UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number 811-21727
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FIRST TRUST/FIDAC MORTGAGE INCOME FUND
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(Exact name of registrant as specified in charter)
1001 Warrenville Road, Suite 300
LISLE, IL 60532
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(Address of principal executive offices) (Zip code)
W. Scott Jardine
First Trust Portfolios L.P.
1001 Warrenville Road
Suite 300
LISLE, IL 60532
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(Name and address of agent for service)
registrant's telephone number, including area code: 630-241-4141
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Date of fiscal year end: OCTOBER 31
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Date of reporting period: OCTOBER 31, 2005
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Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. ss. 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
[LOGO] FIDAC
[LOGO] FIRST Trust --------------------------------------
A D V I S O R S L.P. Fixed Income Discount Advisory Company
FIRST TRUST/FIDAC
MORTGAGE INCOME FUND
[GRAPHIC OMITTED]
ANNUAL REPORT
FOR THE PERIOD
MAY 17, 2005 TO OCTOBER 31, 2005
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TABLE OF CONTENTS
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FIRST TRUST/FIDAC MORTGAGE INCOME FUND
ANNUAL REPORT
OCTOBER 31, 2005
Shareholder Letter .......................................................... 1
Portfolio Commentary ........................................................ 2
Portfolio Components ........................................................ 5
Portfolio of Investments .................................................... 6
Statement of Assets and Liabilities ......................................... 8
Statement of Operations ..................................................... 9
Statement of Changes in Net Assets .......................................... 10
Statement of Cash Flows ..................................................... 11
Financial Highlights ........................................................ 12
Notes to Financial Statements ............................................... 13
Report of Independent Registered Public Accounting Firm ..................... 18
Additional Information ...................................................... 19
Dividend Reinvestment Plan
Proxy Voting Policies and Procedures
Portfolio Holdings
NYSE Certification Information
By-Law Amendment
Board Approval of Advisory and Sub-Advisory Agreements
Management .................................................................. 21
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains certain forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933. Forward-looking statements
include statements regarding the goals, beliefs, plans or current expectations
of First Trust Advisors L.P. and/or Fixed Income Discount Advisory Company and
their respective representatives, taking into account the information currently
available to them. Forward-looking statements include all statements that do not
relate solely to current or historical fact. For example, forward-looking
statements include the use of words such as "anticipate," "estimate," "intend,"
"expect," "believe," "plan," "may," "should," "would," or other words that
convey uncertainty of future events or outcomes.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the Fund's actual results, performance or
achievements to be materially different from any future results, performance or
achievements expressed or implied by the forward-looking statements. When
evaluating the information included in this Annual Report, you are cautioned not
to place undue reliance on these forward-looking statements, which reflect the
judgment of First Trust Advisors L.P. and/or Fixed Income Discount Advisory
Company and their respective representatives only as of the date hereof. We
undertake no obligation to publicly revise or update these forward-looking
statements to reflect events and circumstances that arise after the date hereof.
HOW TO READ THIS REPORT
This report contains information that can help you evaluate your investment. It
includes details about the First Trust/FIDAC Mortgage Income Fund (the "Fund")
and presents data and analysis that provide insight into the Fund's performance
and investment approach.
By reading the letter from the Fund's President, James A. Bowen, together with
the portfolio commentary by the portfolio management team at the Fund's
sub-advisor, Fixed Income Discount Advisory Company ("FIDAC"), you will obtain
an understanding of how the market environment affected the Fund's performance.
The statistical information that follows can help you understand the Fund's
performance compared to that of relevant benchmarks.
It is important to keep in mind that the opinions expressed by Mr. Bowen, First
Trust Advisors L.P. and FIDAC personnel are just that: informed opinions. They
should not be considered to be promises or advice. The opinions, like the
statistics, cover the period through the date on the cover of this report. Of
course, the risks of investing in the Fund are spelled out in the prospectus.
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SHAREHOLDER LETTER
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FIRST TRUST/FIDAC MORTGAGE INCOME FUND
ANNUAL REPORT
OCTOBER 31, 2005
Dear Shareholder:
We are pleased to present our first report to shareholders of First Trust/FIDAC
Mortgage Income Fund (NYSE Symbol: FMY). Although it is a short reporting
period, the Fund is off to a good start. We launched and closed our common
equity offering in May 2005. Since that time our economy has endured several
short-term rate increases by the Federal Reserve as well as devastating
hurricanes in the Gulf Coast Region. Despite pressure on the market price, the
Fund has upheld a relatively stable net asset value ("NAV") while maintaining a
steady annualized distribution rate of 6.25% on the $20 Common Share IPO price.
As you know, the Fund's primary investment objective is to seek a high level of
current income. As a secondary objective, the Fund seeks to preserve capital.
The Fund currently pursues these investment objectives by investing primarily in
mortgage-backed securities representing part ownership in a pool of either
residential or commercial mortgage loans that, in the opinion of Fixed Income
Discount Advisory Company ("FIDAC" or the "Sub-Advisor"), offer an attractive
combination of credit quality, yield and maturity.
FIDAC's portfolio management team is positioning the portfolio to invest in
securities that have the potential to outperform other fixed-income securities
as interest rates rise and mortgage refinancing slows. I encourage you to read
the commentary from the FIDAC portfolio management team found on the following
pages. It includes a review of the Fund's performance and the portfolio
managers' outlook for the markets.
We thank you for your confidence in First Trust Advisors L.P. ("First Trust")
and FIDAC and will work diligently to keep earning it.
Sincerely,
/s/ James A. Bowen
James A. Bowen
President of First Trust/FIDAC Mortgage Income Fund
December 8, 2005
Page 1
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A COMMENTARY ON THE FIRST TRUST/FIDAC MORTGAGE INCOME FUND
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SUMMARY
o FIRST TRUST/FIDAC MORTGAGE INCOME FUND: REVIEW OF FUND OBJECTIVES.
o THE MORTGAGE MARKET: PREPAYMENTS EXPECTED TO SLOW; ASSESSING THE "NEW"
NEWS AT FANNIE MAE.
o THE ECONOMY: DESPITE KATRINA, FED RAISES RATES AGAIN; GREENSPAN TAKES
ON HOUSING.
o THE MARKETS: RATES RISE ACROSS THE CURVE; THE SHORT END LEADS THE WAY.
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
The First Trust/FIDAC Mortgage Income Fund (the "Fund" or "FMY") received
approximately $76 million in proceeds from its initial public offering on May
26, 2005. The Fund's primary investment objective is to seek a high level of
current income. As a secondary objective, the Fund seeks to preserve capital.
The Fund will pursue its objectives by investing primarily in mortgage-backed
securities representing part ownership in a pool of either residential or
commercial mortgage loans that, in the opinion of the Fund's sub-advisor, offer
an attractive combination of credit quality, yield and maturity. These
securities may be issued by government agencies or by private originators or
issuers, generally in the form of pass-through certificates, collateralized
mortgage obligations, residential mortgage-backed securities or commercial
mortgage-backed securities. The Fund may leverage to an aggregate amount of up
to 33 1/3% of the Fund's Managed Assets. The Fund intends to utilize leverage
primarily through the use of reverse repurchase agreements.
FUND PERFORMANCE
Since inception through October 31, 2005, First Trust/FIDAC Mortgage Income Fund
had a net asset value ("NAV") return of 1.37%. The Fund's benchmark, the Lehman
Brothers MBS Fixed Rate Index, had a total return of -0.25% over the same
period. The NAV of the Fund declined 0.21% from $19.06 to $19.02, while the Fund
paid dividends totaling $0.3126 per share through October 31, 2005.
The Fund's market value total return for the period ended October 31, 2005 was
-16.5%. The difference between the market value total return and the NAV total
return is a result of the initial sales load and the Fund trading at a discount
to its NAV on October 31, 2005. On October 31, 2005, the Fund closed at a market
price of $16.40 and reported a NAV of $19.02.
The Fund has an initial bias towards rising interest rates and should outperform
other fixed-income investments when interest rates are rising. The Fund is able
to benefit from the rising yields by investing in securities that perform better
as interest rates rise and consumers refinance their mortgage loans at a slower
pace. Over the period May 26, 2005 through October 31, 2005, yields on the
two-year U.S. Treasury Note increased 75 basis points (a basis point is 0.01%)
while the 10-year Treasury Note increased 47 basis points and 30-year
conventional mortgage rates, as measured by Freddie Mac Commitment Rates,
increased 50 basis points.
THE MORTGAGE MARKET
With the exception of October 2005, prepayment speeds stayed relatively fast as
the low rate environment of June and July worked its way through the mortgage
pipeline. For the month of October, mortgage prepayment speeds decreased for
fixed-rate and adjustable-rate mortgages as higher rates and fewer business days
in October tempered mortgage refinancing activity. As we enter the fall/winter
months, we expect higher mortgage rates and slower seasonal factors to lower
prepayment speeds further. The Mortgage Bankers Association Refinancing Index is
reflecting this anticipated slowdown, as it now stands at 1,863, which is about
13% lower than the three-month average of 2,151. We will be paying very close
attention to whether this expected slowdown is just the usual seasonal noise or
if it reflects a slowing in the overall housing market going forward. Typically,
a slowing housing market would imply sustainable lower prepayment rates relative
to the recent past. Also, lower prepayments would cause repayment periods on
existing securities to expand and likely lead to spreads on mortgage-backed
securities to widen. We have experienced some of this spread widening in the
mortgage-backed securities sector recently as the 10-year Treasury yield
increased by 23 basis points during October.
The popular press has devoted an extraordinary amount of time and concern to the
number of alternative mortgage products that have come to define today's robust
housing market. The most popular, and perhaps most risky, of these products has
been Option ARMs (also known as Negative Amortization ARMs). An Option ARM
typically provides the borrower with four choices each month:
1. The minimum payment, which can start as low as a 1.0% pay rate, and
allows for negative amortization, or in other words a growing
principal balance.
2. An interest-only payment, which is the payment necessary to keep the
loan balance constant and not negatively amortize.
3. A payment of interest and principal that would amortize the loan over
a 30-year period.
4. A payment of interest and principal that would amortize the loan over
a 15-year period.
The most enticing of these options is the minimum payment option because of its
extremely low payment amount. However, because this option allows for the loan
to negatively amortize, it also has the most potential to cause credit problems
for the borrower. This innovative mortgage has become very common over the past
few months as the mortgage banking community has addressed the challenge of
closing the gap between the relatively steep climb in house prices and the
relatively flat growth in personal incomes. Thus, they have been used as a way
for a borrower to stretch his or her affordability levels.
Page 2
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A COMMENTARY ON THE FIRST TRUST/FIDAC MORTGAGE INCOME FUND - (CONTINUED)
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However, as mentioned above, such products do not come without increased risk.
We believe such products have increased the amount of credit risk in the
mortgage market, especially if interest rates rise or house price appreciation
trends lower. IT IS FOR THIS REASON THAT WE HAVE STAYED AWAY FROM PURCHASING
SUCH ASSETS. It is also worth noting that Fannie Mae and Freddie Mac
("government sponsored entities" or "GSEs"), whose mortgage-backed bonds we
purchase, have been reluctant to significantly enter into the Option ARM arena.
For example, according to Lehman Brothers' research, Freddie Mac has been very
selective in taking on such mortgage products, as it has only accounted for 3%
of their business this year.
