as default by one of the
parties or insolvency, among others, and can be transferred by a party only with
the prior written consent of the other party. The Fund may be able to eliminate
its exposure under a swap agreement either by assignment or by other
disposition, or by entering into an offsetting swap agreement with the same
party or a similarly creditworthy party. If the counterparty is unable to meet
its obligations under the contract, declares bankruptcy, defaults or becomes
insolvent, the Fund may not be able to recover the money it expected to receive
under the contract.
A swap agreement can be a form of leverage, which can magnify the Fund's
gains or losses. In order to reduce the risk associated with leveraging, the
Fund will cover its current obligations under swap agreements according to
guidelines established by the Securities and Exchange Commission. If the Fund
enters into a swap agreement on a net basis, it will be required to segregate
assets on the Fund's records with a daily value at least equal to the excess, if
any, of the Fund's accrued obligations under the swap agreement over the accrued
amount the Fund is entitled to receive under the agreement. If the Fund enters
into a swap agreement on other than a net basis, it will be required to
segregate assets on the Fund's records with a value equal to the full amount of
the Fund's accrued obligations under the agreement.
Equity Swaps. In a typical equity swap, one party agrees to pay another
party the return on a security, security index or basket of securities in return
for a specified interest rate. By entering into an equity index swap, for
example, the index receiver can gain exposure to securities making up the index
of securities without actually purchasing those securities. Equity index swaps
involve not only the risk associated with investment in the securities
represented in the index, but also the risk that the performance of such
securities, including dividends, will not exceed the interest that the Fund will
be committed to pay under the swap.
-18-
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.
The Trustees set broad policies for the Fund and choose the Fund's officers. The
Board of Trustees is divided into three classes, Class I, Class II and Class
III. Each Trustee was initially elected for a term of from one to three years,
depending on the class, as more fully described below. In connection with the
issuance of the Preferred Shares, one Trustee from Class II and one Trustee from
Class III shall be designated to be elected by the holders of all outstanding
senior equity securities of the Fund (including the Preferred Shares), voting
together as a single class. At the time of issuance of the Preferred Shares, no
other senior equity securities will be outstanding. Upon expiration of their
existing terms, the Trustee will be elected either by the holders of the Common
Shares and holders of senior equity securities (voting together as a single
class), or by the holders of the outstanding senior equity securities, as
applicable, to serve until the third succeeding annual shareholder meeting
subsequent to his or her election or thereafter in each case when his or her
respective successors are duly elected and qualified. Holders of Preferred
Shares will be entitled to elect a majority of the Fund's Trustees under certain
circumstances. See "Description of Shares - Preferred Shares - Voting Rights" in
the Prospectus. The officers of the Fund serve indefinite terms.
The following is a list of the Trustees and officers of the Fund 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 hold, if applicable.
Term of Number of
Office(2) Portfolios
and Year in Fund Other
Position and First Principal Complex Directorships
Name, Address and Date Offices with Elected or Occupations Overseen Held by
of Birth Fund Appointed During Past 5 Years by Trustee Trustee
______________________ ____________ __________ ___________________ __________ _____________
Trustee who is an
Interested Person of
the Fund
____________________
James A. Bowen(1) President, o Class III (3)(4) President, First 54 Portfolios Trustee of
1001 Warrenville Road, Chairman of Trust Portfolios L.P. Wheaton
Suite 300 the Board, o 2007 and First Trust College
Lisle, IL 60532 Chief Executive Advisors; Chairman
D.O.B.: 09/55 Officer and of the Board of
Trustee Directors, Bond
Wave LLC and
Stonebridge
Advisors LLC
Trustees who are not
Interested Persons of
the Fund
______________________
Richard E. Erickson Trustee o Class II (3)(4) Physician; President, 54 Portfolios None
c/o First Trust Wheaton Orthopedics;
Advisors L.P. o 2007 Co-owner and
1001 Warrenville Road, Co-Director, Sports Med
Suite 300 Center for Fitness;
Lisle, IL 60532 Limited Partner,
D.O.B.: 04/51 Gundersen Real Estate
Partnership
-19-
Thomas R. Kadlec Trustee o Class II (3)(4) Senior Vice President, 54 Portfolios None
c/o First Trust (May 2007 to Present);
Advisors L.P. o 2007 Vice President, Chief
1001 Warrenville Road, Financial Officer
Suite 300 (1990 to May 2007),
Lisle, IL 60532 ADM Investor Services,
D.O.B.: 11/57 Inc. (Futures Commission
Merchant); Vice President
(May 2005 to Present),
ADM Derivatives, Inc.;
Registered Representative
(2000 to Present),
Segerdahl & Company,
Inc., an NASD member
(Broker-Dealer)
Robert F. Keith Trustee o Class I (3)(4) President, Hibs 54 Portfolios None
c/o First Trust Enterprises (Financial and
Advisors L.P. o 2007 Management Consulting)
1001 Warrenville Road, (2003 to Present);
Suite 300 President, Aramark
Lisle, IL 60532 Service Master
D.O.B.: 11/56 Management (2001 to
2003); President and Chief
Operating Officer, Service
Master Management
Services (1998 to 2003)
Niel B. Nielson Trustee o Class III (3)(4) President, (2002 to 54 Portfolios Director of
c/o First Trust Present) Covenant Covenant
Advisors L.P. o 2007 College; Associate Pastor, Transport Inc.
1001 Warrenville Road, (1997 to 2002) College
Suite 300 Church in Wheaton
Lisle, IL 60532
D.O.B.: 03/54
Officers of the Fund
____________________
Mark R. Bradley Treasurer, o Indefinite term Chief Financial Officer, N/A N/A
1001 Warrenville Road, Controller, Chief Managing Director, First
Suite 300 Financial Officer and o 2007 Trust Portfolios L.P. and
Lisle, IL 60532 Chief Accounting First Trust Advisors;
D.O.B.: 11/57 Officer Chief Financial Officer,
BondWave LLC and
Stonebridge Advisors LLC
Kelley Christensen Vice President o Indefinite term Assistant Vice President N/A N/A
1001 Warrenville Road, of
Suite 300 o 2007 First Trust Portfolios L.P.
Lisle, IL 60532 and
D.O.B.: 09/70 First Trust Advisors L.P.
Christopher R. Fallow Assistant Vice o Indefinite term Assistant Vice President N/A N/A
1001 Warrenville Road, President of First Trust Portfolios
Suite 300 o 2007 L.P. and
Lisle, IL 60532 First Trust Advisors L.P.
D.O.B.: 04/79
-20-
James M. Dykas Assistant o Indefinite term Senior Vice President N/A N/A
1001 Warrenville Road, Treasurer (April 2007 to Present),
Suite 300 o 2007 Vice President, First Trust
Lisle, IL 60532 Portfolios L.P. (January
D.O.B.: 01/66 2005 to April 2007);
Executive Director of Van
Kampen Asset Management
and Morgan Stanley
Investment Management
(December 2002 to January
2005); Vice President, Van
Kampen Asset Management
and Morgan Stanley
Investment Management
(December 2000 to December
2002)
W. Scott Jardine Secretary and Chief o Indefinite term General Counsel, First N/A N/A
1001 Warrenville Road, Compliance Officer Trust Portfolios L.P.
Suite 300 o 2007 and First Trust Advisors;
Lisle, IL 60532 Secretary, BondWave
D.O.B.: 05/60 LLC and Stonebridge
Advisors LLC
Daniel J. Lindquist Vice President o Indefinite term Senior Vice President N/A N/A
1001 Warrenville Road (September 2005
Suite 300 o 2007 to Present), Vice President
Lisle, IL 60532 (April 2004 to
D.O.B: 02/70 September 2005), First
Trust Portfolios L.P. and
First Trust Advisors;
Chief Operating Officer,
Mina Capital
Management, LLC
(January 2004 to
April 2004); Chief
Operating Officer,
Samaritan Asset
Management Services,
Inc. (April 2000 to
January 2004)
Kristi A. Maher Assistant Secretary o Indefinite term Deputy General Counsel N/A N/A
1001 Warrenville Road, (May 2007 to Present),
Suite 300 o 2007 Assistant General Counsel
Lisle, IL 60532 (March 2004 to May
D.O.B.: 12/66 2007), First Trust
Portfolios L.P. and First
Trust Advisors; Associate
(1995 to March 2004),
Chapman and Cutler LLP)
--------------------
(1) Mr. Bowen is deemed an "interested person" of the Fund due to his position
as President of First Trust Advisors, investment adviser of the Fund.
(2) Officer positions with the Fund have an indefinite term.
(3) After a Trustee's initial term, each Trustee is expected to serve a
three-year term concurrent with the class of Trustees for which he serves:
- Mr. Keith, as a Class I Trustee, serves a term until the next annual
shareholder meeting called for the purpose of electing Trustees.
- Messrs. Kadlec and Erickson, as Class II Trustees, serve a term until
the second succeeding annual shareholder meeting called for the purpose of
-21-
electing Trustees. Thereafter, Mr. Erickson shall be subject to election
by the holders of the Common Shares and the senior equity securities,
including the Preferred Shares, voting together as a single class, while
Mr. Kadlec shall be a Trustee to be elected solely by all outstanding
senior equity securities, including the Preferred Shares, voting together
as a single class.
- Messrs. Nielson and Bowen, as Class III Trustees, serve a term until the
third succeeding annual shareholder meeting called for the purpose of
electing Trustees. Thereafter, Mr. Bowen shall be subject to election by
the holders of the Common Shares and the senior equity securities,
including the Preferred Shares, voting together as a single class while
Mr. Nielson shall be a Trustee to be elected solely by all outstanding
senior equity securities, including the Preferred Shares, voting together
as a single class.
(4) Each Trustee has served in such capacity since the Fund's inception.
The Board of Trustees of the Fund has four standing committees, 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 Fund's Declaration and By-Laws. The members of the
Executive Committee shall also serve as a special committee of the Board known
as the Pricing and Dividend Committee which is authorized to exercise all of the
powers and authority of the Board in respect of the issuance and sale, through
an underwritten public offering, of the Preferred Shares of the Fund and all
other such matters relating to such financing, including determining the price
at which such shares are to be sold and approval of the final terms of the
underwriting agreement, including approval of the members of the underwriting
syndicate. Such committee is also responsible for the declaration and setting of
distributions. Messrs. Kadlec and Bowen are members of the Executive Committee.
The Nominating and Governance Committee is responsible for appointing and
nominating non-interested persons to the Fund's Board of Trustees. Messrs.
Erickson, Nielson, Kadlec and Keith 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
Fund has a retirement policy of age 72 for trustees. When a vacancy on the Board
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,
Shareholders of the Fund shall mail such recommendation to W. Scott Jardine at
the Fund's address, 1001 Warrenville Road, Suite 300, Lisle, Illinois 60532.
Such recommendation shall include the following information: (a) evidence of
Fund ownership of the person or entity recommending the candidate (if a Fund
Shareholder); (b) a full description of the proposed candidate's background,
including their education, experience, current employment and date of birth; (c)
names and addresses of at least three professional references for the candidate;
(d) information as to whether the candidate is an "interested person" in
relation to such 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
(e) any other information that may be helpful to the Committee in evaluating the
candidate. If a recommendation is received with satisfactorily completed
information regarding a candidate during a time when a vacancy exists on the
Board or during such other time as the Nominating and Governance Committee is
accepting recommendations, the recommendation will be forwarded to the Chair of
the Nominating and Governance Committee and the outside 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.
-22-
The Valuation Committee is responsible for the oversight of the pricing
procedures of the Fund. Messrs. Erickson, Kadlec, Nielson and Keith are members
of the Valuation Committee.
The Audit Committee is responsible for overseeing the Fund's accounting
and financial reporting process, the system of internal controls, audit process
and evaluating and appointing independent auditors (subject also to Board
approval). Messrs. Erickson, Nielson, Kadlec and Keith serve on the Audit
Committee.
Messrs. Erickson, Nielson, Keith, Kadlec and Bowen are also trustees of
First Defined Portfolio Fund, LLC, an open-end fund with 8 portfolios advised by
First Trust Advisors, the First Trust Value Line(R) 100 Fund, First Trust/Four
Corners Senior Floating Rate Income Fund, First Trust/Four Corners Senior
Floating Rate Income Fund II, Macquarie/First Trust Global Infrastructure/
Utilities Dividend & Income Fund, Energy Income and Growth Fund, First Trust/
Fiduciary Asset Management Covered Call Fund, First Trust/Aberdeen Global
Opportunity Income Fund, First Trust/FIDAC Mortgage Income Fund, First
Trust Strategic High Income Fund, First Trust Strategic High Income Fund II,
First Trust Strategic High Income Fund III, First Trust Tax-Advantaged Preferred
Income Fund and First Trust/Aberdeen Emerging Opportunity Fund, closed-end funds
advised by First Trust Advisors, and First Trust Exchange-Traded Fund and First
Trust Exchange-Traded AlphaDEX Fund, exchange-traded funds advised by First
Trust Advisors (collectively, the "First Trust Fund Complex"). None of the
Trustees who are not "interested persons" of the Fund, nor any of their
immediate family members, has ever been a director, officer or employee of, or
consultant to, First Trust Advisors, First Trust Portfolios L.P. or their
affiliates. In addition, Mr. Bowen and the other officers of the Fund (other
than Christopher Fallow) hold the same positions with the other funds in the
First Trust Fund Complex as they hold with the Fund. Mr. Fallow, Assistant Vice
President of the Fund, serves in the same position for all of the funds in the
First Trust Fund Complex with the exception of First Trust Value Line(R) 100
Fund, First Defined Portfolio Fund, LLC, First Trust Exchange-Traded Fund and
First Trust Exchange-Traded AlphaDEX Fund.
Each investment company in the First Trust Fund Complex pays each
Trustee who is not an officer or employee of First Trust Advisors, any
sub-adviser or any of their affiliates ("Independent Trustees") an annual
retainer of $10,000 per investment company for the first 14 investment companies
in the First Trust Fund Complex and an annual retainer of $7,500 per investment
company for each subsequent investment company added to the First Trust Fund
Complex. The annual retainer is allocated equally among each of the investment
companies. No additional meeting fees are paid in connection with board or
committee meetings. Additionally, Mr. Kadlec is paid $10,000 annually to serve
as the Lead Trustee and Mr. Nielson is paid $5,000 annually to serve as Chairman
of the Audit Committee, with such compensation paid by the investment companies
in the First Trust Fund Complex and divided among those investment companies.
Trustees are also reimbursed by the investment companies in the First Trust Fund
Complex for travel and out-of-pocket expenses in connection with all meetings.
The following table sets forth estimated compensation to be paid by the
Fund projected during the Fund's first full fiscal year to each of the Trustees
and estimated total compensation to be paid to each of the trustees by the First
-23-
Trust Fund Complex for a full calendar year. The Fund has no retirement or
pension plans. The officers and Trustee who are "interested persons" as
designated above serve without any compensation from the Fund.
ESTIMATED TOTAL COMPENSATION
ESTIMATED AGGREGATE FROM FUND AND
NAME OF TRUSTEE COMPENSATION FROM FUND (1) FUND COMPLEX(2)
James A. Bowen $0 $0
Richard E. Erickson $9,559 $162,500
Thomas R. Kadlec $10,147 $172,500
Robert F. Keith $9,559 $162,500
Niel B. Nielson $9,583 $167,500
--------------------
(1) The compensation estimated to be paid by the Fund to the trustees for
the first full fiscal year for services to the Fund.
(2) The total estimated compensation to be paid to Messrs. Erickson, Keith,
Kadlec and Nielson, Independent Trustees, from the Fund and the First
Trust Fund Complex for a full calendar year is based on estimated
compensation to be paid to these Trustees for a full calendar year for
services as Trustees to the Fund and the First Defined Portfolio Fund,
LLC, an open--end fund (with 8 portfolios), the First Trust Exchange-
Traded Fund and the First Trust Exchange-Traded AlphaDEX Fund, exchange-
traded funds, plus estimated compensation to be paid to these trustees
by the First Value Line(R) 100 Fund, the First Trust/Four Corners Senior
Floating Rate Income Fund, the First Trust/Four Corners Senior Floating
Rate Income Fund II, the Macquarie/First Trust Global Infrastructure/
Utilities Dividend & Income Fund, the Energy Income and Growth Fund, the
First Trust/Fiduciary Asset Management Covered Call Fund, the First
Trust/Aberdeen Global Opportunity Income Fund, the First Trust/FIDAC
Mortgage Income Fund, the First Trust Strategic High Income Fund, the
First Trust Strategic High Income Fund II, First Trust Strategic High
Income Fund III, the First Trust Tax-Advantaged Preferred Income Fund
and the First Trust/Aberdeen Emerging Opportunity Fund.
The Fund has no employees. Its officers are compensated by First Trust
Advisors. The Shareholders of the Fund will elect trustees at the next annual
meeting of shareholders.