Fannie Mae and Freddie Mac were back in the headlines in October. The House of
Representatives passed their version of the GSE regulatory reform bill. In
general, the House bill calls for the creation of a new regulator that would
have the power to bar the GSEs from new business lines and place them under
receivership in the event of default. It also has a requirement that 3.5% of
their after-tax profits be allocated to a fund for affordable housing. However,
the bill does not include any portfolio size limits. Thus, we believe it is
unlikely that this legislation will be enacted prior to year-end because the
Senate's version of the bill calls for specific portfolio limits. These limits
address the concerns of Fed Chairman Greenspan and the White House that the GSEs
are too large. We expect the debate surrounding the portfolio limits to continue
into 2006.
In related news, the Office of Federal Housing Enterprise, the current GSE
regulator, announced Fannie Mae reached the 30% capital surplus target that had
been imposed because of the accounting restatement process that is under way. To
meet this requirement, Fannie Mae has had to shrink its portfolio by $177 billon
year-to-date. We believe most market participants are hoping that by meeting its
capital surplus target, Fannie Mae signals an inflection point for shrinkage in
its portfolio and that the company will slowly come back to the market.
THE ECONOMY
Interest rates in the period ended October 31, 2005 have exhibited significant
volatility, particularly in the short end of the yield curve. The Fed has
continued its Fed tightening program, even in the wake of Hurricanes Katrina and
Rita. On November 1, 2005, the Federal Funds rate was increased to 4.00%, the
highest since 2001. The bond market has come to accept that inflation is indeed
an issue to be countered with the tools of monetary policy.
Before Hurricane Katrina, we believed the economy was perceived to be fairly
vibrant. In particular, housing has remained strong, with new and existing home
sales posting near-record numbers, and consumer spending was strong. Real estate
valuations rose, providing good support for spending. Since Hurricane Katrina,
we have seen a drop in consumer spending, although this has been primarily a
consequence of higher energy prices. Looking ahead, we expect to see continued
volatility in the bond market as the Federal Reserve continues its tightening
pattern. We also will watch the effects of higher rates on the housing market
and its potential ramifications on consumer patterns.
Market participants obtained clarity on at least one question: Ben S. Bernanke
will step into the very large shoes of the soon-to-retire Alan Greenspan as the
new Chairman of the Federal Reserve in January, pending his confirmation by the
U.S. Senate. Bernanke is an academic who has spent the last three years in
government service, most recently as the Chairman of the President's Council of
Economic Advisors and before that as a governor of the Federal Reserve Board.
Prior to that he headed the economics department at Princeton University. In
general, the bond and the stock markets have reacted calmly to the idea of
Bernanke as the new leader at the Fed. He's a known commodity with an extensive
body of work on macroeconomic policy and monetary policy, with a focus on
studying the Great Depression.
While the market knows who will be the new Fed Chair, it now is focusing on what
kind of policymaker he will be. In this regard, several of his intellectual
touchstones have come under scrutiny. Dr. Bernanke first garnered attention
beyond the halls of academia when, in November 2002, he delivered a speech that
became the basis for the Fed's deflation-fighting policy. In "Deflation: Making
Sure `It' Doesn't Happen Here," Bernanke essentially argued that the Fed would
take any steps necessary to stave off deflation, including non-traditional
policy tools. These tools, such as fomenting inflation by cranking up the
currency printing press or buying back Treasuries, are a viable alternative as
interest rates neared zero because, as he said, "Sustained deflation can be
highly destructive to a modern economy and should be strongly resisted." The
following year, Bernanke gave a speech entitled "A Perspective on Inflation
Targeting," in which he spoke admiringly of the track record of central banks
around the world which practice the policy. Bernanke has also been a vocal
proponent of transparency and clarity in communicating the Fed's approach to
monetary policy. As it relates to the Fed's ability to influence market
expectations, he said last year that "the Federal Open Market Committee
statement has become an increasingly important tool of policy." These speeches
and his other writings have been combed over as the market has tried to evaluate
the future Bernanke-led Federal Reserve.
We will likely get some clues to Bernanke's approach going forward during his
confirmation hearings. In the meantime, though, the Fed Funds futures market is
generally expecting the Fed Funds rate to be increased by 25 basis points at
each of the remaining two meetings that will be overseen by Alan Greenspan. We
have no special insight into what Bernanke will do once in office. In his
nomination press conference, Bernanke stated, "My first priority will be to
maintain continuity with the policies and policy strategies established during
the
Page 3
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A COMMENTARY ON THE FIRST TRUST/FIDAC MORTGAGE INCOME FUND - (CONTINUED)
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Greenspan years." We take that to mean that he will not be dogmatic or
ideological in his approach, although his style will certainly be
different--more transparency in his speeches and official Fed statements.
Instead, we believe, he will focus on the data. Thus, the question that the
market must think about is what kind of economy is Bernanke inheriting?
Certain aspects of the economy are solid. The Institute of Supply Management
reported strong non-manufacturing and manufacturing results for October, with
strength in employment and prices paid. The first estimate of third quarter
Gross Domestic Product came in at 3.8%, higher than consensus, and core
inflation moved mostly sideways, while headline numbers (which include the more
volatile food and energy components) rose. The core PCE (personal consumption
expenditures by major type of product), which has been identified as the Fed's
preferred measure of inflation, rose 2.0% on a year-over-year basis through
September, at the high end of the so-called comfort range. On the other hand, we
note weakness in housing and consumer spending, both important data series for
the U.S. economy going forward. Real consumer spending fell by -0.4% in
September following a -1.0% decline in August, portending slowing spending in
the fourth quarter. Spending on both durables and non-durables fell in the
month, which offset small gains in consumption of services. Inventories of
unsold homes are rising, mortgage rates are rising, and mortgage refinancing
activity is declining.
Perhaps the most germane economic variable for the prospective Fed Chairman to
consider is the fact that the current tightening cycle has successfully
flattened the yield curve. Currently, the spread between the 10-year Treasury
and Fed Funds stands at approximately 70 basis points, below its long run
average of about 90 basis points, and well in from the 359 basis point spread in
the second quarter of 2004. The shape of the yield curve is a good leading
indicator of economic activity. The Federal Reserve Bank of New York recently
released a piece on the yield curve as a leading indicator. According to the
author, "The difference between long-term and short-term interest rates has
borne a consistent negative relationship with subsequent real economic activity
in the United States, with a lead time of about four to six quarters." To again
quote from the New York Fed, "A tightening of monetary policy usually means a
rise in short-term interest rates, typically intended in the end to lead to a
reduction in inflationary pressures. When these pressures subside, it is
expected that a policy of easing will follow."
THE MARKETS
During the period, yields in the fixed-income market rose across the board. The
short end of the curve experienced the brunt of the sell- off, reflecting the
perception that the Fed may need to pursue more of a tightening policy. Stocks
finished the period slightly higher and oil hit new highs in the wake of
Hurricane Katrina. Comparative economic data is shown in the table below.
%
31-OCT-05 31-MAY-05 CHANGE
FEDERAL FUNDS RATE 3.8% 3.0% 25.0%
2-YEAR US TREASURY 4.4% 3.6% 22.4%
10-YEAR US TREASURY 4.6% 4.0% 14.3%
30-YEAR CONVENTIONAL MORTGAGE 6.1% 5.5% 12.3%
DOLLAR INDEX 90.07 87.76 2.6%
S&P 500 1,207.01 1,191.50 1.3%
NASDAQ COMPOSITE 2,120.30 2,068.22 2.5%
GOLD $/OZ (NEARBY CONTRACT) $ 466.90 $ 416.30 12.2%
OIL $/BBL (NEARBY CONTRACT) $ 59.76 $ 51.97 15.0%
MBA REFI INDEX (MONTH-END VALUE) 1,862.8 2,142.10 -13.0%
Page 4
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
PORTFOLIO COMPONENTS+
OCTOBER 31, 2005
[THE FOLLOWING TABLE WAS REPRESENTED BY A PIE CHART IN THE PRINTED MATERIAL.]
U.S. Government Agency Mortgage-Backed Securities 68.7%
Collateralized Mortgage Obligations 31.3%
+ Percentages are based on total investments. Please note that the
percentages shown on the Portfolio of Investments are based on net assets.
See Notes to Financial Statements. Page 5
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 2005
MARKET
SHARES DESCRIPTION VALUE
---------------- ------------------------------------------------------ ---------------
U.S. GOVERNMENT AGENCY MORTGAGE-BACKED
SECURITIES - 87.0%
FEDERAL HOME LOAN MORTGAGE CORPORATION
(FHLMC) - 69.4%
$ 5,831,125 Gold, Pool A35567, 5.50%, 6/01/35 .................... $ 5,759,705
7,781,382 Gold, Pool A45294, 5.50%, 6/01/35 .................... 7,686,076
5,972,320 Gold, Pool A45498, 5.50%, 6/01/35 .................... 5,899,171
30,347,644 Gold, Pool G01649, 5.00%, 2/01/34 .................... 29,315,912
4,927,884 Gold, Pool G08062, 5.00%, 6/01/35 .................... 4,744,331
---------------
53,405,195
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FEDERAL NATIONAL MORTGAGE ASSOCIATION
(FNMA) - 17.6%
5,916,765 Pool 256007, 6.00%, 10/01/35 ......................... 6,017,362
7,820,526 Pool 825966, 5.00%, 7/01/35 .......................... 7,530,567
---------------
13,547,929
---------------
TOTAL U.S. GOVERNMENT AGENCY
MORTGAGE-BACKED SECURITIES ........................... 66,953,124
(Cost $68,892,102) ---------------
COLLATERALIZED MORTGAGE OBLIGATIONS - 39.7%
3,000,000 Banc of America Mortgage Securities,
Series 2005-1, Class 1A16, 5.50%, 2/25/35 ........ 2,954,061
3,000,000 Citicorp Mortgage Securities, Inc.,
Series 2005-3, Class 1A3, 5.50%, 4/25/35 ......... 2,889,350
16,691,891 Federal Home Loan Mortgage Corp.,
Series 2807, Class SB, IO, 3.48%, 11/15/33+ ...... 1,711,553
8,893,033 Federal Home Loan Mortgage Corp.,
Series 2869, Class ST, IO, 3.28%, 3/15/23+ ....... 683,895
4,739,600 Federal Home Loan Mortgage Corp.,
Series 2870, Class JI, IO, 5.00%, 10/15/27 ....... 972,757
792,000 Federal Home Loan Mortgage Corp.,
Series 2888, Class OI, IO, 5.00%, 1/15/27 ........ 167,040
2,912,072 Federal Home Loan Mortgage Corp.,
Series 2906, Class XW, 5.64%, 7/15/34+ ........... 2,839,990
1,774,808 Federal Home Loan Mortgage Corp.,
Series 2921, Class IQ, IO, 5.00%, 1/15/29 ........ 410,660
2,482,619 Federal Home Loan Mortgage Corp.,
Series 2938, Class PI, IO, 5.00%, 11/15/28 ....... 366,003
1,933,440 Federal Home Loan Mortgage Corp.,
Series 2943, Class JI, IO, 5.00%, 1/15/24 ........ 288,795
34,579,658 Federal Home Loan Mortgage Corp., STRIP,
Series 227, Class IO, IO, 5.00%, 12/01/34 ........ 8,909,667
4,807,557 Federal Home Loan Mortgage Corp., STRIP,
Series 231, Class IO, IO, 5.50%, 8/01/35 ......... 1,255,974
12,810,598 Federal Home Loan Mortgage Corp., STRIP,
Series 232, Class IO, IO, 5.00%, 8/01/35 ......... 3,360,781
Page 6 See Notes to Financial Statements.
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
PORTFOLIO OF INVESTMENTS - (CONTINUED)
OCTOBER 31, 2005
MARKET
SHARES DESCRIPTION VALUE
---------------- ------------------------------------------------------ ---------------
COLLATERALIZED MORTGAGE OBLIGATIONS- (CONTINUED)
$ 2,627,730 Federal National Mortgage Association,
Series 2005-39, Class BI, IO,
5.00%, 6/25/28 ................................... $ 358,100
12,806,363 Federal National Mortgage Association, STRIP,
Series 360, Class 2, IO, 5.00%, 7/01/35 .......... 3,333,656
---------------
TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS ............ 30,502,281
(Cost $28,894,125) ---------------
TOTAL INVESTMENTS - 126.7% ........................... 97,455,405
(Cost $97,786,227)*
REVERSE REPURCHASE AGREEMENT - (26.1)%
(20,100,000) (With UBS Securities 4.09% dated 10/31/05,
to be repurchased at $20,102,284 on 11/01/05,
collateralized by $20,676,479 Federal Home
Loan Mortgage Corp., Gold, 5.00% due 2/01/34) ........ (20,100,000)
---------------
NET OTHER ASSETS AND LIABILITIES - (0.6)% ............ (430,686)
---------------
NET ASSETS - 100.0% .................................. $ 76,924,719
===============
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* Aggregate cost for federal income tax and financial reporting purposes
is $97,835,075.
+ Variable rate security. The interest rate shown reflects the rate in
effect at October 31, 2005.
STRIP Separate trading of registered interest and principal of securities
IO Interest Only
See Notes to Financial Statements. Page 7
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 2005
ASSETS:
Investments, at value
(Cost $97,786,227) ............................................................... $ 97,455,405
Cash ................................................................................ 293,352
Interest receivable ................................................................. 686,186
Receivable from investment advisor .................................................. 40,996
Prepaid expenses .................................................................... 3,950
------------
Total Assets ................................................................... 98,479,889
------------
LIABILITIES:
Reverse repurchase agreement ........................................................ 20,100,000
Payables:
Investment securities purchased ................................................ 1,249,932
Investment advisory fees ....................................................... 69,204
Audit and legal fees ........................................................... 47,977
Printing fees .................................................................. 36,324
Interest expense on reverse repurchase agreements .............................. 25,996
Administrative fees ............................................................ 6,513
Custodian fees ................................................................. 2,136
Accrued expenses .................................................................... 17,088
------------
Total Liabilities ............................................................ 21,555,170
------------
NET ASSETS .......................................................................... $ 76,924,719
============
NET ASSETS CONSIST OF:
Undistributed net investment income ................................................. $ 226,733
Accumulated net realized loss on investments sold ................................... (73,390)
Net unrealized depreciation of investments .......................................... (330,822)
Par value ........................................................................... 40,452
Paid-in capital ..................................................................... 77,061,746
------------
Total Net Assets ............................................................. $ 76,924,719
============
NET ASSET VALUE, per Common Share (par value $0.01 per Common Share) ................ $ 19.02
============
Number of Common Shares outstanding ................................................. 4,045,236
============
Page 8 See Notes to Financial Statements.
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED OCTOBER 31, 2005*
INVESTMENT INCOME:
Interest ............................................................................ $ 2,197,444
------------
Total investment income ........................................................ 2,197,444
------------
EXPENSES:
Investment advisory fees ............................................................ 393,922
Interest expense on reverse repurchase agreements ................................... 218,513
Audit and legal fees ................................................................ 58,809
Administration fees ................................................................. 39,392
Trustees' fees and expenses ......................................................... 26,302
Custodian fees ...................................................................... 5,349
Other ............................................................................... 85,842
------------
Total expenses ................................................................. 828,129
Fees waived by the investment advisor .......................................... (59,088)
Fees waived by the administrator ............................................... (7,878)
------------
Net expenses ........................................................................ 761,163
------------
NET INVESTMENT INCOME ............................................................... 1,436,281
------------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain/(loss) on:
Securities transactions ........................................................ 15,549
Written option transactions .................................................... (33,946)
------------
Net realized loss on investments during the period .................................. (18,397)
------------
Net change in unrealized appreciation/(depreciation) of investments during the period (330,822)
------------
Net realized and unrealized loss on investments ..................................... (349,219)
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS ................................ $ 1,087,062
============
----------------------------------------------------------------------
* The Fund commenced operations on May 17, 2005.
See Notes to Financial Statements. Page 9
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
STATEMENT OF CHANGES IN NET ASSETS
PERIOD
ENDED
10/31/2005*
------------
OPERATIONS:
Net investment income ............................................................... $ 1,436,281
Net realized loss on investments during the period .................................. (18,397)
Net change in unrealized appreciation/(depreciation) of investments during the period (330,822)
------------
Net increase in net assets resulting from operations ................................ 1,087,062
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income ............................................................... (1,264,541)
------------
Total distributions to shareholders ................................................. (1,264,541)
CAPITAL TRANSACTIONS:
Net proceeds from sale of 4,045,236 Common Shares ................................... 77,264,007
Offering costs ...................................................................... (161,809)
------------
Net increase from capital transactions .............................................. 77,102,198
------------
Net increase in net assets .......................................................... 76,924,719
NET ASSETS:
Beginning of period ................................................................. --
------------
End of period ....................................................................... $ 76,924,719
============
Undistributed net investment income at end of period ................................ $ 226,733
============
----------------------------------------------------------------------
* The Fund commenced operations on May 17, 2005.
Page 10 See Notes to Financial Statements.
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
STATEMENT OF CASH FLOWS
FOR THE PERIOD ENDED OCTOBER 31, 2005*
CASH FLOWS FROM OPERATING ACTIVITIES:
Net increase in net assets resulting from operations ............... $ 1,087,062
Adjustments to reconcile net increase in net assets resulting
from operations to net cash used by operating activities:
Changes in assets and liabilities:
Increase in investments, at value** .......................... (97,455,405)
Increase in interest receivable .............................. (686,186)
Increase in other assets ..................................... (44,946)
Increase in payable for investment securities purchased ...... 1,249,932
Increase in interest expense on reverse repurchase agreements 25,996
Increase in investment advisory fees payable ................. 69,204
Increase in audit and legal fees payable ..................... 47,977
Increase in printing fees payable ............................ 36,324
Increase in administrative fees payable ...................... 6,513
Increase in custodian fees payable ........................... 2,136
Increase in accrued expenses ................................. 17,088
------------
CASH USED BY OPERATING ACTIVITIES .................................. $(95,644,305)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from Common Shares sold ......................... 77,102,198
Distributions to shareholders from net investment income ..... (1,264,541)
Increase in reverse repurchase agreements .................... 20,100,000
------------
CASH PROVIDED BY FINANCING ACTIVITIES .............................. 95,937,657
Increase in cash ............................................. 293,352
Cash at beginning of period .................................. --
------------
Cash at end of period ........................................ 293,352
------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the period for interest ..................... $ 192,517
----------------------------------------------------------------------
* The Fund commenced operations on May 17, 2005.
** Includes net change in unrealized depreciation on investments of
$(330,822).
See Notes to Financial Statements. Page 11
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT THE PERIOD
PERIOD
ENDED
10/31/2005*
------------
Net asset value, beginning of period ................................... $ 19.10
------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income .................................................. 0.36
Net realized and unrealized loss on investments ........................ (0.09)
------------
Total from investment operations ....................................... 0.27
------------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income .................................................. (0.31)
------------
Total from distributions ............................................... (0.31)
------------
Common shares offering costs charged to paid-in capital ................ (0.04)
------------
Net asset value, end of period ......................................... $ 19.02
============
Market value, end of period ............................................ $ 16.40
============
TOTAL RETURN BASED ON NET ASSET VALUE (A)+ ............................. 1.37%
============
TOTAL RETURN BASED ON MARKET VALUE (B)+ ................................ (16.53)%
============
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) ................................... $ 76,925
Ratio of net expenses to average net assets excluding interest expense . 1.62%**
Ratio of net expenses to average net assets ............................ 2.28%**
Ratio of total expenses to average net assets .......................... 2.48%**
Ratio of net investment income to average net assets ................... 4.30%**
Portfolio turnover rate ................................................ 14.37%
----------------------------------------------------------------------
* The Fund commenced operations on May 17, 2005.
** Annualized.
(a) Total return based on net asset value is the combination of reinvested
dividend income and reinvested capital gains distributions, if any, at
prices obtained by the Dividend Reinvestment Plan and changes in net asset
value per share and does not reflect sales load.
(b) Total return based on market value is the combination of reinvested
dividend income and 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.
+ Total return is not annualized for periods less than one year.
Page 12 See Notes to Financial Statements.
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
1. FUND DESCRIPTION
First Trust/FIDAC Mortgage Income Fund (the "Fund") is a diversified closed-end
management investment company organized as a Massachusetts business trust on
February 22, 2005, and is registered with the Securities and Exchange Commission
("SEC") under the Investment Company Act of 1940, as amended (the "1940 Act").
The Fund trades under the ticker symbol FMY on the New York Stock Exchange
("NYSE").
The Fund's primary investment objective is to seek a high level of current
income. As a secondary objective, the Fund will seek to preserve capital. The
Fund will pursue these objectives by investing in mortgage-backed securities
that, in the opinion of Fixed Income Discount Advisory Company ("FIDAC" or the
Fund's "Sub-Advisor"), offer an attractive combination of credit quality, yield
and maturity. There can be no assurance that the Fund's investment objectives
will be achieved.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statements. Actual results could differ from those estimates.
A. PORTFOLIO VALUATION:
The net asset value ("NAV") of the Common Shares of the Fund is computed based
upon the value of the Fund's portfolio securities and other assets. The NAV is
determined as of the close of regular trading on the New York Stock Exchange
("NYSE"), normally 4:00 p.m. Eastern time, on each day the NYSE is open for
trading. The Fund calculates NAV per Common Share by subtracting the Fund's
liabilities (including accrued expenses, dividends payable and all borrowings of
the Fund) from the Fund's Managed Assets (the value of the securities and other
investments the Fund holds plus cash or other assets, including interest accrued
but not yet received) and dividing the result by the total number of Common
Shares outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value according
to procedures adopted by the Fund's Board of Trustees. Securities for which
market quotations are readily available are valued at market value, which is
currently determined using the last reported sale price or, if no sales are
reported (as in the case of some securities traded over-the-counter), the last
reported bid price, except that certain U.S. government securities are valued at
the mean between the last reported bid and asked prices. The Fund will value
mortgage-backed securities ("MBS") and other debt securities not traded in an
organized market on the basis of valuations provided by dealers or by an
independent pricing service, approved by the Board of Trustees, which uses
information with respect to transactions in such securities, quotations from
dealers, market transactions for comparable securities, various relationships
between securities and yield to maturity in determining value. Debt securities
having a remaining maturity of less than sixty days when purchased and debt
securities originally purchased with maturities of sixty days or more but which
currently have maturities of less than sixty days are valued at cost adjusted
for amortization of premiums and accretion of discounts. In the event that
market quotations are not readily available, the pricing service does not
provide a valuation for a particular security, or the valuations are deemed
unreliable, or if events occurring after the close of the principal markets for
particular securities (e.g., domestic debt and foreign securities), but before
the Fund values its assets, would materially affect NAV, First Trust Advisors
L.P. ("First Trust") may use a fair value method to value the Fund's securities
and investments. The use of fair value pricing by the Fund is governed by
valuation procedures adopted by the Fund's Board of Trustees, and in accordance
with the provisions of the 1940 Act.