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 May 31, 2007:
-24-
AGGREGATE DOLLAR RANGE OF
EQUITY SECURITIES IN
DOLLAR RANGE OF ALL REGISTERED INVESTMENT COMPANIES
EQUITY SECURITIES OVERSEEN BY TRUSTEE IN
TRUSTEE IN THE FUND FIRST TRUST FUND COMPLEX
Mr. Bowen None Over $100,000
Mr. Erickson None $ 50,001-$100,000
Mr. Kadlec None Over $100,000
Mr. Keith None Over $100,000
Mr. Nielson None $ 50,001- $100,000
As of May 31, 2007, the Trustees of the Fund who are not "interested
persons" of the Fund and immediate family members do not own beneficially or of
record any class of securities of an investment adviser or principal underwriter
of the Fund or any person directly or indirectly controlling, controlled by, or
under common control with an investment adviser or principal underwriter of the
Fund.
INVESTMENT ADVISER
First Trust Advisors L.P., 1001 Warrenville Road, Suite 300, Lisle,
Illinois 60532, is the investment adviser to the Fund. As investment adviser,
First Trust Advisors provides the Fund with professional investment supervision
and selects the Fund's Sub-Adviser (with the approval of the Board of Trustees)
and permits any of its officers or employees to serve without compensation as
Trustees or officers of the Fund if elected to such positions. First Trust
Advisors supervises the activities of the Fund's Sub-Adviser and provides the
Fund with certain other services necessary with the management of the portfolio.
First Trust Advisors is an Illinois limited partnership formed in 1991
and an investment adviser registered with the Securities and Exchange Commission
under the Investment Advisers Act of 1940 (the "Advisers Act"). First Trust
Advisors is a limited partnership with one limited partner, Grace Partners of
DuPage L.P. ("Grace Partners"), and one general partner, The Charger
Corporation. Grace Partners is a limited partnership with one general partner,
The Charger Corporation, and a number of limited partners. Grace Partners' and
The Charger Corporation's primary business is investment advisory and
broker/dealer services through their interests. The Charger Corporation is an
Illinois corporation controlled by the Robert Donald Van Kampen family. First
Trust Advisors is controlled by Grace Partners and The Charger Corporation.
First Trust Advisors is also adviser or sub-adviser to 25 mutual funds,
12 exchange-traded funds and 14 closed-end funds (including the Fund) and is the
portfolio supervisor of certain unit investment trusts sponsored by First Trust
Portfolios. First Trust Portfolios specializes in the underwriting, trading and
distribution of unit investment trusts and other securities. First Trust
Portfolios, an Illinois limited partnership formed in 1991, acts as sponsor for
successive series of The First Trust Combined Series, FT Series (formerly known
-25-
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.
First Trust Portfolios introduced the first insured unit investment trust in
1974 and to date, more than $70 billion in gross assets have been deposited in
First Trust Portfolios unit investment trusts.
First Trust Advisors acts as investment adviser to the Fund pursuant to
an Investment Management Agreement. The Investment Management Agreement
continues in effect for the Fund from year to year after its initial two-year
term so long as its continuation is approved at least annually by the trustees
including a majority of the Independent Trustees, or the vote of a majority of
the outstanding voting securities of the Fund. It may be terminated at any time
without the payment of any penalty upon 60 days' written notice by either party,
or by a majority vote of the outstanding voting securities of the Fund
(accompanied by appropriate notice), and will terminate automatically upon
assignment. The Investment Management Agreement also may be terminated, at any
time, without payment of any penalty, by the Board or by vote of a majority of
the outstanding voting securities of the Fund, in the event that it shall have
been established by a court of competent jurisdiction that the Adviser, or any
officer or director of the Adviser, has taken any action which results in a
breach of the covenants of the Adviser set forth in the Investment Management
Agreement. The Investment Management Agreement provides that First Trust
Advisors shall not be liable for any loss sustained by reason of the purchase,
sale or retention of any security, whether or not the purchase, sale or
retention shall have been based upon the investigation and research made by any
other individual, firm or corporation, if the 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 the Adviser in
performance of its obligations and duties, or by reason of its reckless
disregard of its obligations and duties under the Investment Management
Agreement. As compensation for its services, the Fund pays First Trust Advisors
a fee as described in the Prospectus. See "Management of the Fund--Investment
Management Agreement" in the Fund's Prospectus.
In addition to the fee of First Trust Advisors, the Fund pays all other
costs and expenses of its operations, including: compensation of its Trustees
(other than the Trustee affiliated with First Trust Advisors); custodian,
transfer agency, administrative, accounting and dividend disbursing expenses;
legal fees; expenses of independent auditors; expenses of preparing, printing
and distributing shareholder reports, notices, proxy statements and reports to
governmental agencies; and taxes, if any. All fees and expenses are accrued
daily and deducted before payment of dividends to investors.
The Investment Management Agreement has been approved by the Board of
Trustees of the Fund, including a majority of the Independent Trustees, and the
sole shareholder of the Fund. Information regarding the Board of Trustees'
approval of the Investment Management and Sub-Advisory Agreements will be
available in the Fund's semi-annual report for the fiscal period ending May 31,
2007.
CODE OF ETHICS
The Fund, Adviser and Sub-Adviser have adopted codes of ethics under
Rule 17j-1 under the 1940 Act. These codes permit personnel subject to the code
-26-
to invest in securities, including securities that may be purchased or held by
the Fund. These codes can be reviewed and copied at the Securities and Exchange
Commission's Public Reference Room in Washington, D.C. Information on the
operation of the Public Reference Room may be obtained by calling the Securities
and Exchange Commission at (202) 942-8090. The codes of ethics are available on
the EDGAR Database on the Securities and Exchange Commission's web site
(http://www.sec.gov), and copies of these codes may be obtained, after paying a
duplicating fee, by electronic request at the following e-mail address:
publicinfo@sec.gov, or by writing the Commission Public Reference Section,
Washington, D.C. 20549-0102.
PROXY VOTING POLICIES AND PROCEDURES
The Fund has adopted a proxy voting policy that seeks to ensure that
proxies for securities held by the Fund are voted consistently and solely in the
best economic interests of the Fund.
The Board of Trustees is responsible for oversight of the Fund's proxy
voting process. The Board has delegated day-to-day proxy voting responsibility
to Gallatin. Gallatin's Proxy Voting Policy is set forth in Appendix B to this
Statement of Additional Information.
Information regarding how the Fund voted proxies relating to portfolio
securities is available without charge, upon request, by calling (800) 621-1675
or by accessing the Securities and Exchange Commission's website at
http://www.sec.gov.
SUB-ADVISER
Gallatin, a registered investment adviser, acts as Sub-Adviser to the
Fund. Gallatin provides asset management and advisory services to high net worth
individuals and institutional investors. Gallatin, organized in 2005, is a
wholly-owned subsidiary of A.G. Edwards, Inc. The majority of Gallatin's
investment personnel previously comprised A.G. Edwards' Asset Management
Department, and its investment management team has remained intact since that
time. Its 13 managers and analysts count more than 180 years of aggregate
investment experience.
Among its investment strategies, Gallatin has approximately $10.3
billion of assets under management as of May 31, 2007. Of these, approximately
$3.1 billion are managed in equity and investment grade fixed income portfolios.
Gallatin also manages approximately $7.2 billion in portfolios of selected
exchange-traded funds ("ETFs") that are guided by proprietary asset allocation
models. These models are driven by the firm's analysis of cyclical changes
within the economy and financial markets combined with quantitative modeling.
Gallatin's advisory arm also employs investment manager analysts who provide
careful selection and monitoring of mutual funds, unit investment trusts, ETFs
and separate account managers.
On May 31, 2007, Wachovia Corp. announced that it had reached an
agreement in principle with A.G. Edwards, Inc. under which Wachovia Corp. will
acquire A.G. Edwards, Inc. (the "Acquisition"). Gallatin is a wholly-owned
-27-
subsidiary of A.G. Edwards, Inc. Subject to certain regulatory approvals and the
approval by the shareholders of A.G. Edwards, Inc., the Acquisition is expected
to be completed in the fourth quarter of 2007. Depending on the structure and
terms of the Acquisition, the Acquisition, if completed, may result in a change
of control of Gallatin which would constitute an assignment, as that term is
defined in the Investment Company Act of 1940, as amended, of the Sub-Advisory
Agreement among the Fund, Gallatin and First Trust Advisors L.P., the Fund's
Adviser, thus having the effect of automatically terminating the Sub-Advisory
Agreement. In the event of the automatic termination of the Sub-Advisory
Agreement, it is expected that a new Sub-Advisory Agreement among the Fund,
Gallatin and First Trust Advisors L.P., pursuant to which Gallatin would
continue to serve as the Fund's Sub-Adviser following completion of the
Acquisition, would be presented to the Fund's Board of Trustees and the Fund's
shareholders for their approval.
Gallatin will be responsible for the day-to-day management of the Fund's
portfolio utilizing a team of portfolio managers comprised of the following
Gallatin personnel:
Mark A. Keller, CFA, Senior Vice President, Chief Investment Officer
Mark Keller serves as senior vice president and chief investment officer
for Gallatin. Since 1994 Mr. Keller has led the Asset Management program for
A.G. Edwards, Inc. and its affiliates and continues in this capacity now as part
of the wholly owned subsidiary, Gallatin Asset Management. Mr. Keller also
chairs the A.G. Edwards Investment Strategy Committee. Prior to 1994, he served
for 15 years in A.G. Edwards' Securities Research Department as an analyst
covering a variety of industries. During his last five years in Securities
Research, Mr. Keller served as equity strategist and manager of the firm's Focus
List. He has been a CFA charterholder since 1984 and has a B.A. from Wheaton
College (Illinois).
David B. Miyazaki, CFA, Vice President, Equity Portfolio Manager
David Miyazaki serves as a portfolio manager for Gallatin where he
manages equity portfolios with a value discipline. He is also a member of the
A.G. Edwards Investment Strategy Committee, working to establish and maintain
the firm's asset allocation recommendations. Prior to joining A.G. Edwards in
1999, Mr. Miyazaki managed a short-term interest rate arbitrage portfolio for
Koch Industries from 1996 to 1999. He worked as an analyst for Prudential
Capital's private placement group from 1993 to 1996 and traded mortgage-backed
securities for a boutique firm in Dallas, Texas, from 1991-1993. Mr. Miyazaki
has been a CFA charterholder since 1995. He graduated from Texas Christian
University with a B.A. in business administration.
Daniel T. Winter, CFA, Vice President, Equity Portfolio Manager
Dan Winter serves as a portfolio manager for Gallatin where he manages
equity portfolios with a value discipline. He has served A.G. Edwards, Inc. and
its affiliates in an equity portfolio manager capacity since 1992, first for
A.G. Edwards Trust Co., then with A.G. Edwards Asset Management department and
continues in this capacity now as part of the wholly owned subsidiary, Gallatin
Asset Management. During his tenure with A.G. Edwards Trust Co., Mr. Winter
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specialized in the management of a variety of portfolios, including charitable
remainder trusts, foundations, endowments, employee benefits, and rabbi and
personal trusts; in 1996 he formally joined the Asset Management department. He
also directs the daily trading for the equity portfolios. Mr. Winter has been a
CFA charterholder since 1995. He earned a B.A. in business management with a
finance concentration from Eckerd College (St. Petersburg, Fla.) and an M.B.A.
from Saint Louis University.
The portfolio managers also have responsibility for the day-to-day
management of accounts other than the Fund, including separate accounts. The
advisory fees received by Gallatin in connection with the management of the Fund
and other accounts are not based on the performance of the Fund or the other
accounts. Information regarding those other accounts is set forth below.
NUMBER OF OTHER ACCOUNTS MANAGED AND ASSETS BY ACCOUNT TYPE
AS OF JANUARY 31, 2007
PORTFOLIO MANAGER REGISTERED INVESTMENT
COMPANIES OTHER POOLED
(OTHER THAN THE FUND) INVESTMENT VEHICLES OTHER ACCOUNTS
Mark Keller Number: 2 Number: 12 Number: 47,190
Assets: $450 million Assets: $71.33 million Assets: $8.59 billion
Daniel Winter Number: 2 Number: 11 Number: 45,275
Assets: $450 million Assets: $26.0 million Assets: $7.33 billion
David Miyazaki Number: 2 Number: 11 Number: 45,275
Assets: $450 million Assets: $26.0 million Assets: $7.33 billion
As shown in the table above, certain portfolio managers may manage other
accounts. Fees earned by Gallatin may vary among these accounts. These factors
could create conflicts of interest if a portfolio manager identified a limited
investment opportunity that may be appropriate for more than one account, but
the Fund is not able to take full advantage of that opportunity due to the need
to allocate that opportunity among multiple accounts. In addition, the portfolio
manager may execute transactions for other accounts that may adversely impact
the value of securities held by the Fund. However, Gallatin believes that these
risks are mitigated by the fact that: (i) accounts with like investment
strategies managed by a particular portfolio manager are generally managed in a
similar fashion, subject to exceptions to account for particular investment
restrictions or policies applicable only to certain accounts, differences in
cash flows and account sizes, and similar factors; (ii) the equity securities in
which the Fund will invest are typically liquid securities; and (iii) portfolio
manager personal trading is monitored to avoid potential conflicts. In addition,
Gallatin has adopted trade allocation procedures that require equitable
allocation of trade orders for a particular security among participating
accounts.
Securities considered as investments for the Fund also may be
appropriate for other investment accounts managed by the Sub-Adviser or its
affiliates. Whenever decisions are made to buy or sell securities by the Fund
and one or more of the other accounts simultaneously, the Sub-Adviser may
aggregate the purchases and sales of the securities and will allocate the
securities transactions in a manner which it believes to be equitable under the
-29-
circumstances. As a result of the allocations, there may be instances where the
Fund will not participate in a transaction that is allocated among other
accounts. While these aggregation and allocation policies could have a
detrimental effect on the price or amount of the securities available to the
Fund from time to time, it is the opinion of the Trustees of the Fund that the
benefits from the Sub-Adviser organization outweigh any disadvantage that may
arise from exposure to simultaneous transactions.
As of February 28, 2007, the portfolio managers received all of their
compensation from Gallatin. Gallatin seeks to maintain a highly competitive
compensation program designed to attract and retain qualified investment
professionals, which includes portfolio managers and research analysts, and to
align the interests of its investment professionals with that of its clients and
overall firm results. The principal components of compensation for portfolio
managers include a base salary, annual bonus, annual discretionary merit bonus,
and various retirement benefits.
At May 31, 2007, none of the portfolio managers beneficially owned (as
determined pursuant to Rule 16a-1(a)(2) under the Securities Exchange Act of
1934 (the "1934 Act")) any shares of the Fund. After completion of the initial
Fund offering, the portfolio managers may purchase Common Shares of the Fund for
their personal accounts.
The Sub-Adviser, subject to the Board of Trustees' and Adviser's
supervision, provides the Fund with discretionary investment services.
Specifically, the Sub-Adviser is responsible for managing the investments of the
Fund in accordance with the Fund's investment objectives, policies, and
restrictions as provided in the Prospectus and this Statement of Additional
Information, as may be subsequently changed by the Board of Trustees. The
Sub-Adviser further agrees to conform to all applicable laws and regulations of
the Securities and Exchange Commission in all material respects and to conduct
its activities under the Sub-Advisory Agreement in accordance with applicable
regulations of any governmental authority pertaining to its investment advisory
services. In the performance of its duties, the Sub-Adviser will satisfy its
fiduciary duties to the Fund, will monitor the Fund's investments, and will
comply with the provisions of the Fund's Declaration and By-laws, and the stated
investment objectives, policies and restrictions of the Fund. The Sub-Adviser is
responsible for effecting all security transactions for the Fund's assets. The
Sub-Advisory Agreement provides that the Sub-Adviser shall not be liable for any
loss suffered by the Fund or the Adviser (including, without limitation, by
reason of the purchase, sale or retention of any security) in connection with
the performance of the Sub-Adviser's duties under the Sub-Advisory Agreement,
except for a loss resulting from willful misfeasance, bad faith or gross
negligence on the part of the Sub-Adviser in performance of its duties under
such Sub-Advisory Agreement, or by reason of its reckless disregard of its
obligations and duties under such Sub-Advisory Agreement.
Pursuant to the Sub-Advisory Agreement among the Adviser, the
Sub-Adviser and the Fund, the Adviser has agreed to pay for the services and
facilities provided by the Sub-Adviser through sub-advisory fees, as set forth
in the Fund's Prospectus.
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The Sub-Advisory Agreement may be terminated without the payment of any
penalty by the Adviser, the Fund's Board of Trustees, or a majority of the
outstanding voting securities of the Fund (as defined in the 1940 Act), upon 60
days' written notice to the Sub-Adviser.
All fees and expenses are accrued daily and deducted before payment of
dividends to investors. The Sub-Advisory Agreement has been approved by the
Board of Trustees of the Fund, including a majority of the Independent Trustees,
and the sole shareholder of the Fund.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Subject to the supervision of the Board of Trustees, the Sub-Adviser
shall have authority and discretion to select brokers and dealers to execute
transactions initiated by the Sub-Adviser and to select the market in which the
transactions will be executed. In placing orders for the sale and purchase of
securities for the Fund, the Sub-Adviser's primary responsibility shall be to
seek the best execution of orders at the most favorable prices. However, this
responsibility shall not obligate the Sub-Adviser to solicit competitive bids
for each transaction or to seek the lowest available commission cost to the
Fund, so long as the Sub-Adviser reasonably believes that the broker or dealer
selected by it can be expected to obtain a "best execution" market price on the
particular transaction and determines in good faith that the commission cost is
reasonable in relation to the value of the brokerage (as defined in Section
28(e)(3) of the 1934 Act) provided by such broker or dealer to the Sub-Adviser,
viewed in terms of either that particular transaction or of the Sub-Adviser's
overall responsibilities with respect to its clients, including the Fund, as to
which the Sub-Adviser exercises investment discretion, notwithstanding that the
Fund may not be the direct or exclusive beneficiary of any such services or that
another broker may be willing to charge the Fund a lower commission on the
particular transaction.