The Fund values exchange-traded options and other derivative contracts at the
closing price on the exchange on which they are principally traded, or if not
traded, or no closing price is available, at the mean between the last bid and
asked prices.
B. OPTION CONTRACTS:
COVERED CALL OPTIONS. The Fund may enter into hedging and strategic transactions
to seek to reduce interest rate risk arising from any use of financial leverage
by the Fund, to facilitate portfolio management and to mitigate risks, including
interest rate and credit risks.
Options the Fund writes (sells) will either be exercised, expire or be cancelled
pursuant to a closing transaction. If the price of the underlying security
exceeds the option's exercise price, it is likely that the option holder will
exercise the option. If an option written (sold) by the Fund is exercised, the
Fund would be obligated to deliver the underlying security to the option holder
upon payment of the
Page 13
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
exercise price. In this case, the option premium received by the Fund will be
added to the amount realized on the sale of the security for purposes of
determining gain or loss. If the price of the underlying security is less than
the option's exercise price, the call option will likely expire without being
exercised. The option premium will be treated as short-term capital gain on the
expiration date of the option. The Fund may also elect to close out its position
in an option prior to its expiration by purchasing an option of the same option
series as the option written (sold) by the Fund.
These options give the option holder the right, but not the obligation, to
purchase a security from the Fund at the strike price on or prior to the
option's expiration date. The ability to successfully implement the Fund's
investment strategy depends on the ability of the Fund's Sub-Advisor to predict
pertinent market movements, which cannot be assured. Thus, the use of options
may require the Fund to sell portfolio securities at inopportune times or for
prices other than current market value, 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. As the writer (seller) of a covered option, the Fund
forgoes, during the option's life, the opportunity to profit from increases in
the market value of the security covering the option above the sum of the
premium and the strike price of the option, but has retained the risk of loss
should the price of the underlying security decline. The writer (seller) of an
option has no control over the time when it may be required to fulfill its
obligation as a writer (seller) of the option. Once an option writer (seller)
has received an exercise notice, it cannot effect a closing purchase transaction
in order to terminate its obligation under the option and must deliver the
underlying security at the exercise price.
NUMBER
OF
CONTRACTS PREMIUMS
---------- ---------
WRITTEN OPTIONS
Options outstanding at the Fund's inception ........ -- $ --
Options written .................................... 280,000 22,070
Options exercised .................................. (60,000) (14,532)
Options expired .................................... (220,000) (7,538)
---------- ---------
Options outstanding at October 31, 2005 ............ -- $ --
========== =========
C. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on the accrual basis, including amortization of premiums and the accretion of
discounts.
Securities purchased or sold on a when-issued or delayed-delivery basis may be
settled a month or more after the trade date; interest income is not accrued
until settlement date. The Fund instructs the custodian to segregate assets of
the Fund with a current value at least equal to the amount of its when-issued
purchase commitments.
D. REVERSE REPURCHASE AGREEMENTS:
A reverse repurchase agreement, although structured as a sale and repurchase
obligation, acts as a financing under which the Fund will effectively pledge its
assets 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 assets continue to
pay principal and interest which are for the benefit of the Fund.
Maximum amount outstanding during the period.............. $20,100,000
Average amount outstanding during the period*............. $12,972,345
Average monthly shares outstanding during the period ..... 4,031,903
Average debt per share outstanding during the period...... $3.22
* The average amount outstanding during the period was calculated by adding the
borrowings at the end of each day and dividing the sum by the number of days in
the period ended October 31, 2005.
Interest rates ranged from 3.24% to 4.09% during the period ended October 31,
2005, on borrowings by the Fund under reverse repurchase agreements, which had
interest expense that aggregated $218,513.
Page 14
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
E. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
The Fund will distribute to holders of its Common Shares monthly dividends of
all or a portion of its net income after the payment of interest and dividends
in connection with leverage. Distributions will automatically be reinvested into
additional Common Shares pursuant to the Fund's Dividend Reinvestment Plan
unless cash distributions are elected by the shareholder.
Distributions from income and capital gains are determined in accordance with
income tax regulations, which may differ from accounting principles generally
accepted in the United States of America. These differences are primarily due to
differing treatments of income and gains on various investment securities held
by the Fund, timing differences and differing characterization of distributions
made by the Fund. Permanent differences incurred during the period ended October
31, 2005, resulting in book and tax accounting differences, have been
reclassified at year end to reflect an increase in undistributed net investment
income by $54,993 and an increase in accumulated net realized loss on
investments by $54,993. Net assets were not affected by this reclassification.
The tax character of distributions paid during fiscal period ended October 31,
2005 is as follows:
2005
----
Distributions paid from:
Ordinary Income................................ $ 1,264,541
As of October 31, 2005, the components of distributable earnings on a tax basis
were as follows:
Undistributed Ordinary Income.................. $ 226,733
Net Unrealized Depreciation.................... $ (379,670)
F. INCOME TAXES:
The Fund intends to qualify as a regulated investment company by complying with
the requirements under Subchapter M of the Internal Revenue Code of 1986, as
amended, and by distributing substantially all of its net investment income and
net realized gains to shareholders. Accordingly, no provision has been made for
federal or state income taxes.
G. EXPENSES:
The Fund pays all expenses directly related to its operations.
H. ORGANIZATION AND OFFERING COSTS:
Organization costs consist of costs incurred to establish the Fund and enable it
to legally do business. These costs include filing fees, listing fees, legal
services pertaining to the organization of the business and audit fees relating
to the initial registration and auditing the initial statement of assets and
liabilities, among other fees. Offering costs consist of legal fees pertaining
to the Fund's Common Shares offered for sale, registration fees, underwriting
fees, and printing of the initial prospectus, among other fees. First Trust and
FIDAC have paid all organization expenses and all offering costs of the Fund
(other than sales load) that exceeded $0.04 per Common Share. The Fund's share
of Common Share offering costs, $161,809, was recorded as a reduction of the
proceeds from the sale of Common Shares.
3. INVESTMENT ADVISORY FEE AND OTHER AFFILIATED TRANSACTIONS
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. First Trust
serves as investment advisor to the Fund pursuant to an Investment Management
Agreement. First Trust is responsible for the ongoing monitoring of the Fund's
investment portfolio, managing the Fund's business affairs and certain
administrative services necessary for the management of the Fund. For these
investment management services, First Trust is entitled to a monthly fee
calculated at an annual rate of 1.00% of the Fund's Managed Assets.
FIDAC serves as the Fund's sub-advisor and manages the Fund's portfolio subject
to First Trust's supervision. The Sub-Advisor receives a portfolio management
fee of 0.50% of Managed Assets that is paid monthly by First Trust from its
investment advisory fee.
Page 15
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
First Trust has agreed to reimburse the Fund for fees and expenses in an amount
equal to 0.15% of the average daily Managed Assets of the Fund through December
31, 2005. The Sub-Advisor has agreed to bear a portion of this expense
reimbursement obligation by reducing the amount of its full sub-advisory fee by
the lesser of (j) $100,000 or (ii) one-half of such organization expenses and
offering costs of the Fund that exceeded 0.2% (or $0.04 per Common Share of the
Fund's offering price. Reimbursements are reported as "fees waived by the
investment advisor" in the Statement of Operations.
PFPC Inc. ("PFPC"), an indirect, majority-owned subsidiary of The PNC Financial
Services Group, Inc., serves as the Fund's Administrator and Transfer Agent in
accordance with certain fee arrangements. PFPC Trust Company, an indirect,
majority-owned subsidiary of The PNC Financial Services Group, Inc., serves as
the Fund's Custodian in accordance with certain fee arrangements. PFPC has
agreed to reimburse the Fund through December 31, 2005 for fees and expenses in
an amount equal to 0.02% of the average daily Managed Assets of the Fund.
Reimbursements are reported as "fees waived by the administrator" in the
Statement of Operations.
The Fund pays each Trustee who is not an officer or employee of First Trust or
any of its affiliates an annual retainer of $10,000, which includes compensation
for all regular quarterly board meetings and regular committee meetings. No
additional meeting fees are paid in connection with regular quarterly board
meetings or regular committee meetings. Additional fees of $1,000 and $500 are
paid to non-interested Trustees for special board meetings and non-regular
committee meetings, respectively. These additional fees are shared by the funds
in the First Trust fund complex that participate in the particular meeting and
are not per fund fees. Trustees are also reimbursed for travel and out-of-pocket
expenses in connection with all meetings.
4. PURCHASES AND SALES OF SECURITIES
Cost of purchases and proceeds from sales of investment securities, excluding
U.S. government and short-term investments, for the period ended October 31,
2005, aggregated amounts were $6,066,563 and $0, respectively.
Cost of purchases and proceeds from sales of U.S. government securities,
excluding short-term investments, for the period ended October 31, 2005,
aggregated amounts were $103,712,442 and $11,015,414, respectively.
As of October 31, 2005, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was $2,204,824
and the aggregate gross unrealized depreciation for all securities in which
there was an excess of tax cost over value was $2,584,494.
5. COMMON SHARES
As of October 31, 2005, 4,045,236 of $0.01 par value Common Shares were issued.
An unlimited number of Common Shares have been authorized under the Fund's
Dividend Reinvestment Plan.
COMMON SHARE TRANSACTIONS WERE AS FOLLOWS:
PERIOD ENDED
OCTOBER 31, 2005
----------------
SHARES AMOUNT
---------- ------------
Proceeds from Common Shares sold................ 4,045,236 $ 77,264,007
Offering costs.................................. -- (161,809)
---------- ------------
4,045,236 $ 77,102,198
========== ============
6. PREFERRED SHARES OF BENEFICIAL INTEREST
The Fund's Declaration of Trust authorizes the issuance of an unlimited number
of preferred shares of beneficial interest, par value $0.01 per share (the
"Preferred Shares"), in one or more classes or series, with rights as determined
by the Board of Trustees without the approval of Common Shareholders. As of
October 31, 2005, no Preferred Shares have been issued.
7. CONCENTRATION OF RISK
An investment in the Fund's Common Shares is subject to investment risk,
including the possible loss of the entire principal invested. An investment in
Common Shares represents an indirect investment in the securities owned by the
Fund. The value of these securities, like other market investments, may move up
or down, sometimes rapidly and unpredictably. Common Shares at any point in time
may be
Page 16
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
worth less than the original investment, even after taking into account the
reinvestment of Fund dividends and distributions. Security prices can fluctuate
for several reasons, including the general condition of the bond market, or when
political or economic events affecting the issuers occur.
8. CAPITAL LOSS CARRYFORWARD
As of October 31, 2005, the Fund had a capital loss carryforward for federal
income tax purposes of $24,542 expiring on October 31, 2013.
9. SUBSEQUENT EVENTS
On October 28, 2005, the Fund declared a dividend of $0.1042 per share, which
represents a dividend from net investment income to Common Shareholders of
record November 8, 2005, payable November 15, 2005.
On November 21, 2005, the Fund declared a dividend of $0.1042 per share, which
represents a dividend from net investment income to Common Shareholders of
record December 5, 2005, payable December 12, 2005.
Page 17
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
--------------------------------------------------------------------------------
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST/FIDAC MORTGAGE INCOME
FUND:
We have audited the accompanying statement of assets and liabilities of First
Trust/FIDAC Mortgage Income Fund (the "Fund"), including the portfolio of
investments, as of October 31, 2005, the related statements of operations,
changes in net assets and cash flows and the financial highlights for the period
May 17, 2005 (inception) through October 31, 2005. These financial statements
and financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. The Fund
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of October 31, 2005, by correspondence with the Fund's
custodian and broker; where replies were not received from the broker, we
performed other auditing procedures. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of First
Trust/FIDAC Mortgage Income Fund as of October 31, 2005, the results of its
operations, the changes in its net assets and cash flows, and the financial
highlights for the period May 17, 2005 (inception) through October 31, 2005, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Deloitte & Touche LLP
Chicago, Illinois
December 9, 2005
Page 18
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION (UNAUDITED)
--------------------------------------------------------------------------------
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
dividends, on your Common Shares will be automatically reinvested by PFPC Inc.
(the "Plan Agent"), in additional Common Shares under the Plan. If you elect to
receive cash distributions, you will receive all distributions in cash paid by
check mailed directly to you by PFPC Inc., as the dividend paying agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
(1) If the Common Shares are trading at or above net asset value ("NAV")
at the time of valuation, the Fund will issue new shares at a price
equal to the greater of (i) NAV per Common Share on that date or (ii)
95% of the market price on that date.
(2) If the Common Shares are trading below NAV at the time of valuation,
the Plan Agent will receive the dividend or distribution in cash and
will purchase Common Shares in the open market, on the NYSE or
elsewhere, for the participants' accounts. It is possible that the
market price for the Common Shares may increase before the Plan Agent
has completed its purchases. Therefore, the average purchase price per
share paid by the Plan Agent may exceed the market price at the time
of valuation, resulting in the purchase of fewer shares than if the
dividend or distribution had been paid in Common Shares issued by the
Fund. The Plan Agent will use all dividends and distributions received
in cash to purchase Common Shares in the open market within 30 days of
the valuation date except where temporary curtailment or suspension of
purchases is necessary to comply with federal securities laws.
Interest will not be paid on any uninvested cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (800) 331-1710, in
accordance with such reasonable requirements as the Plan Agent and Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized, although cash is not received by you.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing PFPC Inc., 301 Bellevue
Parkway, Wilmington, Delaware 19809.
--------------------------------------------------------------------------------
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how
to vote proxies and information on how the Fund votes proxies relating to
portfolio securities during the most recent 12-month period ended June 30 will
be available (1) without charge, upon request, by calling (800) 988-5891; (2) on
the Fund's website located at http://www.ftportfolios.com; and (3) on the
Securities and Exchange Commission's website at http://www.sec.gov.
Page 19
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ADDITIONAL INFORMATION - (CONTINUED)
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FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Form N-Q is available (1) by calling (800)
988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3)
on the SEC's website at http://www.sec.gov; and (4) for review and copying at
the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding
the operation of the PRR may be obtained by calling 1-800-SEC-0330.
NYSE CERTIFICATION INFORMATION
In accordance with Section 303A-12 of the New York Stock Exchange ("NYSE")
Listed Company Manual, the Fund's President has certified to the NYSE that, as
of April 21, 2005, he was not aware of any violation by the Fund of NYSE
corporate governance listing standards. In addition, the Fund's reports to the
SEC on Forms N-CSR and N-Q contain certifications by the Fund's principal
executive officer and principal financial officer that relate to the Fund's
public disclosure in such reports and are required by Rule 30a-2 under the 1940
Act.
BY-LAW AMENDMENT
On December 12, 2005, the Board of Trustees of the Fund approved certain changes
to the By-Laws of the Fund that may have the effect of delaying or preventing a
change of control of the Fund. To receive a copy of the revised By-Laws,
investors may call the Fund at (800) 988-5891.
BOARD APPROVAL OF ADVISORY AND SUB-ADVISORY AGREEMENTS
The Board of Trustees approved the Investment Management Agreement (the
"Agreement") with First Trust Advisors at a meeting held on March 7, 2005.
The Board received and reviewed data from First Trust which the Trustees
discussed at the meeting with representatives of the Advisor, Fund counsel and
independent counsel. The Board concluded that the terms of the Agreement are
fair and reasonable and that the Agreement is in the best interest of the Fund.
The Trustees considered the nature, extent and quality of services to be
provided under the Agreement, noting that First Trust Advisors employees
provided management services to other closed-end funds in the First Trust
complex with diligence and care. They noted the compliance program that had been
developed by First Trust Advisors and the skills of its employees who would be
working with the Fund. The Trustees concluded they were comfortable that First
Trust Advisors had the capabilities and resources to oversee the operations of
the Fund, including overseeing the Sub-Advisor.
The Trustees reviewed information compiled by First Trust Advisors from an
independent source on management and advisory fees charged to similar closed-end
funds, and they discussed with representatives of First Trust Advisors certain
differences between those funds and the Fund. They noted that a portion of the
fee payable by the Fund to First Trust Advisors would then be paid to the
Sub-Advisor, and they took this and other costs to be borne by First Trust
Advisors in connection with its services to be performed under the Agreement
into consideration when analyzing the estimated profitability of the Agreement
to First Trust Advisors. The Trustees concluded that the estimated profitability
was not unreasonable.
At the March 7, 2005 meeting, the Trustees received a presentation from senior
executives of the Sub-Advisor, who described the Sub-Advisor's experience and
investment style and the performance of its other similar accounts. The Trustees
had the opportunity to ask questions and review materials submitted by the
Sub-Advisor, and they met with Fund counsel and independent counsel to review
their duties and responsibilities in connection with their consideration of the
Investment Sub-Advisory Agreement (the "Sub-Advisory Agreement") among the Fund,
the Advisor and the Sub-Advisor, as they also had done for the Agreement. The
Trustees considered the nature, extent and quality of services to be provided by
the Sub-Advisor, and noted the background and experience of the portfolio
managers. They noted that the Sub-Advisor had not previously provided investment
advisory services to a closed-end investment company, but they noted that the
Advisor would be supervising the Sub-Advisor, and that the Sub-Advisor's
compliance program would reflect regulatory restrictions imposed on closed-end
funds.
The Sub-Advisor provided information on fees charged to its other non-closed-end
fund clients, and the Trustees concluded that the fees to be paid under the
Sub-Advisory Agreement were reasonable. The Trustees also concluded that the
terms of the Sub-Advisory Agreement are fair and reasonable and that the
Sub-Advisory Agreement is in the best interest of the Fund.
Page 20
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MANAGEMENT (UNAUDITED)
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FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
BOARD OF TRUSTEES AND OFFICERS
Information pertaining to the Trustees and officers* of the Fund is set forth
below. The statement of additional information includes additional information
about the Trustees and is available without charge, upon request, by calling
(800) 988-5891.
NUMBER OF OTHER
PORTFOLIOS TRUSTEESHIPS/
NAME, D.O.B., ADDRESS AND TERM OF OFFICE AND PRINCIPAL OCCUPATION(S) IN FUND COMPLEX DIRECTORSHIPS
POSITION(S) WITH THE FUND LENGTH OF TIME SERVED DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
DISINTERESTED TRUSTEES
------------------------------------------------------------------------------------------------------------------------------------
Richard E. Erickson, Trustee o One year term Physician; President, 24 portfolios None
D.O.B. 04/51 o 6 months served Wheaton Orthopedics;
c/o First Trust Advisors L.P. Co-owner and Co-
1001 Warrenville Road Director, Sports Med
Suite 300 Center for Fitness;
Lisle, IL 60532 Limited Partner,
Gundersen Real Estate
Partnership
Thomas R. Kadlec, Trustee o One year term Vice President and Chief 24 portfolios None
D.O.B. 11/57 o 6 months served Financial Officer (1990
c/o First Trust Advisors L.P. to present), ADM
1001 Warrenville Road Investor Services, Inc.
Suite 300 (Futures Commission
Lisle, IL 60532 Merchant); Registered
Representative (2000 to
present), Segerdahl &
Company, Inc., an
NASD member (Broker-
Dealer); President, ADM
Derivatives, Inc. (May
2005 to present)
Niel B. Nielson, Trustee o One year term President, Covenant 24 portfolios Director of Good News
D.O.B. 03/54 o 6 months served College (June 2002 to Publishers-Crossway
c/o First Trust Advisors L.P. present); Pastor, College Books; Covenant
1001 Warrenville Road Church in Wheaton Transport, Inc.
Suite 300 (1997 to June 2002)
Lisle, IL 60532
David M. Oster, Trustee o One year term Trader (self-employed) 12 portfolios None
D.O.B. 03/64 o 6 months served (1987 to present)
c/o First Trust Advisors L.P. (Options Trading and
1001 Warrenville Road Market Making)
Suite 300
Lisle, IL 60532
Page 21
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MANAGEMENT - (CONTINUED)
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FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
BOARD OF TRUSTEES AND OFFICERS (CONTINUED)
NUMBER OF OTHER
PORTFOLIOS TRUSTEESHIPS/
NAME, D.O.B., ADDRESS AND TERM OF OFFICE AND PRINCIPAL OCCUPATION(S) IN FUND COMPLEX DIRECTORSHIPS
POSITION(S) WITH THE FUND LENGTH OF TIME SERVED DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
INTERESTED TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
James A. Bowen, Trustee, o One year Trustee President, First Trust 24 portfolios None
President, Chairman of the term and indefinite Advisors L.P. and First
Board and CEO officer term Trust Portfolios L.P.;
D.O.B. 09/55 o 6 months served Chairman of the Board,
1001 Warrenville Road BondWave LLC and
Suite 300 Stonebridge Advisors
Lisle, IL 60532 LLC
------------------------------------------------------------------------------------------------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES
------------------------------------------------------------------------------------------------------------------------------------
Mark R. Bradley, Treasurer, o Indefinite term Chief Financial Officer, N/A N/A
Controller, Chief Financial o 6 months served Managing Director,
Officer, Chief Accounting First Trust Advisors L.P.
Officer and First Trust
D.O.B. 11/57 Portfolios L.P.; Chief
1001 Warrenville Road Financial Officer,
Suite 300 BondWave LLC and
Lisle, IL 60532 Stonebridge Advisors
LLC
Susan M. Brix o Indefinite term Representative, First N/A N/A
Assistant Vice President o 6 months served Trust Portfolios L.P.;
D.O.B. 01/60 Assistant Portfolio
1001 Warrenville Road Manager, First
Suite 300 Trust Advisors L.P.
Lisle, IL 60532
Robert F. Carey, o Indefinite term Senior Vice President, N/A N/A
Vice President o 6 months served First Trust Advisors L.P.
D.O.B. 07/63 and First Trust
1001 Warrenville Road Portfolios L.P.
Suite 300
Lisle, IL 60532
Page 22
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MANAGEMENT - (CONTINUED)
--------------------------------------------------------------------------------
FIRST TRUST/FIDAC MORTGAGE INCOME FUND
OCTOBER 31, 2005
BOARD OF TRUSTEES AND OFFICERS (CONTINUED)
NUMBER OF OTHER
PORTFOLIOS TRUSTEESHIPS/
NAME, D.O.B., ADDRESS AND TERM OF OFFICE AND PRINCIPAL OCCUPATION(S) IN FUND COMPLEX DIRECTORSHIPS
POSITION(S) WITH TRUST LENGTH OF TIME SERVED DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE
------------------------------------------------------------------------------------------------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES- (CONTINUED)
------------------------------------------------------------------------------------------------------------------------------------
W. Scott Jardine, Secretary o Indefinite term General Counsel, N/A N/A
and Chief Compliance o 6 months served First Trust Advisors L.P.