The Sub-Adviser's objective in selecting brokers and dealers and in
effecting portfolio transactions is to seek to obtain the best combination of
price and execution with respect to its clients' portfolio transactions. Steps
associated with seeking best execution are: (1) determine each client's trading
requirements; (2) select appropriate trading methods, venues, and agents to
execute the trades under the circumstances; (3) evaluate market liquidity of
each security and take appropriate steps to avoid excessive market impact; (4)
maintain client confidentiality and proprietary information inherent in the
decision to trade; and (5) review the results on a periodic basis.
In arranging for the purchase and sale of clients' portfolio securities,
the Sub-Adviser takes numerous factors into consideration. The best net price,
giving effect to brokerage commissions, spreads and other costs, is normally an
important factor in this decision, but a number of other judgmental factors are
considered as they are deemed relevant. The factors include, but are not limited
to: the execution capabilities required by the transactions; the ability and
willingness of the broker or dealer to facilitate the accounts' portfolio
transactions by participating therein for its own account; the importance to the
account of speed, efficiency and confidentiality; the broker or dealer's
apparent familiarity with sources from or to whom particular securities might be
purchased or sold; the reputation and perceived soundness of the broker or
dealer; the Sub-Adviser's knowledge of negotiated commission rates and spreads
-31-
currently available; the nature of the security being traded; the size and type
of the transaction; the nature and character of the markets for the security to
be purchased or sold; the desired timing of the trade; the activity existing and
expected in the market for the particular security; confidentiality; the
execution, clearance and settlement capabilities as well as the reputation and
perceived soundness of the broker-dealer selected and others which are
considered; the Sub-Adviser's knowledge of actual or apparent operational
problems of any broker-dealer; the broker-dealer's execution services rendered
on a continuing basis and in other transactions; the reasonableness of spreads
or commissions; as well as other matters relevant to the selection of a broker
or dealer for portfolio transactions for any account. The Sub-Adviser does not
adhere to any rigid formula in making the selection of the applicable broker or
dealer for portfolio transactions, but weighs a combination of the preceding
factors.
When buying or selling securities in dealer markets, the Sub-Adviser
generally prefers to deal directly with market makers in the securities. The
Sub-Adviser will typically effect these trades on a "net" basis, and will not
pay the market maker any commission, commission equivalent or markup/markdown
other than the "spread." Usually, the market maker profits from the "spread,"
that is, the difference between the price paid (or received) by the Sub-Adviser
and the price received (or paid) by the market maker in trades with other
broker-dealers or other customers.
The Sub-Adviser may use Electronic Communications Networks ("ECN") or
Alternative Trading Systems ("ATS") to effect such over-the-counter trades for
equity securities when, in the Sub-Adviser's judgment, the use of an ECN or ATS
may result in equal or more favorable overall executions for the transactions.
Portfolio transactions for each client account will generally be
completed independently, except when the Sub-Adviser is in the position of
buying or selling the same security for a number of clients at approximately the
same time. Because of market fluctuations, the prices obtained on such
transactions within a single day may vary substantially. In order to avoid
having clients receive different prices for the same security on the same day,
the Sub-Adviser endeavors, when possible, to use an "averaging" procedure.
Under this procedure, purchases or sales of a particular security for
clients' accounts will at times be combined or "batched" with purchases or sales
for other advisory clients by the Sub-Adviser unless the client has expressly
directed otherwise. Such batched trades may be used to facilitate best
execution, including negotiating more favorable prices, obtaining more timely or
equitable execution or reducing overall commission charges. In such cases, the
price shown on confirmations of clients' purchases or sales will be the average
execution price on all of the purchases and sales that are aggregated for this
purpose.
The Sub-Adviser may also consider the following when deciding on
allocations: (1) cash flow changes (including available cash, redemptions,
exchanges, capital additions and capital withdrawals) may provide a basis to
deviate from a pre-established allocation as long as it does not result in an
unfair advantage to specific accounts or types of accounts over time; (2)
accounts with specialized investment objectives or restrictions emphasizing
investment in a specific category of securities may be given priority over other
-32-
accounts in allocating such securities; and (3) for bond trades, street
convention and good delivery often dictate the minimum size and par amounts and
may result in deviations from pro rata distribution.
DESCRIPTION OF SHARES
COMMON SHARES
The beneficial interest of the Fund may be divided from time to time
into shares of beneficial interest of such classes and of such designations and
par value (if any) and with such rights, preferences, privileges and
restrictions as shall be determined by the Trustees from time to time in their
sole discretion, without shareholder vote. The Fund's Declaration initially
authorizes the issuance of an unlimited number of Common Shares. The Common
Shares have a par value of $0.01 per share and, subject to the rights of holders
of preferred shares, including the Preferred Shares, have equal rights as to the
payment of dividends and the distribution of assets upon liquidation of the
Fund. The Common Shares are fully paid and, subject to matters discussed in
"Certain Provisions in the Declaration of Trust," non-assessable, and currently
have no pre-emptive or conversion rights (except as may otherwise be determined
by the Trustees in their sole discretion) or rights to cumulative voting in the
election of Trustees.
The Fund's Common Shares are currently listed on the New York Stock
Exchange. The trading or ticker symbol of the Common Shares is "FGB." The Fund
intends to hold annual meetings of shareholders so long as the Common Shares are
listed on a national securities exchange and such meetings are required as a
condition to such listing.
Shares of closed-end investment companies may frequently trade at prices
lower than NAV. NAV will be reduced immediately following the offering after
payment of the sales load and organization and offering expenses. Although the
value of the Fund's net assets is generally considered by market participants in
determining whether to purchase or sell shares, whether investors will realize
gains or losses upon the sale of Common Shares will depend entirely upon whether
the market price of the Common Shares at the time of sale is above or below the
original purchase price for the shares. Since the market price of the Fund's
Common Shares will be determined by factors beyond the control of the Fund, the
Fund cannot predict whether the Common Shares will trade at, below, or above NAV
or at, below or above the initial public offering price. Accordingly, the Common
Shares are designed primarily for long-term investors, and investors in the
Common Shares should not view the Fund as a vehicle for trading purposes. See
"Repurchase of Fund Shares; Conversion to Open-End Fund" below and "The Fund's
Investments" in the Fund's Prospectus.
PREFERRED SHARES
Under the terms of the Declaration, the Board of Trustees has the
authority in its sole discretion, without shareholder vote, to authorize the
issuance of preferred shares in one or more classes or series with such rights
and terms, including voting rights, dividend rates, redemption provisions,
liquidation preferences and conversion provisions as determined by the Board of
Trustees.
-33-
The Preferred Shares will have a liquidation preference of $25,000 per
share plus an amount equal to accumulated but unpaid distributions (whether or
not earned or declared by the Fund). Preferred shares of the Fund will rank on
parity with shares of any other class or series of preferred shares of the Fund
as to the payment of periodic dividends or distributions, including distribution
of assets upon liquidation. All preferred shares of the Fund carry one vote per
share on all matters on which such shares are entitled to be voted. The
Preferred Shares will, when issued, be fully paid and non-assessable and have no
preemptive, exchange, conversion or cumulative voting rights.
BORROWINGS
The Declaration authorizes the Fund, without prior approval of the
Common or Preferred Shareholders, to borrow money. In this connection, the Fund
may enter into reverse repurchase agreements, issue notes or other evidence of
indebtedness (including bank borrowings or commercial paper) ("Borrowings") and
may secure any such Borrowings by mortgaging, pledging or otherwise subjecting
as security the Fund's assets. In connection with such Borrowings, the Fund may
be required to maintain average balances with the lender or to pay a commitment
or other fee to maintain a line of credit. Any such requirements will increase
the cost of borrowing over the stated interest rate. A reverse repurchase
agreement, although structured as a sale and repurchase obligation, acts as a
financing under which the Fund will effectively pledge its securities as
collateral to secure a short-term loan. Generally, the other party to the
agreement makes the loan in an amount equal to a percentage of the market value
of the pledged collateral. At the maturity of the reverse repurchase agreement,
the Fund will be required to repay the loan and correspondingly receive back its
collateral. While used as collateral, the securities continue to pay principal
and interest which are for the benefit of the Fund. The Fund may borrow from
banks and other financial institutions.
Limitations on Borrowings. Under the requirements of the 1940 Act, the
Fund, immediately after any Borrowings, must have an "asset coverage" of at
least 300% (33-1/3% of Managed Assets after Borrowings). With respect to such
Borrowings, "asset coverage" means the ratio which the value of the total assets
of the Fund, less all liabilities and indebtedness not represented by senior
securities (as defined in the 1940 Act), bears to the aggregate amount of such
Borrowings represented by senior securities issued by the Fund. Certain types of
Borrowings may result in the Fund being subject to covenants in credit
agreements relating to asset coverages or portfolio composition or otherwise. In
addition, the Fund is subject to certain restrictions imposed by guidelines of
one or more nationally recognized statistical rating organizations which may
issue ratings for short-term corporate debt securities or the Preferred Shares
issued by the Fund. Such restrictions may be more stringent than those imposed
by the 1940 Act.
Distribution Preference. The rights of lenders to the Fund to receive
interest on and repayment of principal of any such Borrowings will be senior to
those of the Common and Preferred Shareholders, and the terms of any such
Borrowings may contain provisions which limit certain activities of the Fund,
including the payment of dividends to Common and Preferred Shareholders in
certain circumstances.
-34-
Voting Rights. The 1940 Act grants (in certain circumstances) to the
lenders to the Fund certain voting rights in the event the asset coverage falls
below specified levels. In the event that the Fund elects to be treated as a
regulated investment company under the Code and such provisions would impair the
Fund's status as a regulated investment company, the Fund, subject to its
ability to liquidate its portfolio, intends to repay the Borrowings. Any
Borrowings will likely be ranked senior or equal to all other existing and
future borrowings of the Fund.
The discussion above describes the Fund's Board of Trustees' present
intention with respect to an offering of Borrowings. If authorized by the Board
of Trustees, the terms of any Borrowings may be the same as, or different from,
the terms described above, subject to applicable law and the Fund's Declaration.
ADDITIONAL INFORMATION CONCERNING THE AUCTIONS OF THE PREFERRED SHARES
GENERAL
DTC will act as the Securities Depository with respect to each series of
Preferred Shares. All of the Preferred Shares will be registered in the name of
Cede & Co., as nominee of the Securities Depository. The global certificates
held by Cede & Co. will bear a legend to the effect that such certificate is
issued subject to the provisions restricting transfers of the Preferred Shares
contained in the Statement Establishing and Fixing the Rights and Preferences of
Series __ Auction Preferred Shares and Series __ Auction Preferred Shares. We
will also issue stop-transfer instructions to the transfer agent for the
Preferred Shares. Prior to the commencement of the right of holders of the
Preferred Shares to elect a majority of our trustees, in circumstances described
under "Description of Preferred Shares-Voting Rights" in the Prospectus, Cede &
Co. will be the holder of record of the Preferred Shares. Owners of Preferred
Shares are not entitled to receive certificates representing their ownership
interest.
DTC, a New York-chartered limited purpose trust company, performs
services for its participants, some of whom (and/or their representatives) own
DTC. DTC maintains lists of its participants and will maintain the positions
(ownership interests) held by each such participants in the Preferred Shares,
whether for its own account or as a nominee for another person.
CONCERNING THE AUCTION AGENT
The Auction Agent, currently ___________, will act as our agent in
connection with the auctions of the Preferred Shares (the "Auctions"). In the
absence of willful misconduct or gross negligence on its part, the Auction Agent
will not be liable for any action taken, suffered, or omitted or for any error
of judgment made by it in the performance of its duties under the Auction Agency
Agreement between the Fund and the Auction Agent and will not be liable for any
error of judgment made in good faith unless the Auction Agent was grossly
negligent in ascertaining the facts pertinent to making such decision. We will
indemnify the Auction Agent and its officers, directors, employees and agents
for, and hold it harmless against, any loss, liability or expense incurred
without gross negligence or willful misconduct on the part of the Auction Agent
arising out of or in connection with its agency under the Auction Agency
-35-
Agreement and under the Broker-Dealer Agreements entered into by the Auction
Agent pursuant to the Auction Agency Agreement, including the costs and expenses
of defending itself against any claim of liability in connection with its
exercise or performance of any of its duties thereunder, except such as may
result from its gross negligence or willful misconduct. We will pay to the
Auction Agent from time to time reasonable compensation for all services
rendered by it under the Auction Agency Agreement.
The Auction Agent may conclusively rely upon, as evidence of the
identities of the holders of the Preferred Shares, the Auction Agent's registry
of holders, and the results of auctions and notices from any Broker-Dealer (or
other person, if permitted by the Fund) with respect to transfers described
under the "The Auction" in the Prospectus and notices from the Fund. The Auction
Agent is not required to accept any such notice for an auction unless it is
received by the Auction Agent by 3:00 p.m., Eastern time, on the business day
preceding such Auction.
BROKER-DEALERS
The Auction Agent after each Auction for Preferred Shares will pay to
each Broker-Dealer, from funds provided by the Fund, a service charge at the
annual rate of [___ of 1%] in the case of any Auction immediately preceding a
distribution period of less than one year, or a percentage agreed to by the Fund
and the Broker-Dealer in the case of any Auction immediately preceding a
distribution period of one year or longer, of the liquidation preference
($25,000 per share) of the Preferred Shares placed by such Broker-Dealer at such
Auction. For purposes of the preceding sentence, the Preferred Shares will be
placed by a Broker-Dealer if such shares were (a) the subject of hold orders
deemed to have been submitted to the Auction Agent by the Broker-Dealer and
acquired by such Broker-Dealer for its customers who are beneficial owners of
those Preferred Shares or (b) the subject of an order submitted by such
Broker-Dealer that is (i) a bid of an existing holder that resulted in the
existing holder continuing to hold Preferred Shares as a result of the Auction
or (ii) a bid of a potential holder that resulted in the potential holder
purchasing Preferred Shares as a result of the Auction or (iii) a valid hold
order. The Fund will pay to the Auction Agent the service charge in the amount
set forth above no later than [12:00 noon] on the date of each Auction.
BROKER-DEALER BIDDING
The Broker-Dealer Agreements provide that a Broker-Dealer (other than an
affiliate of the Fund) may submit orders in Auctions for its own account (either
as an existing holder or a potential holder), and a Broker-Dealer may routinely
do so in the auction rate securities market in its sole discretion, unless the
Fund notifies all Broker-Dealers that they may no longer do so, in which case
Broker-Dealers may continue to submit hold orders and sell orders for their own
accounts. If a Broker-Dealer submits an order for its own account, it would have
an advantage over other bidders because such Broker-Dealer would have knowledge
of some or all of the other orders placed through such Broker-Dealer in that
Auction. Therefore, a Broker-Dealer could determine the rate and size of its
order to increase the likelihood that its order will be accepted in the Auction
or that the Auction will clear at a particular rate. For this reason, and
because each Broker-Dealer is appointed and paid by the Auction Agent, with
funds provided by us, to serve as a Broker-Dealer in the Auction, each
-36-
Broker-Dealer's interests in conducting an Auction may differ from those of
holders of Preferred Shares ("Beneficial Owners") and potential beneficial
owners who participate in Auctions. A Broker-Dealer would not have knowledge of
orders submitted to the Auction Agent by any other firm that is, or may in the
future be, appointed to accept orders pursuant to a Broker-Dealer Agreement.
Each Broker-Dealer may routinely place one or more bids in an Auction
for its own account to acquire the Preferred Shares for its inventory, to seek
to prevent an event in which there are insufficient clearing bids ("Auction
Failure Event") (which would result in the distribution rate being set at the
maximum rate on the auction date) or to seek to prevent an Auction from clearing
at a rate that such Broker-Dealer believes does not reflect the market for the
Preferred Shares. Each Broker-Dealer may place such bids even after obtaining
knowledge of some or all of the other orders submitted through it. When bidding
for its own account, each Broker-Dealer may also bid outside or inside the range
of rates that it posts in its "price talk." Each Broker-Dealer also may
routinely encourage bidding by others in Auctions, including to prevent an
Auction Failure Event or an Auction from clearing at a rate that such
Broker-Dealer believes does not reflect the market for the Preferred Shares.
Each Broker-Dealer may routinely encourage such bids even after obtaining
knowledge of some or all of the other orders submitted through it.