Officer and First Trust
D.O.B. 05/60 Portfolios L.P.;
1001 Warrenville Road Secretary, BondWave
Suite 300 LLC and Stonebridge
Lisle, IL 60532 Advisors LLC
Kristi A. Maher o Indefinite term Assistant General N/A N/A
Assistant Secretary o 6 months served Counsel, First Trust
D.O.B. 12/66 Portfolios L.P. (March
1001 Warrenville Road 2004 to present);
Suite 300 Associate, Chapman and
Lisle, IL 60532 Cutler LLP (1995-2004)
Roger F. Testin o Indefinite term Senior Vice President, N/A N/A
Vice President o 6 months served First Trust Advisors L.P.
D.O.B. 06/66 (August 2001 to
1001 Warrenville Road present); Analyst, Dolan
Suite 300 Capital Management
Lisle, IL 60532 (1998-2001)
________________________
* The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 23
This Page Left Blank Intentionally.
ITEM 2. CODE OF ETHICS.
(a) The Registrant, as of the end of the period covered by this report, has
adopted a code of ethics that applies to the Registrant's principal
executive officer, principal financial officer, principal accounting
officer or controller, or persons performing similar functions,
regardless of whether these individuals are employed by the Registrant
or a third party.
(c) There have been no amendments, during the period covered by this
report, to a provision of the code of ethics that applies to the
Registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are employed
by the Registrant or a third party, and that relates to any element of
the code of ethics description.
(d) The Registrant has not granted any waivers, including an implicit
waiver, from a provision of the code of ethics that applies to the
Registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are employed
by the Registrant or a third party, that relates to one or more of the
items set forth in paragraph (b) of this item's instructions.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
As of the end of the period covered by the report, the Registrant's board of
trustees has determined that Thomas R. Kadlec is qualified to serve as an audit
committee financial expert serving on its audit committee and that he is
"independent," as defined by Item 3 of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) AUDIT FEES (REGISTRANT) -- The aggregate fees billed from the
Registrant's inception on May 25, 2005 through October 31, 2005, for
professional services rendered by the principal accountant for the audit of the
Registrant's annual financial statements or services that are normally provided
by the accountant in connection with statutory and regulatory filings or
engagements for such fiscal year were $15,500.
(b) AUDIT-RELATED FEES (REGISTRANT) -- The aggregate fees billed from
the Registrant's inception on May 25, 2005 through October 31, 2005, for
assurance and related services by the principal accountant that are reasonably
related to the performance of the audit of the Registrant's financial statements
and are not reported under paragraph (a) of this Item were $0.
AUDIT-RELATED FEES (INVESTMENT ADVISER) -- The aggregate fees
billed from the Registrant's inception on May 25, 2005 through October 31, 2005,
for assurance and related services by the principal accountant that are
reasonably related to the performance of the audit of the adviser's financial
statements and are not reported under paragraph (a) of this Item were $2,400.
These fees were for expenses related to the December 31, 2004 audit of the
adviser's financial statements.
(c) TAX FEES (REGISTRANT) -- The aggregate fees billed from the
Registrant's inception on May 25, 2005 through October 31, 2005, for
professional services rendered by the principal accountant for tax compliance,
tax advice, and tax planning to the Registrant were $0.
TAX FEES (INVESTMENT ADVISER) -- The aggregate fees billed from
the Registrant's inception on May 25, 2005 through October 31, 2005, for
professional services rendered by the principal accountant for tax compliance,
tax advice, and tax planning to the Registrant's adviser were $0.
(d) ALL OTHER FEES (REGISTRANT) -- The aggregate fees billed from the
Registrant's inception on May 25, 2005 through October e1, 2005, for products
and services provided by the principal accountant to the Registrant, other than
the services reported in paragraphs (a) through (c) of this Item were $0.
ALL OTHER FEES (INVESTMENT ADVISER) -- The aggregate fees billed
from the Registrant's inception on May 25, 2005 through October 31, 2005 for
products and services provided by the principal accountant to the Registrant's
investment adviser, other than services reported in paragraphs (a) through (c)
of this Item were $0.
(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c)(7) of Rule 2-01 of Regulation S-X.
Pursuant to its charter and its Audit and Non-Audit Services
Pre-Approval Policy adopted December 12, 2005, the Audit Committee (the
"COMMITTEE") is responsible for the pre-approval of all audit services and
permitted non-audit services (including the fees and terms thereof) to be
performed for the Registrant by its independent auditors. The Chairman of the
Committee is authorized to give such pre-approvals on behalf of the Committee up
to $25,000 and report any such pre-approval to the full Committee.
The Committee is also responsible for the pre-approval of the
independent auditor's engagements for non-audit services with the Registrant's
adviser (not including a sub-adviser whose role is primarily portfolio
management and is sub-contracted or overseen by another investment adviser) and
any entity controlling, controlled by or under common control with the
investment adviser that provides ongoing services to the Registrant, if the
engagement relates directly to the operations and financial reporting of the
Registrant, subject to the DE MINIMIS exceptions for non-audit services
described in Rule 2-01 of Regulation S-X. If the independent auditor has
provided non-audit services to the Registrant's adviser (other than any
sub-adviser whose role is primarily portfolio management and is sub-contracted
with or overseen by another investment adviser) and any entity controlling,
controlled by or under common control with the investment adviser that provides
ongoing services to the Registrant that were not pre-approved pursuant to the DE
MINIMIS exception, the Committee will consider whether the provision of such
non-audit services is compatible with the auditor's independence.
(e)(2) The percentage of services described in each of paragraphs (b)
through (d) for the Registrant and the Registrant's investment adviser of this
Item that were approved by the audit
committee pursuant to the pre-approval exceptions included in paragraph (c)
(7)(i)(C) or paragraph(C)(7)(ii) of Rule 2-01 of Regulation S-X are as follows:
(b) 0%.
(c) Not Applicable.
(d) Not Applicable.
(f) The percentage of hours expended on the principal accountant's
engagement to audit the Registrant's financial statements for the most recent
fiscal year that were attributed to work performed by persons other than the
principal accountant's full-time, permanent employees was less than fifty
percent.
(g) The aggregate non-audit fees billed by the Registrant's accountant
for services rendered to the Registrant, and rendered to the Registrant's
investment adviser (not including any sub-adviser whose role is primarily
portfolio management and is subcontracted with or overseen by another investment
adviser), and any entity controlling, controlled by, or under common control
with the adviser that provides ongoing services to the Registrant from the
inception of the Registrant on May 25, 2005 through October 31, 2005 were $0 for
the Registrant and $2,400 for the Registrant's investment adviser.
(h) Not applicable. The audit committee pre-approved all non-audit
services rendered to the Registrant's investment adviser and any entity
controlling, controlled by or under common control with the adviser that
provides ongoing services to the Registrant.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
(a) The Registrant has a separately designated audit committee consisting
of all the independent directors of the Registrant. The members of the
audit committee are: Thomas R. Kadlec, Niel B. Nielson, Richard E.
Erickson and David M. Oster.
ITEM 6. SCHEDULE OF INVESTMENTS.
Schedule of Investments in securities of unaffiliated issuers as of the close of
the reporting period is included as part of the report to shareholders filed
under Item 1 of this Form N-CSR.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Proxy Voting Policies and Procedures are attached herewith.
FIRST TRUST ADVISORS, L.P.
FIRST TRUST FUNDS
PROXY VOTING GUIDELINES
First Trust Advisors, L.P. (the "ADVISER") serves as investment adviser
providing discretionary investment advisory services for several open or
closed-end investment companies (the "FUNDS"). As part of these services, the
Adviser has full responsibility for proxy voting and related duties. In
fulfilling these duties, the Adviser and Funds have adopted the following
policies and procedures:
1. It is the Adviser's policy to seek to ensure that proxies for
securities held by a Fund are voted consistently and solely in the
best economic interests of the respective Fund.
2. The Adviser shall be responsible for the oversight of a Fund's
proxy voting process and shall assign a senior member of its staff
to be responsible for this oversight.
3. The Adviser has engaged the services of Institutional Shareholder
Services, Inc. ("ISS") to make recommendations to the Adviser on
the voting of proxies related to securities held by a Fund. ISS
provides voting recommendations based on established guidelines
and practices. The Adviser has adopted these ISS Proxy Voting
Guidelines.
4. The Adviser shall review the ISS recommendations and generally
will vote the proxies in accordance with such recommendations.
Notwithstanding the foregoing, the Adviser may not vote in
accordance with the ISS recommendations if the Adviser believes
that the specific ISS recommendation is not in the best interests
of the respective Fund.
5. If the Adviser manages the assets or pension fund of a company and
any of the Adviser's clients hold any securities in that company,
the Adviser will vote proxies relating to such company's
securities in accordance with the ISS recommendations to avoid any
conflict of interest. In addition, if the Adviser has actual
knowledge of any other type of material conflict of interest
between itself and the respective Fund with respect to the voting
of a proxy, the Adviser shall vote the applicable proxy in
accordance with the ISS recommendations to avoid such conflict of
interest.
6. If a Fund requests the Adviser to follow specific voting
guidelines or additional guidelines, the Adviser shall review the
request and follow such guidelines, unless the Adviser determines
that it is unable to follow such guidelines. In such case, the
Adviser shall inform the Fund that it is not able to follow the
Fund's request.
7. The Adviser may have clients in addition to the Funds which have
provided the Adviser with discretionary authority to vote proxies
on their behalf. In such cases, the Adviser shall follow the same
policies and procedures.
Dated: September 15, 2003
EXHIBIT B
ISS 2005 PROXY VOTING
GUIDELINES SUMMARY
The following is a condensed version of all proxy voting recommendations
contained in the ISS Proxy Voting Manual.
1. OPERATIONAL ITEMS
ADJOURN MEETING
Generally vote AGAINST proposals to provide management with the authority to
adjourn an annual or special meeting absent compelling reasons to support the
proposal.
Vote FOR proposals that relate specifically to soliciting votes for a merger or
transaction for which ISS has recommended a FOR vote. Vote AGAINST proposals if
the wording is too vague or if the proposal includes "other business."
AMEND QUORUM REQUIREMENTS
Vote AGAINST proposals to reduce quorum requirements for shareholder meetings
below a majority of the shares outstanding unless there are compelling reasons
to support the proposal.
AMEND MINOR BYLAWS
Vote FOR bylaw or charter changes that are of a housekeeping nature (updates or
corrections).
CHANGE COMPANY NAME
Vote FOR proposals to change the corporate name.
CHANGE DATE, TIME, OR LOCATION OF ANNUAL MEETING
Vote FOR management proposals to change the date/time/location of the annual
meeting unless the proposed change is unreasonable.
Vote AGAINST shareholder proposals to change the date/time/location of the
annual meeting unless the current scheduling or location is unreasonable.
RATIFYING AUDITORS
Vote FOR proposals to ratify auditors, unless any of the following apply:
o An auditor has a financial interest in or association with the company,
and is therefore not independent
o Fees for non-audit services are excessive, or
o There is reason to believe that the independent auditor has rendered an
opinion which is neither accurate nor indicative of the company's
financial position.
Vote CASE-BY-CASE on shareholder proposals asking companies to prohibit or limit
their auditors from engaging in non-audit services.