Bids by any Broker-Dealer or by those it may encourage to place bids are
likely to affect (i) the distribution rate -- including preventing the
applicable rate from being set at the maximum rate on the Auction date or
otherwise causing bidders to receive a higher or lower rate than they might have
received had such Broker-Dealer not bid or not encouraged others to bid and (ii)
the allocation of Preferred Shares being auctioned -- including displacing some
Beneficial Owners or potential beneficial owners who may have their bids
rejected or receive fewer Preferred Shares than they would have received if such
Broker-Dealer had not bid or encouraged others to bid. Because of these
practices, the fact that an Auction clears successfully does not mean that an
investment in the Preferred Shares involves no significant liquidity or credit
risk. No Broker-Dealer is obligated to continue to place such bids or encourage
other bidders to do so in any particular Auction to prevent an Auction from
failing or clearing at a distribution rate such Broker-Dealer believes does not
reflect the market for the Preferred Shares. Investors should not assume that
any Broker-Dealer will do so or that Auction Failure Events will not occur.
Investors should also be aware that bids by a Broker-Dealer or by those it may
encourage to place bids may cause unfavorable distribution rates to occur.
In any particular Auction, if all outstanding Preferred Shares are the
subject of submitted hold orders, the applicable rate for the next succeeding
distribution period will be below the market rate on such Auction date, as
described below (such a situation is called an "All Hold Auction"). When an All
Hold Auction is likely, a Broker-Dealer may, but is not obligated to, advise
Beneficial Owners of that fact, which might facilitate the submission of bids by
Beneficial Owners that would avoid the occurrence of an All Hold Auction. If a
Broker-Dealer decides to inform Beneficial Owners of the likelihood of an All
Hold Auction, it will make that information available to all Beneficial Owners
at the same time. If a Broker-Dealer holds any Preferred Shares for its own
account on an Auction date, such Broker-Dealer will submit a sell order into the
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Auction with respect to such Preferred Shares, which would prevent that Auction
from being an All Hold Auction. A Broker-Dealer may, but is not obligated to,
submit bids for its own account in that same Auction, as set forth above.
AUCTION DEALER FEES
For many auction rate securities, a broker-dealer is appointed by the
issuer of the securities to serve as a dealer for the related Auctions and is
paid by the issuer for its services. With respect to the Preferred Shares, each
Broker-Dealer has been appointed to serve as a dealer in the Auctions pursuant
to the Broker-Dealer Agreement between the Auction Agent and such Broker-Dealer.
Each Broker-Dealer Agreement provides that the Auction Agent will pay to each
Broker-Dealer from funds provided by us auction dealer fees at an annual rate of
a percentage of the principal amount of the Preferred Shares sold or
successfully placed through such Broker-Dealer. As a result, a Broker-Dealer's
interests in conducting Auctions may differ from those of investors who
participate in Auctions.
A Broker-Dealer may share a portion of the auction dealer fees it
receives from the Auction Agent with other broker-dealers that submit orders
through such Broker-Dealer that such Broker-Dealer successfully places in the
Auction. In general, auction dealers may share with a Broker-Dealer a portion of
the fees they receive from an issuer when those dealers submit orders for such
Broker-Dealer (on behalf of such Broker-Dealer or its customers) into Auctions
in which such Broker-Dealer does not serve as a dealer. Similarly, with respect
to Auctions for other auction rate securities for which a Broker--Dealer does
not serve as a dealer, the other broker-dealers who serve as dealers in those
Auctions may share auction dealer fees with such Broker-Dealer for orders that
such Broker-Dealer submits through those broker-dealers that those
broker-dealers successfully place in those Auctions.
PRICE TALK
Before the start of an Auction, a Broker-Dealer may, in its discretion,
make available to Beneficial Owners and potential beneficial owners such
Broker-Dealer's good faith judgment of the range of likely clearing rates for
the Auction, based on market and other information. This is known as "price
talk." Price talk is not a guarantee that the distribution rate established
through the Auction will be a distribution rate within the price talk, and
Beneficial Owners and potential beneficial owners are free to use it or ignore
it. If a Broker-Dealer provides price talk, such Broker-Dealer will make the
price talk available to all Beneficial Owners and potential beneficial owner. A
Broker-Dealer may occasionally update and change the price talk based on changes
in issuer credit quality or macroeconomic factors that are likely to result in a
change in interest rate levels, such as an announcement by the Federal Reserve
Board of a change in the Federal Funds rate or an announcement by the Bureau of
Labor Statistics of unemployment numbers. Such Broker-Dealer will make such
changes available to all Beneficial Owners and potential beneficial owners that
were given the original price talk.
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ALL-OR-NOTHING BIDS
No Broker-Dealer accepts "all-or-nothing" bids (i.e., bids whereby the
bidder proposes to reject an allocation smaller than the entire quantity bid) or
any other type of bid that allows the bidder to avoid auction procedures that
require the pro rata allocation of Preferred Shares where there are not
sufficient sell orders to fill all bids at the clearing rate.
NO ASSURANCES REGARDING AUCTION OUTCOMES
None of the Broker-Dealers provides any assurance as to the outcome of
any Auction. Nor does any Broker-Dealer provide any assurance that any orders
will be accepted or that the Auction will clear at a rate that a bidder
considers acceptable. Bids may be rejected or may be only partially filled, and
the rate on any Preferred Shares purchased or retained may be lower than the
bidder expected.
DEADLINES/AUCTION PERIODS
Each particular Auction has a formal time deadline by which all bids
must be submitted by each Broker-Dealer to the Auction Agent. This deadline is
called the "Submission Deadline." To provide sufficient time to process and
submit customer bids to the Auction Agent before the Submission Deadline, each
Broker-Dealer imposes an earlier deadline -- called the "Internal Submission
Deadline" -- by which bidders must submit bids to such Broker-Dealer. The
Internal Submission Deadline is subject to change by such Broker-Dealer. A
Broker-Dealer may allow for correction of clerical errors after the Internal
Submission Deadline and prior to the Submission Deadline. A Broker-Dealer may
submit Bids for its own account at any time until the Auction Submission
Deadline. The Auction Agent may allow for the correction of clerical errors for
a specified period of time after the Auction Submission Deadline.
During any Auction Period, the Fund may, pursuant to the terms of the
Auction Procedures, designate a Special Rate Period. In Auctions that are
subject to the special rate period, a Broker-Dealer may place a bid to buy the
Preferred Shares that may effectively place an upper limit on the rate that can
be set at the Auction at a rate that is below the maximum rate on that Auction
date. Such Broker Dealer may negotiate a separate fee from the Fund in such
circumstances.
BENEFICIAL OWNER'S ABILITY TO RESELL PREFERRED SECURITIES MAY BE LIMITED
Beneficial Owners will be able to sell all of the Preferred Shares in an
Auction that are the subject of submitted sell orders only if there are bidders
willing to purchase all those Preferred Shares offered for sale in the Auction.
If sufficient clearing bids have not been made, Beneficial Owners that have
submitted sell orders will not be able to sell in the Auction all, and may not
be able to sell any, of the Preferred Shares subject to such submitted sell
-39-
orders. As discussed above (see "Broker-Dealer Bidding"), a Broker-Dealer may
submit a bid in an Auction to keep it from failing, but it is not obligated to
do so. There may not always be enough bidders to prevent an auction from failing
in the absence of a Broker-Dealer bidding in the Auction for its own account or
encouraging others to bid. Therefore, Auction Failure Events are possible,
especially if the Fund's credit were to deteriorate, a market disruption were to
occur or if, for any reason, a Broker-Dealer were unable or unwilling to bid.
Between Auctions, there can be no assurance that a secondary market for
the Preferred Shares will develop or, if it does develop, that it will provide
Beneficial Owners the ability to resell the Preferred Shares in the secondary
market on the terms or at the times desired by an Beneficial Owner. A
Broker-Dealer may, in its own discretion, decide to buy or sell the Preferred
Shares in the secondary market for its own account to or from investors at any
time and at any price, including at prices equivalent to, below, or above the
par value of the Preferred Shares. However, no Broker-Dealer is obligated to
make a market in the Preferred Shares, and may discontinue trading in the
Preferred Shares without notice for any reason at any time. Beneficial Owners
who resell between Auctions may receive less than par value, depending on market
conditions.
The Auction Agent Agreement provides that the Auction Agent may resign
from its duties as Auction Agent by giving at least 60 days notice to us. Each
Broker-Dealer Agreement provides that the Broker-Dealer thereunder may resign
upon five days notice or immediately, in certain circumstances, and does not
require, as a condition to the effectiveness of such resignation, that a
replacement Broker-Dealer be in place. Resignation of the Auction Agent under
the Auction Agent Agreement or a Broker-Dealer under a Broker-Dealer Agreement
could impact the ability of the Fund to hold Auctions. For any Auction period
during which there is no duly appointed Auction Agent, or during which there is
no duly appointed Broker-Dealer, it will not be possible to hold Auctions, with
the result that the interest rate on the Preferred Shares will be the maximum
rate on that Auction date.
CERTAIN PROVISIONS IN THE DECLARATION OF TRUST AND BY-LAWS
Under Massachusetts law, shareholders in certain circumstances, could be
held personally liable for the obligations of the Fund. However, the Declaration
contains an express disclaimer of shareholder liability for debts or obligations
of the Fund and requires that notice of such limited liability be given in each
agreement, obligation or instrument entered into or executed by the Fund or the
trustees. The Declaration further provides for indemnification out of the assets
and property of the Fund for all loss and expense of any shareholder held
personally liable for the obligations of the Fund solely by reason of his or her
being a shareholder. In addition, the Fund will assume the defense of any claim
against a shareholder for personal liability at the request of the shareholder.
Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is limited to circumstances in which the Fund would be
unable to meet its obligations. The Fund believes that the likelihood of such
circumstances is remote.
The Declaration provides that the obligations of the Fund are not
binding upon the trustees of the Fund individually, but only upon the assets and
property of the Fund. The Declaration further provides that a Trustee acting in
his or her capacity of Trustee is not personally liable to any person other than
the Fund or its shareholders, for any act, omission, or obligation of the Fund.
A present or former Trustee, officer or employee of the Fund is not liable to
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the Fund or its shareholders for any action or failure to act (including without
limitation the failure to compel in any way any former or acting Trustee to
redress any breach of trust) except for his or her own bad faith, willful
misfeasance, gross negligence or reckless disregard of his or her duties
involved in the conduct of the individual's office, and for nothing else and is
not liable for errors of judgment or mistakes of fact or law.
The Declaration requires the Fund to indemnify any persons who are or
who have been Trustees, officers or employees of the Fund for any liability for
actions or failure to act except to extent prohibited by applicable federal law.
In making any determination as to whether any person is entitled to the
advancement of expenses or indemnification, 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 also clarifies that any Trustee who serves as chair of
the board or of a committee of the board, lead independent Trustee, or audit
committee financial expert, or in any other similar capacity will not be subject
to any greater standard of care or liability because of such position.
The Declaration requires a shareholder vote only on those matters where
the Investment Company Act of 1940 or the Fund's listing with an exchange
require a shareholder vote, but 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 closed end fund, and the sale of all or
substantially all of its assets without shareholder approval if the 1940 Act
would not require such approval. The Declaration further provides that the
Trustees may amend the Declaration in any respect without shareholder approval.
The Declaration, however, prohibits amendments that impair the exemption from
personal liability granted in the Declaration to persons who are or have been
shareholders, Trustees, officers or, employees of the Fund or that limit the
rights to indemnification or insurance provided in the Declaration with respect
to actions or omissions of persons entitled to indemnification under the
Declaration prior to the amendment.
The Declaration and By-Laws include provisions that could limit the
ability of other entities or persons to acquire control of the Fund or to
convert the Fund to open-end status. The number of trustees is currently five,
but by action of two-thirds of the Trustees, the Board may from time to time be
increased or decreased. The Board of Trustees is divided into three classes,
with the terms of one class expiring at each annual meeting of shareholders. The
Fund may establish a separate class for the Trustees elected by the holders of
the Preferred Shares. Vacancies on the Board of Trustees may be filled by a
majority action of the remaining trustees. Such provisions may work to delay a
change in the majority of the Board of Trustees. The provisions of the
Declaration relating to the election and removal of Trustees may be amended only
by vote of two-thirds of the Trustees then in office.
Generally, the Declaration requires the affirmative vote or consent by
holders of at least two-thirds of the shares outstanding and entitled to vote,
except as described below, to authorize: (1) a conversion of the Fund from a
closed-end to an open-end investment company; (2) a merger or consolidation of
the Fund with any corporation, association, trust or other organization,
including a series or class of such other organization (in the limited
circumstances where a vote by shareholders is otherwise required under the
-41-
Declaration); (3) a sale, lease or exchange of all or substantially all of the
Fund's assets (in the limited circumstances where a vote by shareholders is
otherwise required under the Declaration); (4) in certain circumstances, a
termination of the Fund; (5) removal of trustees by shareholders; or (6) certain
transactions in which a Principal Shareholder (as defined below) is a party to
the transactions. However, with respect to items (1), (2) and (3) above, if the
applicable transaction has been already approved by the affirmative vote of
two-thirds of the trustees, then the majority of the outstanding voting
securities as defined in the 1940 Act (a "Majority Shareholder Vote") is
required. In addition, if there are then preferred shares outstanding, with
respect to (1) above, two-thirds of the preferred shares voting as a separate
class shall also be required unless the action has already been approved by
two-thirds of the trustees, in which case then a Majority Shareholder Vote is
required. Such affirmative vote or consent shall be in addition to the vote or
consent of the holders of the shares otherwise required by law or by the terms
of any class or series of preferred shares, whether now or hereafter authorized,
or any agreement between the Fund and any national securities exchange. Further,
in the case of items (2) or (3) that constitute a plan of reorganization (as
such term is used in the 1940 Act) which adversely affects the preferred shares
within the meaning of section 18(a)(2)(D) of the 1940 Act, except as may
otherwise be required by law, the approval of the action in question will also
require the affirmative vote of two-thirds of the preferred shares voting as a
separate class provided, however, that such separate class vote shall be by a
Majority Shareholder Vote if the action in question has previously been approved
by the affirmative vote of two-thirds of the trustees.
As noted above, pursuant to the Declaration, the affirmative approval of
two-thirds of the Shares outstanding and entitled to vote, subject to certain
exceptions, shall be required for the following transactions in which a
Principal Shareholder (as defined below) is a party: (i) the merger or
consolidation of the Fund or any subsidiary of the Fund with or into any
Principal Shareholder; (ii) the issuance of any securities of the Fund to any
Principal Shareholder for cash other than pursuant to a dividend reinvestment or
similar plan available to all shareholders; (iii) the sale, lease or exchange of
all or any substantial part of the assets of the Fund to any Principal
Shareholder (except assets having an aggregate fair market value of less than
$1,000,000, aggregating for the purpose of such computation all assets sold,
leased or exchanged in any series of similar transactions within a twelve-month
period); (iv) the sale, lease or exchange to the Fund or any subsidiary thereof,
in exchange for securities of the Fund, of any assets of any Principal
Shareholder (except assets having an aggregate fair market value of less than
$1,000,000, aggregating for the purposes of such computation all assets sold,
leased or exchanged in any series of similar transactions within a twelve-month
period). However, shareholder approval for the foregoing transactions shall not
be applicable to (i) any transaction, including, without limitation, any rights
offering, made available on a pro rata basis to all shareholders of the Fund or
class thereof unless the trustees specifically make such transaction subject to
this voting provision, (ii) any transaction if the trustees shall by resolution
have approved a memorandum of understanding with such Principal Shareholder with
respect to and substantially consistent with such transaction or (iii) any such
transaction with any corporation of which a majority of the outstanding shares
of all classes of stock normally entitled to vote in elections of directors is
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owned of record or beneficially by the Fund and its subsidiaries. As described
in the Declaration, a Principal Shareholder shall mean any corporation, person
or other entity which is the beneficial owner, directly or indirectly, of more
than 5% of the outstanding shares and shall include any affiliate or associate
(as such terms are defined in the Declaration) of a Principal Shareholder. The
above affirmative vote shall be in addition to the vote of the shareholders
otherwise required by law or by the terms of any class or series of preferred
shares, whether now or hereafter authorized, or any agreement between the Fund
and any national securities exchange.
The provisions of the Declaration described above could have the effect
of depriving the Common Shareholders of opportunities to sell their Common
Shares at a premium over market value by discouraging a third party from seeking
to obtain control of the Fund in a tender offer or similar transaction. The
overall effect of these provisions is to render more difficult the
accomplishment of a merger or the assumption of control by a third party. They
provide, however, the advantage of potentially requiring persons seeking control
of the Fund to negotiate with its management regarding the price to be paid and
facilitating the continuity of the Fund's investment objectives and policies.
The Board of Trustees of the Fund has considered the foregoing anti-takeover
provisions and concluded that they are in the best interests of the Fund and its
Common Shareholders.
The Declaration of Trust also provides that prior to bringing a
derivative action, a demand must first be made on the Trustees by three
unrelated shareholders that hold shares representing at least 5% of the voting
power of the Fund or affected class. 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 shareholders may not proceed with the derivative
action unless the shareholders are 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. If a
demand is rejected, the complaining shareholders 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
shareholders bringing the action may be responsible for the Fund's costs,
including attorney's fee. The Declaration also includes a forum selection clause
requiring that any shareholder litigation be brought in certain courts in
Illinois and further provides that any shareholder bringing an action against
the Fund waive the right to trial by jury to the fullest extent permitted by
law.
Reference should be made to the Declaration on file with the Securities
and Exchange Commission for the full text of these provisions.
REPURCHASE OF FUND SHARES; CONVERSION TO OPEN-END FUND
The Fund is a closed-end investment company and as such its shareholders
will not have the right to cause the Fund to redeem their shares. Instead, the
Fund's Common Shares will trade in the open market at a price that will be a
-43-
function of several factors, including dividend levels (which are in turn
affected by expenses), NAV, call protection, price, dividend stability, relative
demand for and supply of such shares in the market, general market and economic
conditions and other factors. Because shares of a closed-end investment company
may frequently trade at prices lower than NAV, the Trustees, in consultation
with the Fund's Adviser, Sub-Adviser and any corporate finance services and
consulting agent that the Adviser may retain, from time to time may review
possible actions to reduce any such discount. Actions may include the repurchase
of such shares in the open market or in private transactions, the making of a
tender offer for such shares, or the conversion of the Fund to an open-end
investment company. There can be no assurance, however, that the Trustees will
decide to take any of these actions, or that share repurchases or tender offers,
if undertaken, will reduce a market discount. After any consideration of
potential actions to seek to reduce any significant market discount, the
Trustees may, subject to their fiduciary obligations and compliance with
applicable state and federal laws, authorize the commencement of a
share-repurchase program or tender offer. The size and timing of any such share
repurchase program or tender offer will be determined by the Trustees in light
of the market discount of the Common Shares, trading volume of the Common
Shares, information presented to the Trustees regarding the potential impact of
any such share repurchase program or tender offer, and general market and
economic conditions. There can be no assurance that the Fund will in fact effect
repurchases of or tender offers for any of its Common Shares. In addition, any
service fees incurred in connection with any tender offer made by the Fund will
be borne by the Fund and will not reduce the stated consideration to be paid to
tendering Shareholders. Before deciding whether to take any action if the Fund's
Common Shares trade below NAV, the Trustees would consider all relevant factors,
including the extent and duration of the discount, the liquidity of the Fund's
portfolio, the impact of any action that might be taken on the Fund or its
Shareholders and market considerations. Based on these considerations, even if
the Fund's shares should trade at a discount, the Trustees may determine that,
in the interest of the Fund and its Shareholders, no action should be taken.
Subject to its investment limitations, the Fund may borrow to finance
the repurchase of shares or to make a tender offer. Interest on any borrowings
to finance share repurchase transactions or the accumulation of cash by the Fund
in anticipation of share repurchases or tenders will increase the Fund's
expenses and reduce the Fund's net income. Any share repurchase, tender offer or
borrowing that might be approved by the Trustees would have to comply with the
1934 Act and the 1940 Act and the rules and regulations thereunder.
Although the decision to take action in response to a discount from NAV
will be made by the Trustees at the time they consider such issue, it is the
Trustees' present policy, which may be changed by the Trustees, not to authorize
repurchases of Common Shares or a tender offer for such shares if (1) such
transactions, if consummated, would (a) result in the delisting of the Common
Shares from the New York Stock Exchange, or (b) impair status as a registered
closed-end investment company under the 1940 Act; (2) the Fund would not be able
to liquidate portfolio securities in an orderly manner and consistent with the
Fund's investment objectives and policies in order to repurchase shares; or (3)
there is, in the Board's judgment, any (a) material legal action or proceeding
instituted or threatened challenging such transactions or otherwise materially
adversely affecting the Fund, (b) general suspension of or limitation on prices
for trading securities on the New York Stock Exchange, (c) declaration of a
banking moratorium by federal or state authorities or any suspension of payment
by United States or state banks in which the Fund invests, (d) material
limitation affecting the Fund or the issuers of its portfolio securities by
-44-
federal or state authorities on the extension of credit by lending institutions
or on the exchange of non-U.S. currency, (e) commencement of war, armed
hostilities or other international or national calamity directly or indirectly
involving the United States or (f) other event or condition which would have a
material adverse effect (including any adverse tax effect) on the Fund or its
shareholders if shares were repurchased. The Trustees may in the future modify
these conditions in light of experience with respect to the Fund.
Conversion to an open-end company would require the approval of the
holders of at least two-thirds of the Fund's shares outstanding and entitled to
vote; provided, however, that unless otherwise provided by law, if there are
Preferred Shares outstanding, the affirmative vote of two-thirds of the
Preferred Shares voting as a separate class shall be required; provided,
however, that such votes shall be by the affirmative vote of the majority of the
outstanding voting securities, as defined in the 1940 Act, if the action in
question was previously approved by the affirmative vote of two-thirds of the
Trustees. Such affirmative vote or consent shall be in addition to the vote or
consent of the holders of the shares otherwise required by law or by the terms
of any class or series of preferred shares, whether now or hereafter authorized,
or any agreement between the Fund and any national securities exchange. See the
Prospectus under "Description of the Preferred Shares -- Voting Rights." If the
Fund converted to an open-end company, the Fund's Common Shares would no longer
be listed on the New York Stock Exchange. Any Preferred Shares or other
Borrowings would need to be redeemed or repaid upon conversion to an open-end
investment company. Shareholders of an open-end investment company may require
the company to redeem their shares on any business day (except in certain
circumstances as authorized by or under the 1940 Act) at their NAV, less such
redemption charge or contingent deferred sales change, if any, as might be in
effect at the time of redemption. In order to avoid maintaining large cash
positions or liquidating favorable investments to meet redemptions, open-end
companies typically engage in a continuous offering of their shares. Open-end
companies are thus subject to periodic asset in-flows and out-flows that can
complicate portfolio management. The Trustees may at any time propose conversion
of the Fund to an open-end company depending upon their judgment as to the
advisability of such action in light of circumstances then prevailing.
The repurchase by the Fund of its shares at prices below NAV will result
in an increase in the NAV of those shares that remain outstanding. However,
there can be no assurance that share repurchases or tenders at or below NAV will
result in the Fund's shares trading at a price equal to their NAV. Nevertheless,
the fact that the Fund's shares may be the subject of repurchase or tender
offers from time to time may reduce any spread between market price and NAV that
might otherwise exist.
In addition, a purchase by the Fund of its Common Shares will decrease
the Fund's Managed Assets which would likely have the effect of increasing the
Fund's expense ratio.
FEDERAL INCOME TAX MATTERS
This section summarizes some of the main U.S. federal income tax
consequences of owning and disposing of Preferred Shares. This section is
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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 foreign tax consequences.
This federal income tax summary is based in part on the advice of
counsel to the Fund. The Internal Revenue Service could disagree with any
conclusions set forth in this section. In addition, our counsel was not asked to
review, and has not reached a conclusion with respect to the federal income tax
treatment of the assets to be held by 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.
The Fund intends to qualify annually and to elect to be treated as a
regulated investment company ("RIC") under the Code and to comply with
applicable distribution requirements so that it will not pay federal income tax
on income and capital gains distributed to its Preferred Shareholders.
The Preferred Shares will constitute stock, and distributions by us with
respect to the Preferred Shares (other than distributions in redemption of
Preferred Shares that are treated as exchanges of stock under Section 302(b) of
the Code) will constitute dividends to the extent of our current and accumulated
earnings and profits as calculated for federal income tax purposes. It is
possible, however, that the Internal Revenue Service might take a contrary
position, asserting, for example, that the Preferred Shares constitute debt. If
this position were upheld, the discussion of the treatment of distributions
below would not apply. Instead, distributions to you would constitute interest,
whether or not they exceeded our earnings and profits, would be included in full
in your income, and would be taxed as ordinary income. Our counsel believes that
such a position, if asserted by the Internal Revenue Service, would be unlikely
to be upheld by a competent court.
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, 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 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 (ii) not more than 25% of the value of its total
assets is invested in the securities (other than U.S. government securities or
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the securities of other RICs) of any one issuer, the securities (other than the
securities of other RICs) 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 (c) 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.
The IRS currently requires that a RIC that has two or more classes of
stock disregard disproportionate allocations between such classes of each type
of its income (such as ordinary income and capital gains) and instead allocate
to each such class proportionate amounts of each type of its income based upon
the percentage of total dividends distributed to each class for the taxable
year. Accordingly, we intend each taxable year to allocate capital gain
dividends for tax purposes among our Common Shares and Preferred Shares in
proportion to the total dividends paid to each class during or with respect to
such year. In order to satisfy both the 1940 Act requirement that capital gains
dividends be distributed only once (or, under certain circumstances, twice) per
year and the federal income tax requirements, we may under certain circumstances
be forced to retain capital gains and pay tax on those retained gains at the
Fund level, all without the benefit of deemed gain distributions and deemed tax
credits to our shareholders; in addition, our shareholders may be treated as
having received ordinary income dividends in respect of the retained capital
gains. In short, compliance with both the 1940 Act and the RIC federal income
tax requirements may result in double taxation of gains that we have to retain
and pay tax on, or alternatively, we may accelerate capital losses and defer
capital gains, even if this would be contrary to our otherwise desired
investment objectives, in an attempt to minimize the net capital gains that
could become subject to double taxation.
In addition, also because of the 1940 Act limitations on when capital
gain dividends may be distributed, shareholders who hold Preferred Shares on the
ex-dividend date for a capital gains dividend will be entitled to a capital
gains dividend, but shareholders who hold shares at other times during the year
(but not on the capital gains ex-dividend date) would not be entitled to a
capital gains dividend.
As a RIC, 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 its shareholders. The Fund intends to
distribute to its Preferred Shareholders, at least annually, substantially all
of its investment company taxable income and net capital gain. If the Fund
retains any net capital gain or investment company taxable income, it will
generally be subject to federal income tax at regular corporate rates on the
amount retained. In addition, amounts not distributed on a timely basis in
accordance with a calendar year distribution requirement are subject to a
nondeductible 4% excise tax unless, generally, the Fund distributes during each
calendar year an amount equal to the sum of (1) at least 98% of its ordinary
income (not taking into account any capital gains or losses) for the calendar
year, (2) at least 98% 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. To prevent application of
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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. These distributions will
be taxable to Preferred Shareholders in the calendar year in which the
distributions are declared, rather than the calendar year in which the
distributions are received.
If the Fund failed to qualify as a RIC or failed to satisfy the 90%
distribution requirement in any taxable year, the Fund would be taxed as an
ordinary corporation on its taxable income (even if such income were distributed
to its shareholders) and all distributions out of earnings and profits would be
taxed to Preferred Shareholders as dividend income, which, in general and
subject to limitations under the Code, under current law would constitute
qualified dividend income in the case of individual Preferred Shareholders and
would be eligible for the corporate dividends received deduction.
DISTRIBUTIONS
Dividends paid out of the Fund's investment company taxable income
(computed without regard to deduction for dividends paid) generally are taxable
to a shareholder as ordinary income to the extent of the Fund's earnings and
profits. However, certain ordinary income distributions that are specifically
designated by the Fund may constitute qualified dividend income eligible for
taxation at capital gains tax rates. In particular, a portion of the ordinary
income dividends received by an individual shareholder from a RIC such as the
Fund are generally taxed at the same rates that apply to net capital gain
(generally, a maximum rate of 15%), provided certain holding period requirements
are satisfied and provided the dividends are attributable to qualified dividend
income received by the Fund itself. Dividends received by the Fund from REITs
and foreign corporations are treated as qualified dividend income only in
certain circumstances. Dividends paid out of the Fund's investment company
taxable income that are not attributable to qualified dividend income received
by the Fund itself are not taxed to individual shareholders at the same rates
that apply to net capital gain but are generally taxed at the shareholder's
higher ordinary tax rate.
These special rules relating to the taxation of ordinary income
dividends from RICs generally apply to taxable years beginning before January 1,
2011.
Distributions of net capital gain (the excess of net long-term capital
gain over net short-term capital loss), if any, properly designated as capital
gain dividends are taxable to a shareholder as long-term capital gains,
regardless of how long the shareholder has held Fund shares. 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 tax basis in his or her shares. To the extent that
the amount of any 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.
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DIVIDENDS RECEIVED DEDUCTION
A corporation that owns shares will generally be entitled to the 70%
dividends received deduction with respect to a portion of the dividends received
from the Fund.
SALE OF FUND SHARES
Upon the sale or other disposition of shares of the Fund, which a
shareholder holds as a capital asset, 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 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 this 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 net capital gain
received by the shareholder with respect to the shares.
The Fund may, at its option, redeem the Preferred Shares in whole or in
part and the Fund is generally required to redeem the Preferred Shares to the
extent required to maintain the Preferred Shares Basic Maintenance Amount and
the 1940 Act Preferred Shares Asset Coverage. Gain or loss, if any, resulting
from such a redemption of the Preferred Shares will be taxed as gain or loss
from the sale or exchange of these shares rather than as a dividend but only if
the redemption distribution (a) is deemed not to be essentially equivalent to a
dividend, (b) is in complete redemption of the Preferred Shareholder's interest
in the Fund, (c) is "substantially disproportionate" with respect to the
Preferred Shareholder's interest in the Fund, or (d) with respect to a
non-corporate Preferred Shareholder, is in partial liquidation of the Fund. For
purposes of (a), (b) and (c) above, a Preferred Shareholder's ownership of
Common Shares, if any, will be taken into account.
NATURE OF THE FUND'S INVESTMENTS
Certain of the Fund's investment practices may be subject to special and
complex federal income tax provisions that may, among other things, (1)
disallow, suspend or otherwise limit the allowance of certain losses or
deductions, (2) convert lower taxed long-term capital gain into higher taxed
short-term capital gain or ordinary income, (3) convert an ordinary loss or a
deduction into a capital loss (the deductibility of which is more limited), (4)
cause the Fund to recognize income or gain without a corresponding receipt of
cash, (5) adversely affect the time as to when a purchase or sale of stock or
securities is deemed to occur and (6) adversely alter the characterization of
certain complex financial transactions. The Fund will monitor its transactions,
will make the appropriate tax elections and take appropriate actions in order to
mitigate the effect of these rules and prevent disqualification of the Fund from
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being taxed as a regulated investment company (including disposing of certain
investments to generate cash or borrowing cash to satisfy its distribution
requirements).
INVESTMENT IN SECURITIES OF UNCERTAIN TAX CHARACTER
The Fund may invest in preferred securities or other securities the U.S.
federal income tax treatment of which may not be clear or may be subject to
recharacterization by the Internal Revenue Service. To the extent the tax
treatment of such securities or the income from such securities differs from the
tax treatment expected by the Fund, it could affect the timing or character of
income recognized by the Fund, requiring the Fund to purchase or sell
securities, or otherwise change its portfolio, in order to comply with the tax
rules applicable to regulated investment companies under the Code.
BACKUP WITHHOLDING
The Fund may be required to withhold U.S. federal income tax from all
taxable distributions and sale proceeds payable to shareholders who fail to
provide the Fund with their correct taxpayer identification number or to make
required certifications, or who have been notified by the Internal Revenue
Service that they are subject to backup withholding. The withholding percentage
is 28% until 2011, when the percentage will revert to 31% unless amended by
Congress. Corporate shareholders and certain other shareholders specified in the
Code generally are exempt from 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, for United States federal income tax
purposes, 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.
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 U.S. tax of 30% (or lower treaty rate), which tax is generally
withheld from such distributions, subject to certain exceptions described below.
Distributions of capital gain dividends and any amounts retained by the
Fund which are designated as undistributed capital gains will not be subject to
U.S. tax at the rate of 30% (or lower treaty rate) unless the non-U.S.
shareholder is a nonresident alien individual and is physically present in the
United States for 183 or more days during the taxable year and meets certain
other requirements. However, this 30% tax (or lower rate under an applicable
treaty) on capital gains of nonresident alien individuals who are physically
present in the United States for 183 or more days only applies in exceptional
cases because any individual present in the United States for 183 or more days
during the taxable year is generally treated as a resident for U.S. income tax
-50-
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. 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 183 or more days during the taxable year and meets certain other
requirements. In the case of dividends with respect to taxable years of the Fund
beginning after 2004 and prior to 2008, distributions from the Fund that are
properly designated by the Fund as short-term capital gain dividends
attributable to certain short-term capital gains recognized by the Fund are
subject to similar rules.
In the case of dividends with respect to taxable years of the Fund
beginning after 2004 and prior to 2008, distributions from the Fund that are
properly designated by the Fund as interest-related dividends attributable to
certain interest received by the Fund may not be subject to U.S. federal income
tax when received by certain non-U.S. shareholders, provided the Fund makes
certain elections and certain conditions are met.
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 designated 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.
ALTERNATIVE MINIMUM TAX
As with any taxable investment, investors may be subject to the federal
alternative minimum tax on their income (including taxable income from the
fund), depending on their individual circumstances.
PERFORMANCE RELATED AND COMPARATIVE INFORMATION
The Fund may quote certain performance-related information and may
compare certain aspects of its portfolio and structure to other substantially
similar closed-end funds. In reports or other communications to shareholders of
the Fund or in advertising materials, the Fund may compare its performance with
that of (i) other investment companies listed in the rankings prepared by
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Lipper, Inc., Morningstar Inc. or other independent services; publications such
as Barrons, Business Week, Forbes, Fortune, Institutional Investor, Kiplinger's
Personal Finance, Money, Morningstar Mutual Fund Values, The New York Times, The
Wall Street Journal and USA Today; or other industry or financial publications
or (ii) the Lehman Brothers MBS Fixed Rate Index and other relevant indices and
industry publications. The Fund may also compare the historical volatility of
its portfolio to the volatility of such indices during the same time periods.