Vote CASE-BY-CASE on shareholder proposals asking for audit firm rotation,
taking into account the tenure of the audit firm, the length of rotation
specified in the proposal, any significant audit-related issues at the company,
the number of Audit Committee meetings held each year, the number of financial
experts serving on the
committee, and whether the company has a periodic renewal process where the
auditor is evaluated for both audit quality and competitive price.
TRANSACT OTHER BUSINESS
Vote AGAINST proposals to approve other business when it appears as voting item.
VOTING ON DIRECTOR NOMINEES IN UNCONTESTED ELECTIONS
Votes on director nominees should be made on a CASE-BY-CASE basis, examining the
following factors: composition of the board and key board committees, attendance
at board meetings, corporate governance provisions and takeover activity,
long-term company performance relative to a market index, directors' investment
in the company, whether the chairman is also serving as CEO, and whether a
retired CEO sits on the board. However, there are some actions by directors that
should result in votes being withheld. These instances include directors who:
o Attend less than 75 percent of the board and committee meetings without a
valid excuse
o Implement or renew a dead-hand or modified dead-hand poison pill
o Adopt a poison pill without shareholder approval since the company's last
annual meeting and there is no requirement to put the pill to shareholder
vote within 12 months of its adoption
o Ignore a shareholder proposal that is approved by a majority of the shares
outstanding
o Ignore a shareholder proposal that is approved by a majority of the votes
cast for two consecutive years
o Failed to act on takeover offers where the majority of the shareholders
tendered their shares
o Are inside directors or affiliated outsiders and sit on the audit,
compensation, or nominating committees
o Are inside directors or affiliated outsiders and the full board serves as
the audit, compensation, or nominating committee or the company does not
have one of these committees
o Are audit committee members and the non -audit fees paid to the auditor
are excessive.
In addition, directors who enacted egregious corporate governance policies or
failed to replace management as appropriate would be subject to recommendations
to withhold votes.
o Are inside directors or affiliated outside directors and the full board is
less than majority independent
o Sit on more than six public company boards, or on more than two public
boards in addition to their own if they are CEOs of public companies.
o Are on the compensation committee when there is a negative correlation
between chief executive pay and company performance
o Have failed to address the issue(s) that resulted in any of the directors
receiving more than 50% withhold votes out of those cast at the previous
board election
AGE LIMITS
Vote AGAINST shareholder or management proposals to limit the tenure of outside
directors either through term limits or mandatory retirement ages.
BOARD SIZE
Vote FOR proposals seeking to fix the board size or designate a range for the
board size.
Vote AGAINST proposals that give management the ability to alter the size of the
board outside of a specified range without shareholder approval.
CLASSIFICATION/DECLASSIFICATION OF THE BOARD
Vote AGAINST proposals to classify the board.
Vote FOR proposals to repeal classified boards and to elect all directors
annually.
CUMULATIVE VOTING
Vote AGAINST proposals to eliminate cumulative voting.
Vote proposals to restore or permit cumulative voting on a CASE-BY-CASE basis
based on the extent that shareholders have access to the board through their own
nominations.
DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY PROTECTION
Proposals on director and officer indemnification and liability protection
should be evaluated on a CASE-BYCASE basis, using Delaware law as the standard.
Vote AGAINST proposals to eliminate entirely directors' and officers' liability
for monetary damages for violating the duty of care.
Vote AGAINST indemnification proposals that would expand coverage beyond just
legal expenses to acts, such as negligence, that are more serious violations of
fiduciary obligation than mere carelessness.
Vote FOR only those proposals providing such expanded coverage in cases when a
director's or officer's legal defense was unsuccessful if both of the following
apply:
o The director was found to have acted in good faith and in a manner that he
reasonably believed was in the best interests of the company, and
o Only if the director's legal expenses would be covered.
ESTABLISH/AMEND NOMINEE QUALIFICATIONS
Vote CASE-BY-CASE on proposals that establish or amend director qualifications.
Votes should be based on how reasonable the criteria are and to what degree they
may preclude dissident nominees from joining the board. Vote AGAINST shareholder
proposals requiring two candidates per board seat.
FILLING VACANCIES/REMOVAL OF DIRECTORS
Vote AGAINST proposals that provide that directors may be removed only for
cause.
Vote FOR proposals to restore shareholder ability to remove directors with or
without cause.
Vote AGAINST proposals that provide that only continuing directors may elect
replacements to fill board vacancies.
Vote FOR proposals that permit shareholders to elect directors to fill board
vacancies.
INDEPENDENT CHAIRMAN (SEPARATE CHAIRMAN/CEO)
Generally vote FOR shareholder proposals requiring the position of chairman be
filled by an independent director unless there are compelling reasons to
recommend against the proposal, such as a counterbalancing governance structure.
This should include all of the following:
o Designated lead director, elected by and from the independent board
members with clearly delineated and comprehensive duties. (The role may
alternatively reside with a presiding director, vice chairman, or rotating
lead director).
o Two-thirds independent board
o All-independent key committees
o Established governance guidelines
Additionally, the company should not have under-performed its peers.
MAJORITY OF INDEPENDENT DIRECTORS/ESTABLISHMENT OF COMMITTEES
Vote FOR shareholder proposals asking that a majority or more of directors be
independent unless the board composition already meets the proposed threshold by
ISS's definition of independence.
Vote FOR shareholder proposals asking that board audit, compensation, and/or
nominating committees be composed exclusively of independent directors if they
currently do not meet that standard.
OPEN ACCESS
Vote CASE-BY-CASE on shareholder proposals asking for open access taking into
account the ownership threshold specified in the proposal and the proponent's
rationale for targeting the company in terms of board and director conduct.
STOCK OWNERSHIP REQUIREMENTS
Generally vote AGAINST shareholder proposals that mandate a minimum amount of
stock that directors must own in order to qualify as a director or to remain on
the board. While ISS favors stock ownership on the part of directors, the
company should determine the appropriate ownership requirement.
Vote CASE-BY-CASE shareholder proposals asking that the company adopt a holding
or retention period for its executives (for holding stock after the vesting or
exercise of equity awards), taking into account any stock ownership requirements
or holding period/retention ratio already in place and the actual ownership
level of executives.
TERM LIMITS
Vote AGAINST shareholder or management proposals to limit the tenure of outside
directors either through term limits or mandatory retirement ages.
3. PROXY CONTESTS
VOTING FOR DIRECTOR NOMINEES IN CONTESTED ELECTIONS
Votes in a contested election of directors must be evaluated on a CASE-BY-CASE
basis, considering the following factors:
o Long-term financial performance of the target company relative to its
industry; management's track record
o Background to the proxy contest
o Qualifications of director nominees (both slates)
o Evaluation of what each side is offering shareholders as well as the
likelihood that the proposed objectives and goals can be met; and stock
ownership positions.
REIMBURSING PROXY SOLICITATION EXPENSES
Voting to reimburse proxy solicitation expenses should be analyzed on a
CASE-BY-CASE basis. In cases where ISS recommends in favor of the dissidents, we
also recommend voting for reimbursing proxy solicitation expenses.
CONFIDENTIAL VOTING
Vote FOR shareholder proposals requesting that corporations adopt confidential
voting, use independent vote tabulators and use independent inspectors of
election, as long as the proposal includes a provision for proxy contests as
follows: In the case of a contested election, management should be permitted to
request that the dissident group honor its confidential voting policy. If the
dissidents agree, the policy remains in place. If the dissidents will not agree,
the confidential voting policy is waived.
Vote FOR management proposals to adopt confidential voting.
4. ANTITAKEOVER DEFENSES AND VOTING RELATED ISSUES
Advance Notice Requirements for Shareholder Proposals/Nominations
Votes on advance notice proposals are determined on a CASE-BY-CASE basis, giving
support to those proposals which allow shareholders to submit proposals as close
to the meeting date as reasonably possible and within the broadest window
possible.
AMEND BYLAWS WITHOUT SHAREHOLDER CONSENT
Vote AGAINST proposals giving the board exclusive authority to amend the bylaws.
Vote FOR proposals giving the board the ability to amend the bylaws in addition
to shareholders.
POISON PILLS
Vote FOR shareholder proposals requesting that the company submit its poison
pill to a shareholder vote or redeem it.
Vote FOR shareholder proposals asking that any future pill be put to a
shareholder vote.
SHAREHOLDER ABILITY TO ACT BY WRITTEN CONSENT
Vote AGAINST proposals to restrict or prohibit shareholder ability to take
action by written consent.
Vote FOR proposals to allow or make easier shareholder action by written
consent.
SHAREHOLDER ABILITY TO CALL SPECIAL MEETINGS
Vote AGAINST proposals to restrict or prohibit shareholder ability to call
special meetings.
Vote FOR proposals that remove restrictions on the right of shareholders to act
independently of management.
SUPERMAJORITY VOTE REQUIREMENTS
Vote AGAINST proposals to require a supermajority shareholder vote.
Vote FOR proposals to lower supermajority vote requirements.
5. MERGERS AND CORPORATE RESTRUCTURINGS
APPRAISAL RIGHTS
Vote FOR proposals to restore, or provide shareholders with, rights of
appraisal.
ASSET PURCHASES
Vote CASE-BY-CASE on asset purchase proposals, considering the following
factors:
o Purchase price
o Fairness opinion
o Financial and strategic benefits
o How the deal was negotiated
o Conflicts of interest
o Other alternatives for the business
o Noncompletion risk.
ASSET SALES
Votes on asset sales should be determined on a CASE-BY-CASE basis, considering
the following factors:
o Impact on the balance sheet/working capital
o Potential elimination of diseconomies
o Anticipated financial and operating benefits
o Anticipated use of funds
o Value received for the asset
o Fairness opinion
o How the deal was negotiated
o Conflicts of interest.
BUNDLED PROPOSALS
Review on a CASE-BY-CASE basis bundled or "conditioned" proxy proposals.
In the case of items that are conditioned upon each other, examine the benefits
and costs of the packaged items.
In instances when the joint effect of the conditioned items is not in
shareholders' best interests, vote against the proposals. If the combined effect
is positive, support such proposals.
CONVERSION OF SECURITIES
Votes on proposals regarding conversion of securities are determined on a
CASE-BY-CASE basis. When evaluating these proposals the investor should review
the dilution to existing shareholders, the conversion price relative to market
value, financial issues, control issues, termination penalties, and conflicts of
interest.
Vote FOR the conversion if it is expected that the company will be subject to
onerous penalties or will be forced to file for bankruptcy if the transaction is
not approved.
CORPORATE REORGANIZATION/DEBT RESTRUCTURING/PREPACKAGED BANKRUPTCY PLANS/REVERSE
LEVERAGED BUYOUTS/WRAP PLANS
Votes on proposals to increase common and/or preferred shares and to issue
shares as part of a debt restructuring plan are determined on a CASE-BY-CASE
basis, taking into consideration the following:
o Dilution to existing shareholders' position
o Terms of the offer
o Financial issues
o Management's efforts to pursue other alternatives
o Control issues
o Conflicts of interest.
Vote FOR the debt restructuring if it is expected that the company will file for
bankruptcy if the transaction is not approved.