(Volatility is a generally accepted barometer of the market risk associated with
a portfolio of securities and is generally measured in comparison to the stock
market as a whole -- the beta -- or in absolute terms -- the standard
deviation.) Comparison of the Fund to an alternative investment should be made
with consideration of differences in features and expected performance. The Fund
may obtain data from sources or reporting services, such as Bloomberg Financial
and Lipper Inc., that the Fund believes to be generally accurate.
The Fund may, from time to time, show the standard deviation of either
the Fund or the Fund's investment strategy and the standard deviation of the
Fund's benchmark index. Standard deviation is a statistical measure of the
historical volatility of a portfolio. Standard deviation is the measure of
dispersion of historical returns around the mean rate of return.
From time to time, the Fund may quote the Fund's total return, aggregate
total return or yield in advertisements or in reports and other communications
to shareholders. The Fund's performance will vary depending upon market
conditions, the composition of its portfolio and its operating expenses.
Consequently any given performance quotation should not be considered
representative of the Fund's performance in the future. In addition, because
performance will fluctuate, it may not provide a basis for comparing an
investment in the Fund with certain bank deposits or other investments that pay
a fixed yield for a stated period of time. Investments comparing the Fund's
performance with that of other investment companies should give consideration to
the quality and type of the respective investment companies' portfolio
securities.
The Fund's "average annual total return" is computed according to a
formula prescribed by the Securities and Exchange Commission. The formula can be
expressed as follows:
Average Annual Total Return will be computed as follows:
ERV = P(1+T)/n/
Where P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1-, 5-, or 10-year periods at
the end of the 1-, 5-, or 10-year periods (or fractional
portion).
The Fund may also quote after-tax total returns to show the impact of
assumed federal income taxes on an investment in the Fund. The Fund's total
return "after taxes on distributions" shows the effect of taxable distributions,
but not any taxable gain or loss, on an investment in shares of the Fund for a
specified period of time. The Fund's total return "after taxes on distributions
and sale of Fund shares" shows the effect of both taxable distributions and any
-52-
taxable gain or loss realized by the shareholder upon the sale of fund shares at
the end of a specified period. To determine these figures, all income,
short-term capital gain distributions, and long-term capital gains distributions
are assumed to have been taxed at the highest marginal individualized federal
tax rate then in effect. Those maximum tax rates are applied to distributions
prior to reinvestment and the after-tax portion is assumed to have been
reinvested in the Fund. State and local taxes are ignored.
Actual after-tax returns depend on a shareholder's tax situation and may
differ from those shown. After-tax returns reflect past tax effects and are not
predictive of future tax effects.
Average Annual Total Return (After Taxes on Distributions) will be
computed as follows:
ATV/D/ = P(1+T)/n/
Where: P = a hypothetical initial investment of $1,000
T = average annual total return (after taxes on distributions)
n = number of years
ATV/D/ = ending value of a hypothetical $1,000 investment made at
the beginning of the period, at the end of the period (or
fractional portion thereof), after taxes on fund
distributions but not after taxes on redemptions.
Average Annual Total Return (After Taxes on Distributions and Sale of
Fund Shares) will be computed as follows:
ATV/DR/ = P(1+T)/n/
Where: P = a hypothetical initial investment of $1,000
T = average annual total return (after taxes on distributions
and redemption) n = number of years
ATV/DR/ = ending value of a hypothetical $1,000 investment made at
the beginning periods, at the end of the periods (or
fractional portion thereof), after taxes on fund
distributions and redemptions.
Quotations of yield for the Fund will be based on all investment income
per share earned during a particular 30-day period (including dividends and
interest), less expenses accrued during the period ("net investment income") and
are computed by dividing net investment income by the maximum offering price per
share on the last day of the period, according to the following formula:
Yield = 2 [( a-b/cd +1)/6/ - 1]
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends
d = the maximum offering price per share on the last day of the
period
Past performance is not indicative of future results. At the time Common
Shareholders sell their shares, they may be worth more or less than their
original investment.
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INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Financial Statements of the Fund as of April 23, 2007, appearing in
this Statement of Additional Information have been audited by
_____________________, an independent registered public accounting firm, as set
forth in their report thereon appearing elsewhere herein, and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing. _____________________ audits and reports on the Fund's
annual financial statements, and performs other professional accounting,
auditing and advisory services when engaged to do so by the Fund. The principal
business address of _____________________ is
______________________________________________________.
CUSTODIAN, ADMINISTRATOR, FUND ACCOUNTANT AND TRANSFER AGENT
PFPC Trust Company, 8800 Tinicum Blvd., 3rd Floor, Philadelphia,
Pennsylvania 19153, serves as custodian for the Fund. As such, PFPC Trust
Company has custody of all securities and cash of the Fund and attends to the
collection of principal and income and payment for and collection of proceeds of
securities bought and sold by the Fund. PFPC Inc., 4400 Computer Drive,
Westboro, Massachusetts 01531, is the transfer, registrar, dividend disbursing
agent and shareholder servicing agent with respect to the Common Shares for the
Fund and provides certain clerical, bookkeeping, shareholder servicing and
administrative services necessary for the operation of the Fund and maintenance
of shareholder accounts. PFPC Inc. also provides certain accounting and
administrative services to the Fund pursuant to an Administration and Accounting
Services Agreement, 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 certain Fund accounting information; and providing
other continuous accounting and administrative services.
________________________________________________________________________, is the
transfer agent, registrar, and dividend paying agent with respect to the
Preferred Shares.
ADDITIONAL INFORMATION
A Registration Statement on Form N-2, including amendments thereto,
relating to the shares of the Fund offered hereby, has been filed by the Fund
with the Securities and Exchange Commission. The Fund's Prospectus and this
Statement of Additional Information do not contain all of the information set
forth in the Registration Statement, including any exhibits and schedules
thereto. For further information with respect to the Fund and the shares offered
hereby, reference is made to the Fund's Registration Statement. Statements
contained in the Fund's Prospectus and this Statement of Additional Information
as to the contents of any contract or other document referred to are not
necessarily complete and in each instance reference is made to the copy of the
contract or other document filed as an exhibit to the Registration Statement,
each statement being qualified in all respects by such reference. Copies of the
Registration Statement may be inspected without charge at the Securities and
Exchange Commission's principal office in Washington, D.C., and copies of all or
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any part thereof may be obtained from the Securities and Exchange Commission
upon the payment of certain fees prescribed by the Securities and Exchange
Commission.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Trustees and Shareholder of
First Trust/Gallatin Specialty Finance and Financial Opportunities Fund:
FIRST TRUST/GALLATIN SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
FINANCIAL STATEMENTS
STATEMENT OF AUDITED ASSETS AND LIABILITIES
ASSETS: Statement of Assets and
Liabilities
April 23, 2007
Cash $100,008
Offering costs $400,000
________
$500,008
========
LIABILITIES:
Offering costs payable $400,000
Net Assets $100,008
========
NET ASSETS -Applicable to 5,236 shares $100,008
________
NET ASSET VALUE PER SHARE (net assets divided
by 5,236 shares) $19.10
========
MAXIMUM OFFERING PRICE PER SHARE (net asset
value plus sales charge of 4.5% of offering price) $20.00
________
NOTES TO STATEMENT OF ASSETS AND LIABILITIES:
NOTE 1. ORGANIZATION
First Trust/Gallatin Specialty Finance and Financial Opportunities Fund
(the "Fund") is a newly organized, non-diversified, closed-end management
investment company registered under the Investment Company Act of 1940, as
amended (the "1940 Act"). The Fund was organized on March 20, 2007 as a
Massachusetts business trust pursuant to a Declaration of Trust governed by the
laws of the Commonwealth of Massachusetts. As a newly organized entity, the Fund
has no operating history. The Fund has had no operations through April 23, 2007
other than those relating to organizational matters and the sale and issuance of
5,236 common shares of beneficial interest to First Trust Portfolios L.P.
NOTE 2. SIGNIFICANT ACCOUNTING POLICIES
First Trust Advisors L.P. ("the Adviser") has assumed organization costs
estimated to be $50,000. The Adviser has also agreed to assume offering costs in
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excess of $.04 a share, if any. Offering costs will be charged to
paid-in-capital in proportion to the number of shares sold during the offering
period.
The Fund's statement of assets and liabilities is prepared in conformity
with accounting principles generally accepted in the United States of America
which require management to make estimates and assumptions that affect the
reported amounts and disclosures in the statement of assets and liabilities.
Actual results could differ from those estimates.
The Fund intends to comply in its initial fiscal year and thereafter
with provisions of the Internal Revenue Code applicable to regulated investment
companies and as such, will not be subject to federal income taxes on otherwise
taxable income (including net realized capital gains) distributed to
shareholders.
NOTE 3. FEES AND OTHER TRANSACTIONS WITH AFFILIATED PARTIES
On April 16, 2007, the Fund's Board of Trustees approved an Investment
Management Agreement with the Adviser. The Fund has agreed to pay an annual
management fee for the services and facilities provided by the Adviser, payable
on a monthly basis, equal to the annual rate of 1.00% of the Fund's average
daily managed assets as defined in the prospectus.
Gallatin Asset Management, Inc. (the "Sub-Adviser") will receive a
portfolio management fee equal to 0.50% of the Fund's average daily managed
assets. The Sub-Adviser's fee is paid by the Adviser out of the Adviser's
management fee.
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STATEMENT OF ASSETS AND LIABILITIES
__________, 2007 (UNAUDITED)
STATEMENT OF OPERATIONS FOR THE PERIOD
ENDED __________, 2007 (UNAUDITED)
STATEMENT OF CHANGES IN NET ASSETS FOR
THE PERIOD ENDED __________, 2007 (UNAUDITED)
FIRST TRUST/GALLATIN SPECIALTY FINANCE AND FINANCIAL
OPPORTUNITIES FUND: PORTFOLIO OF INVESTMENTS
__________, 2007 (UNAUDITED)
APPENDIX A
RATINGS OF INVESTMENTS
Standard & Poor's Ratings Group -- A brief description of the applicable
Standard & Poor's Ratings Group, a division of The McGraw-Hill Companies
("Standard & Poor's" or "S&P"), rating symbols and their meanings (as published
by S&P) follows:
A Standard & Poor's issue credit rating is a current opinion of the
creditworthiness of an obligor with respect to a specific financial obligation,
a specific class of financial obligations, or a specific financial program. It
takes into consideration the creditworthiness of guarantors, insurers, or other
forms of credit enhancement on the obligation. The issue credit rating is not a
recommendation to purchase, sell, or hold a financial obligation, inasmuch as it
does not comment as to market price or suitability for a particular investor.
Issue credit ratings are based on current information furnished by the
obligors or obtained by Standard & Poor's from other sources it considers
reliable. Standard & Poor's does not perform an audit in connection with any
credit rating and may, on occasion, rely on unaudited financial information.
Credit ratings may be changed, suspended, or withdrawn as a result of changes
in, or unavailability of, such information, or based on other circumstances.
Issue credit ratings can be either long-term or short-term. Short-term
ratings are generally assigned to those obligations considered short-term in the
relevant market. In the U.S., for example, that means obligations with an
original maturity of no more than 365 days-including commercial paper.
Short-term ratings are also used to indicate the creditworthiness of an obligor
with respect to put features on long-term obligations. The result is a dual
rating, in which the short-term rating addresses the put feature, in addition to
the usual long-term rating. Medium-term notes are assigned long-term ratings.
LONG-TERM ISSUE CREDIT RATINGS
Issue credit ratings are based in varying degrees, on the following
considerations:
o 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;
o Nature of and provisions of the obligation; and
o 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 ratings definitions are expressed in terms of default risk. As
such, they pertain to senior obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to reflect the lower priority in
bankruptcy, as noted above.
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 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.
BB, B, CCC, CC, AND C
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
A-2
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
The `C' rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on this
obligation are being continued.
D
An obligation rated `D' is in payment default. The `D' rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The `D' rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar action
if payments on an obligation are jeopardized.
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.
c
The `c' subscript is used to provide additional information to investors
that the bank may terminate its obligation to purchase tendered bonds if the
long-term credit rating of the issuer is below an investment-grade level and/or
the issuer's bonds are deemed taxable.
p
The letter `p' indicates that the rating is provisional. A provisional
rating assumes the successful completion of the project financed by the debt
being rated and indicates that payment of debt service requirements is largely
or entirely dependent upon the successful, timely completion of the project.
A-3
This rating, however, while addressing credit quality subsequent to completion
of the project, makes no comment on the likelihood of or the risk of default
upon failure of such completion. The investor should exercise his own judgment
with respect to such likelihood and risk.
*
Continuance of the ratings is contingent upon Standard & Poor's receipt
of an executed copy of the escrow agreement or closing documentation confirming
investments and cash flows.
r
The `r' highlights derivative, hybrid, and certain other obligations
that Standard & Poor's believes may experience high volatility or high
variability in expected returns as a result of noncredit risks. Examples of such
obligations are securities with principal or interest return indexed to
equities, commodities, or currencies; certain swaps and options; and
interest-only and principal-only mortgage securities. The absence of an `r'
symbol should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
N.R.
Not rated.
Debt obligations of issuers outside the United States and its
territories are rated on the same basis as domestic corporate and municipal
issues. The ratings measure the creditworthiness of the obligor but do not take
into account currency exchange and related uncertainties.
Bond Investment Quality Standards
Under present commercial bank regulations issued by the Comptroller of
the Currency, bonds rated in the top four categories (`AAA,' `AA,' `A,' `BBB,'
commonly known as investment-grade ratings) generally are regarded as eligible
for bank investment. Also, the laws of various states governing legal
investments impose certain rating or other standards for obligations eligible
for investment by savings banks, trust companies, insurance companies, and
fiduciaries in general.
SHORT-TERM ISSUE CREDIT RATINGS
Notes. A Standard & Poor's note rating reflects the liquidity factors
and market access risks unique to notes. Notes due in three years or less will
likely receive a note rating. Notes maturing beyond three years will most likely
receive a long-term debt rating. The following criteria will be used in making
that assessment:
- Chapter 1 Amortization schedule -- the larger the final maturity
relative to other maturities, the more likely it will be treated as a
note; and
A-4
- Chapter 2 Source of payment -- the more dependent the issue is on the
market for its refinancing, the more likely it will be treated as a
note.
Note rating symbols are as follows:
SP-1
Strong capacity to pay principal and interest. An issue determined to
possess a very strong capacity to pay debt service is given a plus (+)
designation.
SP-2
Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
SP-3
Speculative capacity to pay principal and interest.
COMMERCIAL PAPER
An S&P commercial paper rating is a current assessment of the likelihood
of timely payment of debt having an original maturity of no more than 365 days.
Ratings are graded into several categories, ranging from `A-1' for the highest
quality obligations to `D' for the lowest. These categories are as follows:
A-1
A short-term obligation rated `A-1' is rated in the highest category by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is strong. Within this category, certain obligations are
designated with a plus sign (+). This indicates that the obligor's capacity to
meet its financial commitment on these obligations is extremely strong.
A-2
A short-term obligation rated `A-2' is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher rating categories. However, the obligor's capacity to meet
its financial commitment on the obligation is satisfactory.
A-3
A short-term obligation rated `A-3' exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
A-5
B
A short-term obligation rated `B' is regarded as having significant
speculative characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet its
financial commitment on the obligation.
C
A short-term obligation rated `C' is currently vulnerable to nonpayment
and is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation.
D
A short-term obligation rated `D' is in payment default. The `D' rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The `D'
rating also will be used upon the filing of a bankruptcy petition or the taking
of a similar action if payments on an obligation are jeopardized.
Moody's Investors Service, Inc. -- A brief description of the applicable
Moody's Investors Service, Inc. ("Moody's") rating symbols and their meanings
(as published by Moody's) follows:
LONG-TERM DEBT RATINGS
Aaa
Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa
Bonds rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risk appear somewhat larger than the Aaa securities.
A
A-6
Bonds rated A possess many favorable investment attributes and are to be
considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa
Bonds rated Baa are considered as medium-grade obligations (i.e., they
are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present, but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba
Bonds rated Ba are judged to have speculative elements; their future
cannot be considered as well-assured. Often the protection of interest and
principal payments may be very moderate, and thereby not well safeguarded during
both good and bad times over the future. Uncertainty of position characterizes
bonds in this class.
B
Bonds rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa
Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca
Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked shortcomings.
C
Bonds rated C are the lowest rated class of bonds, and issues so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing.
Note: Moody's applies numerical modifiers 1, 2, and 3 in 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.
A-7
SHORT-TERM DEBT RATINGS
There are three rating categories for short-term municipal obligations
that are considered investment grade. These ratings are designated as Municipal
Investment Grade (MIG) and are divided into three levels -- MIG 1 through MIG 3.
In addition, those short-term obligations that are of speculative quality are
designated SG, or speculative grade. MIG ratings expire at the maturity of the
obligation.
MIG 1
This designation denotes superior credit quality. Excellent protection
is afforded by established cash flows, highly reliable liquidity support, or
demonstrated broad-based access to the market for refinancing.
MIG 2
This designation denotes strong credit quality. Margins of protection
are ample, although not as large as in the preceding group.
MIG 3
This designation denotes acceptable credit quality. Liquidity and
cash-flow protection may be narrow, and market access for refinancing is likely
to be less well-established.
SG
This designation denotes speculative-grade credit quality. Debt
instruments in this category may lack sufficient margins of protection.
DEMAND OBLIGATION RATINGS
In the case of variable rate demand obligations (VRDOs), a two-component
rating is assigned; a long or short-term debt rating and a demand obligation
rating. The first element represents Moody's evaluation of the degree of risk
associated with scheduled principal and interest payments. The second element
represents Moody's evaluation of the degree of risk associated with the ability
to receive purchase price upon demand ("demand feature"), using a variation of
the MIG rating scale, the Variable Municipal Investment Grade or VMIG rating.
When either the long- or short-term aspect of a VRDO is not rated, that piece is
designated NR, e.g., Aaa/NR or NR/VMIG 1. VMIG rating expirations are a function
of each issue's specific structural or credit features.
VMIG 1
This designation denotes superior credit quality. Excellent protection
is afforded by the superior short-term credit strength of the liquidity provider
and structural and legal protections that ensure the timely payment of purchase
price upon demand.
A-8
VMIG 2
This designation denotes strong credit quality. Good protection is
afforded by the strong short-term credit strength of the liquidity provider and
structural and legal protections that ensure the timely payment of purchase
price upon demand.
VMIG 3
This designation denotes acceptable credit quality. Adequate protection
is afforded by the satisfactory short-term credit strength of the liquidity
provider and structural and legal protections that ensure the timely payment of
purchase price upon demand.
SG
This designation denotes speculative-grade credit quality. Demand
features rated in this category may supported by a liquidity provider that does
not have an investment grade short-term rating or may lack the structural and/or
legal protections necessary to ensure the timely payment of purchase price upon
demand.
COMMERCIAL PAPER
Moody's short-term ratings are opinions of the ability of issuers to
honor short-term financial obligations. Ratings may be assigned to issuers,
short-term programs or to individual short-term debt instruments. Such
obligations generally have an original maturity not exceeding thirteen months,
unless explicitly noted.
Moody's employs the following designations to indicate the relative
repayment ability of rated issuers:
P-1
Issuers (or supporting institutions) rated Prime-1 have a superior
ability to repay short-term debt obligations.
P-2
Issuers (or supporting institutions) rated Prime-2 have a strong ability
to repay short-term debt obligations.
P-3
Issuers (or supporting institutions) rated Prime-3 have an acceptable
ability to repay short-term obligations.
NP
A-9
Issuers (or supporting institutions) rated Not Prime do not fall within
any of the Prime rating categories.
Note: Canadian issuers rated P-1 or P-2 have their short-term ratings
enhanced by the senior-most long-term rating of the issuer, its guarantor or
support-provider.
Fitch Rating Services, Inc.-- A brief description of the applicable
Fitch Rating Services, Inc. ("Fitch") ratings symbols and meanings (as
published by Fitch) follows:
LONG-TERM CREDIT RATINGS
International Long-Term Credit Ratings are more commonly referred to as
simply "Long-Term Ratings." The following scale applies to foreign currency and
local currency ratings.
International credit ratings assess the capacity to meet foreign or
local currency commitments. Both foreign and local currency ratings are
internationally comparable assessments. The local currency rating measures the
probability of payment only within the sovereign state's currency and
jurisdiction.
AAA
Highest credit quality. `AAA' ratings denote the lowest expectation of
credit risk. They are assigned only in case of exceptionally strong capacity for
timely payment of financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.
AA
Very high credit quality. `AA' ratings denote a very low expectation of
credit risk. They indicate very strong capacity for timely payment of financial
commitments. This capacity is not significantly vulnerable to foreseeable
events.
A
High credit quality. `A' ratings denote a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered
strong. This capacity may, nevertheless, be more vulnerable to changes in
circumstances or in economic conditions than is the case for higher ratings.
BBB
Good credit quality. `BBB' ratings indicate that there is currently a
low expectation of credit risk. The capacity for timely payment of financial
commitments is considered adequate, but adverse changes in circumstances and in
economic conditions are more likely to impair this capacity. This is the lowest
investment-grade category.
A-10
BB
Speculative. `BB' ratings indicate that there is a possibility of credit
risk developing, particularly as the result of adverse economic change over
time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment grade.
B
Highly speculative. `B' ratings indicate that significant credit risk is
present, but a limited margin of safety remains. Financial commitments are
currently being met; however, capacity for continued payment is contingent upon
a sustained, favorable business and economic environment.
CCC, CC, C
High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon sustained, favorable business or
economic developments. A `CC' rating indicates that default of some kind appears
probable. `C' ratings signal imminent default.
DDD, DD, D
Default. The ratings of obligations in this category are based on their
prospects for achieving partial or full recovery in a reorganization or
liquidation of the obligor. While expected recovery values are highly
speculative and cannot be estimated with any precision, the following serve as
general guidelines. `DDD' obligations have the highest potential for recovery,
around 90%-100% of outstanding amounts and accrued interest. `DD' indicates
potential recoveries in the range of 50%-90% and `D' the lowest recovery
potential, i.e., below 50%.
Entities rated in this category have defaulted on some or all of their
obligations. Entities rated `DDD' have the highest prospect for resumption of
performance or continued operation with or without a formal reorganization
process. Entities rated `DD' and `D' are generally undergoing a formal
reorganization or liquidation process; those rated `DD' are likely to satisfy a
higher portion of their outstanding obligations, while entities rated `D' have a
poor prospect of repaying all obligations.
SHORT-TERM CREDIT RATINGS
International Short-Term Credit Ratings are more commonly referred to as
simply "Short-Term Ratings." The following scale applies to foreign currency and
local currency ratings.
A-11
A short-term rating has a time horizon of less than 12 months for most
obligations, or up to three years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to meet financial commitments
in a timely manner.
International credit ratings assess the capacity to meet foreign or
local currency commitments. Both foreign and local currency ratings are
internationally comparable assessments. The local currency rating measures the
probability of payment only within the sovereign state's currency and
jurisdiction.
F1
Highest credit quality. Indicates the strongest capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2
Good credit quality. A satisfactory capacity for timely payment of
financial commitments, but the margin of safety is not as great as in the case
of the higher ratings.
F3
Fair credit quality. The capacity for timely payment of financial
commitments is adequate; however, near-term adverse changes could result in a
reduction to non-investment grade.
B
Speculative. Minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
C
High default risk. Default is a real possibility. Capacity for meeting
financial commitments is solely reliant upon a sustained, favorable business and
economic environment.
D
Default. Denotes actual or imminent payment default.
Notes to Long-term and Short-term ratings:
"+" or "-" may be appended to a rating to denote relative status within
major rating categories. Such suffixes are not added to the `AAA' Long-term
rating category, to categories below `CCC,' or to Short-term ratings other than
`F1'.
A-12
`NR' indicates that Fitch does not rate the issuer or issue in question.
`Withdrawn': A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
Rating Watch: Ratings are placed on Rating Watch to notify investors
that there is a reasonable probability of a rating change and the likely
direction of such change. These are designated as "Positive," indicating a
potential upgrade, "Negative," for a potential downgrade, or "Evolving," if
ratings may be raised, lowered or maintained. Rating Watch is typically resolved
over a relatively short period.
A Rating Outlook indicates the direction a rating is likely to move over
a one to two year period. Outlooks may be positive, stable, or negative. A
positive or negative Rating Outlook does not imply a rating change is
inevitable. Similarly, ratings for which outlooks are `stable' could be
downgraded before an outlook moves to positive or negative if circumstances
warrant such an action. Occasionally, Fitch may be unable to identify the
fundamental trend. In these cases, the Rating Outlook may be described as
evolving.
A-13
APPENDIX B
GALLATIN ASSET MANAGEMENT, INC.
PROXY VOTING GUIDELINES
PROXY POLICIES AND PROCEDURES
THE GALLATIN PROXY COMMITTEE
The Gallatin Specialty Finance Fund Investment Committee has established
a proxy committee, the Gallatin Proxy Committee, which is responsible for the
development of proxy guidelines and overseeing the proxy voting process. The
proxy voting policy is designed to ensure that shares are voted in what Gallatin
Asset Management, Inc. ("Gallatin") believes to be the best interests of the
client and the value of the investment. The Gallatin Proxy Committee consists of
members of the Gallatin Specialty Finance Fund Investment Committee as well as
other members of Gallatin. In addition to the Gallatin Specialty Finance Fund
Investment Committee's knowledge of the companies it holds in its portfolios,
the Gallatin Proxy Committee may rely upon independent research provided by
third parties in fulfilling its responsibilities.
HOW THE GALLATIN PROXY COMMITTEE VOTES PROXIES-FIDUCIARY CONSIDERATIONS
To assist in analyzing proxies, the Gallatin Proxy Committee may engage
the services of an unaffiliated third party corporate governance research
service to act as agent for the administrative and ministerial aspects of proxy
voting of portfolio securities, as well as to provide independent research and
record keeping services. Although recommendations from outside proxy services
may be reviewed and considered in making a final voting decision, the Gallatin
Proxy Committee does not consider these recommendations to be determinative of
its ultimate decision.
The Gallatin Proxy Committee is responsible for making the final voting
decision based on its review of the agenda, analysis and recommendations from
outside proxy voting services, the Gallatin Proxy Committee members' knowledge
of the exchange traded fund, closed-end fund, open-end fund, or other company,
and any other information readily available. For each shareholder meeting, the
Proxy Administrator must obtain voting instructions from the Gallatin Proxy
Committee prior to submitting the vote to Gallatin's voting agent.
As a matter of policy, the members of the Gallatin Proxy Committee will
not be influenced by outside sources whose interests conflict with the interests
of Gallatin's clients. In cases where the voting recommendation differs from the
policy guidelines and the recommendation of the outside proxy voting service,
the Gallatin Proxy Committee will review the recommendation to assure that there
are no known conflicts of interest that influenced the voting decision.
CONFLICTS OF INTEREST
The Gallatin Proxy Committee may occasionally be subject to conflicts of
interest in voting proxies due to business or personal relationships with
persons having an interest in the outcome of certain votes. For example,
Gallatin's affiliate, A.G. Edwards & Sons, Inc., may provide custody, investment
management, brokerage, investment banking and related services to accounts owned
or controlled by companies whose management is soliciting proxies. Additionally,
key personnel of A.G. Edwards & Sons, Inc. may have business or personal
relationships with other proponents of proxy proposals, corporate directors or
candidates for directorships.
In those instances where the Gallatin Proxy Committee wishes to deviate
from the recommendation of its selected third party proxy voting service, it
will conduct further due diligence and vote the proxies in what it believes to
be the best interest of its clients. In such instances where the recommendation
of a third party provider of proxy services is not followed, the Gallatin Proxy
Committee will take reasonable steps to identify possible conflicts of interest
that could affect its voting independence. These steps shall include the
following:
IDENTIFYING CONFLICTS FROM BUSINESS RELATIONSHIPS
o Determine whether any companies involved in the proxy or their top
officers as identified in their Annual Report with the SEC hold
brokerage or advisory accounts with A.G. Edwards & Sons, Inc.;
o Determine whether any of the companies involved in the proxy conduct
investment banking business with A.G. Edwards & Sons, Inc.;
o Determine if any of the companies involved in the proxy are a large
supplier of goods or services with A.G. Edwards & Sons, Inc.
IDENTIFYING CONFLICTS FROM PERSONAL OR FAMILY RELATIONSHIPS WITH KEY AGE
OFFICERS
In order to identify conflicts that may arise from personal or family
relationships with key A.G. Edwards & Sons, Inc. personnel, the Proxy
Administrator shall deliver to each key person a memorandum requesting that the
key person give notice if they have any of the following relationships that
could create a conflict:
o Is the key person or any close relative of the key person (spouse,
sibling, parent, child, or any other relative who resides with the key
person) an executive, director, or a candidate to be a director of any
company involved in the proxy or otherwise a participant in the proxy?
o Does the key person have a known personal or business relationship with
anyone in one of these categories?
B-2
o Is the key person presently aware of any conflict of interest that may
arise between any company or person involved in the proxy and A.G.
Edwards & Sons, Inc. or one of its clients?
o Has the key person been contacted by any party (internally within A.G.
Edwards & Sons, Inc. or externally) seeking to influence A.G. Edwards &
Sons' voting of proxies?
Key Persons shall include Division Directors of A.G. Edwards & Sons,
Inc., key officers of Gallatin (as identified in Form ADV), the Gallatin
Specialty Finance Fund Investment Committee and the Gallatin Proxy Committee,
and the Proxy Administrator.
Should any conflicts from business relationships be identified or if any
Key Person answers any of the above questions in the affirmative, the Key Person
shall notify the Proxy Administrator of the possible conflict. Where such
possible conflicts are identified, the matter will be referred to the Gallatin
Proxy Committee. After review, if the Gallatin Proxy Committee perceives the
conflict as material, the Gallatin Proxy Committee will either defer to the
voting recommendation of its independent third party provider of proxy services
or send the proxy directly to the relevant advisory clients for a voting
decision.
WEIGHT GIVEN MANAGEMENT RECOMMENDATIONS
One of the primary factors the Gallatin Specialty Finance Fund
Investment Committee considers when determining the desirability of investing in
a particular company is the quality and depth of that company's management.
Accordingly, the recommendation of company's management on any issue is a factor
that it considers in determining how proxies should be voted. However, the
Gallatin Proxy Committee does not consider recommendations from a company's
management to be determinative of its ultimate decision.
GENERAL PROXY VOTING GUIDELINES
The Gallatin Proxy Committee has adopted general guidelines for voting
proxies as summarized below. A third party proxy voting service may be utilized
to vote proxies for the Gallatin Proxy Committee on routine matters in
accordance with these established guidelines. These guidelines are reviewed
periodically by the Gallatin Proxy Committee and are subject to change.
Although these guidelines are to be generally followed, the Gallatin
Proxy Committee reserves the right to deviate from them in rare instances where
individual circumstances may dictate to serve the best interest of its clients.
THE GALLATIN PROXY COMMITTEE PROXY VOTING POLICIES AND PRINCIPLES
The Gallatin Proxy Committee's proxy voting positions have been
developed based on years of experience with proxy voting and corporate
B-3
governance issues. The following guidelines reflect what the Gallatin Proxy
Committee believes to be good corporate governance and behavior:
GALLATIN PROXY VOTING ADMINISTRATION AND PROCEDURES
The Gallatin Proxy Committee is fully cognizant of its responsibility to
process proxies and maintain proxy records pursuant to SEC rules and
regulations. In addition, Gallatin, the Sub-Adviser, understands its fiduciary
duty to vote proxies and that proxy voting decisions may affect the value of
shareholdings. Therefore, Sub-Adviser will attempt to process every vote it
receives for all domestic and foreign proxies. However, there may be situations
in which Sub-Adviser cannot vote proxies. For example, if the cost of voting a
foreign proxy outweighs the benefit of voting, the Gallatin Proxy Committee may
refrain from processing that vote. Additionally, the Gallatin Proxy Committee
may not be given enough time to process the vote. For example, the Gallatin
Proxy Committee, through no fault of its own, may receive a meeting notice from
the company too late, or may be unable to obtain a timely translation of the
agenda. In addition, if Sub-Adviser has outstanding sell orders, the proxies for
those meetings may not be voted in order to facilitate the sale of those
securities. Although Sub-Adviser may hold shares on a company's record date,
should it sell them prior to the company's meeting date, Sub-Adviser ultimately
may decide not to vote those shares. Sub-Adviser may vote against an agenda item
where no further information is provided, particularly in non-U.S. markets.
The following describes the standard procedures that are to be followed
with respect to carrying out Sub-Adviser's proxy policy:
1. All proxy materials received will be received into a database
to maintain tracking and control over such materials. ISS serves as the
proxy voting record keeper for the Sub-Adviser.
2. The Proxy Administrator will review and compile information
on each proxy upon receipt of any agendas, materials, reports,
recommendations from ISS or other information. The Proxy Administrator,
or delegate, will then forward this information to the appropriate
research analyst or Chief Investment Officer for review.
3. In determining how to vote, Sub-Adviser's analysts and
relevant portfolio manager(s) will consider the general guidelines
described in its proxy policy, their in-depth knowledge of the company,
any readily available information and research about the company and its
agenda items, and the recommendations put forth by ISS or other
independent third party providers of proxy services. In cases where the
analysts' recommendation differs from Gallatin's policy guidelines and
ISS recommendation, the Gallatin Proxy Committee will review the
recommendation and the analysts will attest that no conflict of interest
exists.
B-4
4. The Proxy Administrator is responsible for maintaining the
documentation that supports Sub-Adviser's voting position. Such
documentation will include, but is not limited to, any information
provided by ISS or other proxy service providers, and, especially as to
non-routine, materially significant or controversial matters, memoranda
describing the position it has taken, why that position is in the best
interest of its Advisory Clients, an indication of whether it supported
or did not support management and any other relevant information.
Additionally, the Proxy Administrator may include documentation obtained
from the research analyst, portfolio manager and/or legal counsel.
5. After the proxy is completed but before it is returned to the
issuer and/or its agent, the Gallatin Proxy Committee may review those
situations including special or unique documentation to determine that
the appropriate documentation has been created, including conflict of
interest screening.
6. The Proxy Administrator will attempt to submit Sub-Adviser's
vote on all proxies to ISS for processing at least three days prior to
the meeting for U.S. securities and 10 days prior to the meeting for
foreign securities. However, in certain foreign jurisdictions it may be
impossible to return the proxy 10 days in advance of the meeting. In
these situations, the Proxy Administrator will use its best efforts to
send the proxy vote to ISS in sufficient time for the vote to be lodged.
7. The Proxy Administrator is responsible for sending a copy of
the third party vendor's proxy voting ballot report for each client that
has requested a record of votes cast. Written client requests for
information will be documented in the Sub-Adviser's database. The report
specifies the proxy issues that have been voted for the client during
the requested period and the position taken with respect to each issue.
The Proxy Administrator sends one copy to the client, retains a copy of
the request in the client's file.
8. The Gallatin Proxy Committee is responsible for maintaining
appropriate proxy voting records. Such records will include, but are not
limited to, a copy of all materials returned to the issuer and/or its
agent, the documentation described above, listings of proxies voted by
issuer and by client, and any other relevant information. The Gallatin
Proxy Committee may use an outside service such as ISS to support this
function. All records will be retained for at least six years, the first
two of which will be on-site. In addition, the Gallatin Proxy Committee
is responsible for ensuring that the proxy voting policies, procedures
and records of the Sub-Adviser are available as required by law.
B-5
APPENDIX C
FIRST TRUST/GALLATIN SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENT
ESTABLISHING AND FIXING THE RIGHTS AND PREFERENCES
OF SERIES __ AUCTION PREFERRED SHARES AND
SERIES __ AUCTION PREFERRED SHARES
[TO COME BY AMENDMENT]
FIRST TRUST /GALLATIN SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
SERIES ____ AUCTION PREFERRED SHARES
SERIES ____ AUCTION PREFERRED SHARES
STATEMENT OF ADDITIONAL INFORMATION
, 2007
PART C - OTHER INFORMATION
Item 25: Financial Statements and Exhibits
1. Financial Statements:
(i) Statement of Assets and Liabilities as of April 23, 2007
(audited);
(ii) Statement of Assets and Liabilities as of _______________,
2007 (unaudited);
(iii) Statement of Operations for the period from April 23, 2007
(commencement of operations) to _______________, 2007 (unaudited);
(iv) Statement of Changes in Net Assets for the period from
April 23, 2007 (commencement of operations) to _______________,
2007 (unaudited); and
(v) Portfolio of Investments as of _______________, 2007
(unaudited);
Statements, schedules and historical information other than listed above
have been omitted since they are either not applicable or not required,
or the required information is shown in the financial statements or notes
thereto.
2. Exhibits:
a.1. Declaration of Trust dated March 20, 2007. Filed on
March 21, 2007 as Exhibit a. to Registrant's Registration
Statement on Form N-2 (File No. 333-141457) and incorporated
herein by reference.
a.2. Form of Statement Establishing and Fixing Rights and
Preferences of Series __ Auction Preferred Shares and Series __
Auction Preferred Shares. Filed as Appendix C to the Statement of
Additional Information herein.*
b. Amended By-Laws of Fund.*
c. None.
d.1. Form of specimen certificate for the Preferred Shares
of the Registrant.*
d.2. Form of Moody's Rating Guidelines and Fitch Rating
Guidelines.
e. Terms and Conditions of the Dividend Reinvestment Plan.
Filed May 24, 2007 as Exhibit e. to Pre-Effective Amendment No. 2
to Registrant's Registration Statement on Form N-2 (File No.
333-141457) and are incorporated herein by reference.
- 1 -
f. None.
g.1. Form of Investment Management Agreement between
Registrant and First Trust Advisors L.P. Filed May 24, 2007 as
Exhibit g.1 to Pre-Effective Amendment No. 2 to Registrant's
Registration Statement on Form N-2 (File No. 333-141457) and is
incorporated herein by reference.
g.2. Form of Sub-Advisory Agreement between Registrant,
First Trust Advisors L.P. and Gallatin Asset Management, Inc.
Filed May 24, 2007 as Exhibit g.2 to Pre-Effective Amendment No.
2 to Registrant's Registration Statement on Form N-2 (File No.
333-141457) and is incorporated herein by reference.
h.1. Form of Underwriting Agreement.*
h.2. Form of Auction Agency Agreement with respect to
Registrant's Preferred Shares.*
h.3. Form of Broker-Dealer Agreement with respect to
Registrant's Preferred Shares.*
i. None.
j. Form of Custodian Services Agreement between Registrant
and PFPC Trust Company. Filed May 24, 2007 as Exhibit j. to
Pre-Effective Amendment No. 2 to Registrant's Registration
Statement on Form N-2 (File No. 333-141457) and is incorporated
herein by reference.
k.1. Form of Transfer Agency Services Agreement between
Registrant and PFPC Inc. Filed May 24, 2007 as Exhibit k.1 to
Pre-Effective Amendment No. 2 to Registrant's Registration
Statement on Form N-2 (File No. 333-141457) and incorporated
herein by reference.
k.2. Form of Administration and Accounting Services
Agreement. Filed May 24, 2007 as Exhibit k.2 to Pre-Effective
Amendment No. 2 to Registrant's Registration Statement on Form
N-2 (File No. 333-141457) and incorporated herein by reference.
k.3. Form of DTC Letter of Representations.
l.1. Opinion and consent of Chapman and Cutler LLP.*
l.2. Opinion and consent of Bingham McCutchen LLP.*
m. None.
n. Consent of Independent Registered Public Accounting Firm.*
- 2 -
o. None.
p. Subscription Agreement between Registrant and First Trust
Advisors L.P. Filed May 24, 2007 as Exhibit p. to Pre-Effective
Amendment No. 2 to Registrant's Registration Statement on Form N-2 (File
No. 333-141457) and incorporated herein by reference.
q. None.
r.1. Code of Ethics of Registrant. Filed May 24, 2007
as Exhibit r.1 to Pre-Effective Amendment No. 2 to Registrant's
Registration Statement on Form N-2 (File No. 333-141457) and
incorporated herein by reference.
r.2. Code of Ethics of First Trust Portfolios L.P. Filed May 24,
2007 as Exhibit r.2 to Pre-Effective Amendment No. 2 to Registrant's
Registration Statement on Form N-2 (File No. 333-141457) and
incorporated herein by reference.
r.3. Code of Ethics of First Trust Advisors L.P. Filed May 24,
2007 as Exhibit r.3 to Pre-Effective Amendment No. 2 to Registrant's
Registration Statement on Form N-2 (File No. 333-141457) and
incorporated herein by reference.
r.4. Code of Ethics of Gallatin Asset Management, Inc. Filed May
24, 2007 as Exhibit r.4 to Pre-Effective Amendment No. 2 to Registrant's
Registration Statement on Form N-2 (File No. 333-141457) and
incorporated herein by reference.
s. Powers of Attorney.
* To be filed by amendment.
Item 26: Marketing Arrangements
See Exhibit (h.1) of Item 25(2) of this Registration Statement.
- 3 -
Item 27: Other Expenses of Issuance and Distribution
------------------------------------------------------------ ------------------
Securities and Exchange Commission Fees $__________*
------------------------------------------------------------ ------------------
National Association of Securities Dealers, Inc. Fees $__________*
------------------------------------------------------------ ------------------
Printing and Engraving Expenses $__________*
------------------------------------------------------------ ------------------
Legal Fees $__________*
------------------------------------------------------------ ------------------
Rating Agency Fees $__________*
------------------------------------------------------------ ------------------
Accounting Expenses $__________*
------------------------------------------------------------ ------------------
Miscellaneous Expenses $__________*
------------------------------------------------------------ ------------------
Total Offering Expenses $__________*
------------------------------------------------------------ ------------------
* To be filed by amendment.
Item 28: Persons Controlled by or under Common Control with Registrant
Not applicable.
Item 29: Number of Holders of Securities
At July ___, 2007
------------------------------------------------ ------------------------------
Title of Class Number of Record Holders
------------------------------------------------ ------------------------------
Common Shares, $0.01 par value ___
------------------------------------------------ ------------------------------
Preferred Shares, par value, $0.01 per share 0
------------------------------------------------ ------------------------------
- 4 -
Item 30: Indemnification
Section 9.5 of the Registrant's Declaration of Trust provides as
follows:
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 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.
- 5 -
Section __ of the Underwriting Agreement provides as follows:
Item 31: Business and Other Connections of Investment Advisers
(a) First Trust Advisors L.P. ("First Trust Advisors") serves as
investment adviser to the fund and the First Defined Portfolio Fund, LLC and
also serves as adviser or sub-adviser to 25 mutual funds, 32 exchange-traded
funds and 13 other closed-end funds and is the portfolio supervisor of certain
unit investment trusts. Its principal address is 1001 Warrenville Road, Suite
300, Lisle, Illinois 60532.
The principal business of certain of First Trust Advisors' principal
executive officers involves various activities in connection with the
family of unit investment trusts sponsored by First Trust Portfolios L.P.
("First Trust Portfolios" or "FTP"). The principal address of First Trust
Portfolios is 1001 Warrenville Road, Suite 300, Lisle, Illinois 60532.
Information as to Other Business, Profession, Vocation or Employment
During Past Two Years of the Officers and Directors of First Trust
Advisors is as follows:
NAME AND POSITION WITH FIRST TRUST ADVISORS EMPLOYMENT DURING PAST TWO YEARS
James A. Bowen, Managing Director/President Managing Director/President, FTP; Chairman of the Board
of Directors, BondWave LLC and Stonebridge Advisors LLC
Ronald D. McAlister, Managing Director Managing Director, FTP
Mark R. Bradley, Chief Financial Officer and Managing Chief Financial Officer and Managing Director, FTP; Chief
Director Financial Officer, BondWave LLC and Stonebridge Advisors LLC
Robert F. Carey, Chief Investment Officer and Senior Senior Vice President, FTP
Vice President
W. Scott Jardine, General Counsel General Counsel, FTP; Secretary of BondWave LLC
and Stonebridge Advisors LLC
Kristi A. Maher, Deputy General Counsel Deputy General Counsel, FTP
Michelle Quintos, Assistant General Counsel Assistant General Counsel, FTP; Associate, Jones Day,
2002 to December 2005
John Vasko, Assistant General Counsel Senior Counsel, Michaels and May, October 2006 to May
2007; Assistant General Counsel, ARAMARK Corporation
Pamela Wirt, Assistant General Counsel Of Counsel, Vedder, Price, Kaufman and Kammholz, P.C.,
February 2006 to January 2007; Independent Contractor
Attorney SBA Network Services, Inc.
R. Scott Hall, Managing Director Managing Director, FTP
- 6 -
NAME AND POSITION WITH FIRST TRUST ADVISORS EMPLOYMENT DURING PAST TWO YEARS
Andrew S. Roggensack, Managing Director Managing Director, FTP
Elizabeth H. Bull, Senior Vice President Senior Vice President, FTP
Christopher L. Dixon, Senior Vice President Senior Vice President, FTP
Jane Doyle, Senior Vice President Senior Vice President, FTP
James M. Dykas, Senior Vice President Senior Vice President, FTP since January 2005; Executive
Director, Van Kampen Asset Management and Morgan Stanley
Investment Management, 1999 to January 2005
Jon C. Erickson, Senior Vice President Senior Vice President, FTP
Kenneth N. Hass, Senior Vice President Senior Vice President, FTP
Jason T. Henry, Senior Vice President Senior Vice President, FTP
Daniel J. Lindquist, Senior Vice President Senior Vice President, FTP
David G. McGarel, Senior Vice President Senior Vice President, FTP
Mitchell Mohr, Senior Vice President Senior Vice President, FTP
Joseph McDermott, Chief Compliance Officer and Senior Senior Vice President, FTP since April 2006; CCO Driehaus
Vice President Capital Management LLC, Driehaus Securities LLC and
Driehaus Mutual Funds, January 2004 to April 2006
Robert M. Porcellino, Senior Vice President Senior Vice President, FTP
Alan M. Rooney, Senior Vice President Senior Vice President, FTP
Roger F. Testin, Senior Vice President Senior Vice President, FTP
James P. Koeneman, Vice President Vice President, FTP
Ronda L. Saeli, Vice President Vice President, FTP
Kirk Sims, Vice President Vice President, FTP
Walter E. Stubbings, Jr., Vice President Vice President, FTP
Richard S. Swiatek, Vice President Vice President, FTP
Stan Ueland, Vice President Vice President, FTP since August 2005; Vice President
BondWave LLC, May 2004 to August 2005
Michael Zinsky, Vice President Vice President, FTP since April 2005; Senior Tax Manager,
Blackman Kallick, September 2004 through April 2005
- 7 -
NAME AND POSITION WITH FIRST TRUST ADVISORS EMPLOYMENT DURING PAST TWO YEARS
Brad Bradley, Assistant Vice President Assistant Vice President, FTP
Kelley A. Christensen, Assistant Vice President Assistant Vice President, FTP
Katie D. Collins, Assistant Vice President Assistant Vice President, FTP
Kristen Johanneson, Assistant Vice President Assistant Vice President, FTP
Lynae Peays, Assistant Vice President Assistant Vice President, FTP
Omar Sepulveda, Assistant Vice President Assistant Vice President, FTP
John H. Sherren, Assistant Vice President Assistant Vice President, FTP
Michael S. Stange, Assistant Vice President Assistant Vice President, FTP
(b) Sub-Adviser. Gallatin Asset Management, Inc. serves as an
investment sub-adviser of the Fund. Reference is made to: (i) the
information set forth under "Management of the Fund" in the Prospectus
and "Sub-Adviser" in the Statement of Additional Information; and (ii)
the Form ADV of Gallatin Asset Management, Inc. (File No. 801-64561)
filed with the Commission, all of which are incorporated herein by
reference.
Item 32: Location of Accounts and Records
First Trust Advisors L.P. maintains the Declaration of Trust,
By-Laws, minutes of trustees and shareholders meetings and contracts of
the Registrant, all advisory material of the investment adviser, all
general and subsidiary ledgers, journals, trial balances, records of all
portfolio purchases and sales, and all other required records.
Item 33: Management Services
Not applicable.
Item 34: Undertakings
1. Registrant undertakes to suspend the offering of its shares
until it amends its prospectus if (1) subsequent to the effective date of
its Registration Statement, the net asset value declines more than 10
percent from its net asset value as of the effective date of the
Registration Statement, or (2) the net asset value increases to an amount
greater than its net proceeds as stated in the prospectus.
2. Not applicable.
- 8 -
3. Not applicable.
4. Not applicable.
5. The Registrant undertakes that:
(a) For purposes of determining any liability under
the Securities Act of 1933, the information omitted from the
form of prospectus filed as part of a registration statement in
reliance upon Rule 430A and contained in the form of prospectus
filed by the Registrant under Rule 497(h) under the Securities
Act of 1933 shall be deemed to be part of the Registration
Statement as of the time it was declared effective.
(b) For the purpose of determining any liability under
the Securities Act of 1933, each post-effective amendment that
contains a form of prospectus shall be deemed to be a new
registration statement relating to the securities offered
therein, and the offering of the securities at that time shall
be deemed to be the initial bona fide offering thereof.
6. The Registrant undertakes to send by first class mail or
other means designed to ensure equally prompt delivery, within two
business days of receipt of a written or oral request, any Statement of
Additional Information.
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in this City of Lisle, and State of Illinois, on the 13th day of
June, 2007.
FIRST TRUST/GALLATIN SPECIALTY FINANCE
AND FINANCIAL OPPORTUNITIES FUND
By: /s/ James A. Bowen
---------------------------------
James A. Bowen, President
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
------------------------ ------------------------------------ -----------------
/s/ James A. Bowen President, Chairman of the Board June 13, 2007
--------------------- and Trustee (Principal Executive
James A. Bowen Officer)
------------------------ ---------------------------------- -----------------
/s/ Mark R. Bradley Chief Financial Officer and June 13, 2007
--------------------- Treasurer (Principal Financial
Mark R. Bradley and Accounting Officer)
---------------------- -------------------------------- ----------------------
Richard E. Erickson (1) Trustee )
---------------------- ------------------------------ By: /s/ W. Scott Jardine
Thomas R. Kadlec (1) Trustee ) --------------------
---------------------- ------------------------------ W. Scott Jardine
Robert F. Keith (1) Trustee ) Attorney-In-Fact
---------------------- ------------------------------ June 13, 2007
Niel B. Nielson (1) Trustee )
---------------------- ------------------------------- -----------------------
* Original powers of attorney authorizing James A. Bowen, W. Scott
Jardine and Eric F. Fess to execute Registrant's Registration
Statement, and Amendments thereto, for each of the trustees of the
Registrant on whose behalf this Amendment No. 4 is filed, were
previously executed and are filed as an exhibit hereto.
INDEX TO EXHIBITS
d.2. Form of Moody's Rating Guidelines and Fitch Rating Guidelines.
k.3. Form of DTC Letter of Representations.
s. Powers of Attorney