FORMATION OF HOLDING COMPANY
Votes on proposals regarding the formation of a holding company should be
determined on a CASE-BY-CASE basis, taking into consideration the following:
o The reasons for the change
o Any financial or tax benefits
o Regulatory benefits
o Increases in capital structure
o Changes to the articles of incorporation or bylaws of the company.
o Absent compelling financial reasons to recommend the transaction, vote
AGAINST the formation of a holding company if the transaction would
include either of the following:
o Increases in common or preferred stock in excess of the allowable maximum
as calculated by the ISS Capital Structure model
o Adverse changes in shareholder rights
GOING PRIVATE TRANSACTIONS (LBOS AND MINORITY SQUEEZEOUTS)
Vote going private transactions on a CASE-BY-CASE basis, taking into account the
following: offer price/premium, fairness opinion, how the deal was negotiated,
conflicts of interest, other alternatives/offers considered, and noncompletion
risk.
JOINT VENTURES
Votes CASE-BY-CASE on proposals to form joint ventures, taking into account the
following: percentage of assets/business contributed, percentage ownership,
financial and strategic benefits, governance structure, conflicts of interest,
other alternatives, and noncompletion risk.
LIQUIDATIONS
Votes on liquidations should be made on a CASE-BY-CASE basis after reviewing
management's efforts to pursue other alternatives, appraisal value of assets,
and the compensation plan for executives managing the liquidation.
Vote FOR the liquidation if the company will file for bankruptcy if the proposal
is not approved.
MERGERS AND ACQUISITIONS/ ISSUANCE OF SHARES TO FACILITATE MERGER OR ACQUISITION
Votes on mergers and acquisitions should be considered on a CASE-BY-CASE basis,
determining whether the transaction enhances shareholder value by giving
consideration to the following:
o Prospects of the combined company, anticipated financial and operating
benefits
o Offer price
o Fairness opinion
o How the deal was negotiated
o Changes in corporate governance
o Change in the capital structure
o Conflicts of interest.
PRIVATE PLACEMENTS/WARRANTS/CONVERTIBLE DEBENTURES
Votes on proposals regarding private placements should be determined on a
CASE-BY-CASE basis. When evaluating these proposals the investor should review:
dilution to existing shareholders' position, terms of the offer, financial
issues, management's efforts to pursue other alternatives, control issues, and
conflicts of interest.
Vote FOR the private placement if it is expected that the company will file for
bankruptcy if the transaction is not approved.
SPINOFFS
Votes on spinoffs should be considered on a CASE-BY-CASE basis depending on:
o Tax and regulatory advantages
o Planned use of the sale proceeds
o Valuation of spinoff
o Fairness opinion
o Benefits to the parent company
o Conflicts of interest
o Managerial incentives
o Corporate governance changes
o Changes in the capital structure.
VALUE MAXIMIZATION PROPOSALS
Vote CASE-BY-CASE on shareholder proposals seeking to maximize shareholder value
by hiring a financial advisor to explore strategic alternatives, selling the
company or liquidating the company and distributing the proceeds to
shareholders. These proposals should be evaluated based on the following
factors: prolonged poor performance with no turnaround in sight, signs of
entrenched board and management, strategic plan in place for improving value,
likelihood of receiving reasonable value in a sale or dissolution, and whether
company is actively exploring its strategic options, including retaining a
financial advisor.
6. STATE OF INCORPORATION
CONTROL SHARE ACQUISITION PROVISIONS
Vote FOR proposals to opt out of control share acquisition statutes unless doing
so would enable the completion of a takeover that would be detrimental to
shareholders.
Vote AGAINST proposals to amend the charter to include control share acquisition
provisions.
Vote FOR proposals to restore voting rights to the control shares.
CONTROL SHARE CASHOUT PROVISIONS
Vote FOR proposals to opt out of control share cashout statutes.
DISGORGEMENT PROVISIONS
Vote FOR proposals to opt out of state disgorgement provisions.
FAIR PRICE PROVISIONS
Vote proposals to adopt fair price provisions on a CASE-BY-CASE basis,
evaluating factors such as the vote required to approve the proposed
acquisition, the vote required to repeal the fair price provision, and the
mechanism for determining the fair price.
Generally, vote AGAINST fair price provisions with shareholder vote requirements
greater than a majority of disinterested shares.
FREEZEOUT PROVISIONS
Vote FOR proposals to opt out of state freezeout provisions.
GREENMAIL
Vote FOR proposals to adopt antigreenmail charter of bylaw amendments or
otherwise restrict a company's ability to make greenmail payments.
Review on a CASE-BY-CASE basis antigreenmail proposals when they are bundled
with other charter or bylaw amendments.
REINCORPORATION PROPOSALS
Proposals to change a company's state of incorporation should be evaluated on a
CASE-BY-CASE basis, giving consideration to both financial and corporate
governance concerns, including the reasons for reincorporating, a comparison of
the governance provisions, and a comparison of the jurisdictional laws.
Vote FOR reincorporation when the economic factors outweigh any neutral or
negative governance changes.
STAKEHOLDER PROVISIONS
Vote AGAINST proposals that ask the board to consider nonshareholder
constituencies or other nonfinancial effects when evaluating a merger or
business combination.
STATE ANTITAKEOVER STATUTES
Review on a CASE-BY-CASE basis proposals to opt in or out of state takeover
statutes (including control share acquisition statutes, control share cash-out
statutes, freezeout provisions, fair price provisions, stakeholder laws, poison
pill endorsements, severance pay and labor contract provisions, antigreenmail
provisions, and disgorgement provisions).
7. CAPITAL STRUCTURE
ADJUSTMENTS TO PAR VALUE OF COMMON STOCK
Vote FOR management proposals to reduce the par value of common stock.
COMMON STOCK AUTHORIZATION
Votes on proposals to increase the number of shares of common stock authorized
for issuance are determined on a CASE-BY-CASE basis using a model developed by
ISS.
Vote AGAINST proposals at companies with dual-class capital structures to
increase the number of authorized shares of the class of stock that has superior
voting rights.
Vote FOR proposals to approve increases beyond the allowable increase when a
company's shares are in danger of being delisted or if a company's ability to
continue to operate as a going concern is uncertain.
DUAL-CLASS STOCK
Vote AGAINST proposals to create a new class of common stock with superior
voting rights.
Vote FOR proposals to create a new class of nonvoting or subvoting common stock
if:
o It is intended for financing purposes with minimal or no dilution to
current shareholders
o It is not designed to preserve the voting power of an insider or
significant shareholder
ISSUE STOCK FOR USE WITH RIGHTS PLAN
Vote AGAINST proposals that increase authorized common stock for the explicit
purpose of implementing a shareholder rights plan (poison pill).
PREEMPTIVE RIGHTS
Review on a CASE-BY-CASE basis shareholder proposals that seek preemptive
rights. In evaluating proposals on preemptive rights, consider the size of a
company, the characteristics of its shareholder base, and the liquidity of the
stock.
PREFERRED STOCK
Vote AGAINST proposals authorizing the creation of new classes of preferred
stock with unspecified voting, conversion, dividend distribution, and other
rights ("blank check" preferred stock).
Vote FOR proposals to create "declawed" blank check preferred stock (stock that
cannot be used as a takeover defense).
Vote FOR proposals to authorize preferred stock in cases where the company
specifies the voting, dividend, conversion, and other rights of such stock and
the terms of the preferred stock appear reasonable.
Vote AGAINST proposals to increase the number of blank check preferred stock
authorized for issuance when no shares have been issued or reserved for a
specific purpose.
Vote CASE-BY-CASE on proposals to increase the number of blank check preferred
shares after analyzing the number of preferred shares available for issue given
a company's industry and performance in terms of shareholder returns.
RECAPITALIZATION
Votes CASE-BY-CASE on recapitalizations (reclassifications of securities),
taking into account the following: more simplified capital structure, enhanced
liquidity, fairness of conversion terms, impact on voting power and dividends,
reasons for the reclassification, conflicts of interest, and other alternatives
considered.
REVERSE STOCK SPLITS
Vote FOR management proposals to implement a reverse stock split when the number
of authorized shares will be proportionately reduced.
Vote FOR management proposals to implement a reverse stock split to avoid
delisting.
Votes on proposals to implement a reverse stock split that do not
proportionately reduce the number of shares authorized for issue should be
determined on a CASE-BY-CASE basis using a model developed by ISS.
SHARE REPURCHASE PROGRAMS
Vote FOR management proposals to institute open-market share repurchase plans in
which all shareholders may participate on equal terms.
STOCK DISTRIBUTIONS: SPLITS AND DIVIDENDS
Vote FOR management proposals to increase the common share authorization for a
stock split or share dividend, provided that the increase in authorized shares
would not result in an excessive number of shares available for issuance as
determined using a model developed by ISS.
TRACKING STOCK
Votes on the creation of tracking stock are determined on a CASE-BY-CASE basis,
weighing the strategic value of the transaction against such factors as: adverse
governance changes, excessive increases in authorized capital stock, unfair
method of distribution, diminution of voting rights, adverse conversion
features, negative impact on stock option plans, and other alternatives such as
spinoff.
8. EXECUTIVE AND DIRECTOR COMPENSATION
Votes with respect to equity-based compensation plans should be determined on a
CASE-BY-CASE basis. Our methodology for reviewing compensation plans primarily
focuses on the transfer of shareholder wealth (the dollar cost of pay plans to
shareholders instead of simply focusing on voting power dilution). Using the
expanded compensation data disclosed under the SEC's rules, ISS will value every
award type. ISS will include in its analyses an estimated dollar cost for the
proposed plan and all continuing plans. This cost, dilution to shareholders'
equity, will also be expressed as a percentage figure for the transfer of
shareholder wealth, and will be considered along with dilution to voting power.
Once ISS determines the estimated cost of the plan, we compare it to a
company-specific dilution cap.
Our model determines a company-specific allowable pool of shareholder wealth
that may be transferred from the company to plan participants, adjusted for:
o Long-term corporate performance (on an absolute basis and relative to a
standard industry peer group and an appropriate market index),
o Cash compensation, and
o Categorization of the company as emerging, growth, or mature.
These adjustments are pegged to market capitalization.
Vote AGAINST plans that expressly permit the repricing of underwater stock
options without shareholder approval.
Generally vote AGAINST plans in which (1) there is a disconnect between the
CEO's pay and company performance (an increase in pay and a decrease in
performance) and the main source of the pay increase (over half) is equity-based
and (2) the CEO is the participant of the equity proposal. A decrease in
performance is based on negative one- and three-year total shareholder returns.
An increase in pay is based on the CEO's total direct compensation (salary, cash
bonus, present value of stock options, face value of restricted stock, face
value of long-term incentive plan payouts, and all other compensation)
increasing over the previous year. Also may WITHHOLD votes from the Compensation
Committee members.
Generally vote AGAINST plans if the company's most recent three-year burn rate
exceeds one standard deviation in excess of the industry mean and is over two
percent of common shares outstanding. See Table 1 for details.
TABLE 1 : PROXY SEASON 2005 BURN RATE THRESHOLDS
RUSSELL 3000 NON-RUSSELL 3000
------------------------------------------------------------------------------------------------------------------------------
Standard Mean + Std Standard Mean + Std
GICS GICS Dsec Mean Deviation Dev Mean Deviation Dev
------------------------------------------------------------------------------------------------------------------------------
1010 Energy 1.60% 1.02% 2.61% 2.59% 2.19% 4.78%
------------------------------------------------------------------------------------------------------------------------------
1510 Materials 1.55% 0.81% 2.36% 2.54% 1.92% 4.46%
------------------------------------------------------------------------------------------------------------------------------
2010 Capital Goods 1.86% 1.19% 3.05% 3.23% 2.93% 6.17%
------------------------------------------------------------------------------------------------------------------------------
2020 Commercial Services & Supplies 2.87% 1.53% 4.40% 4.39% 3.68% 8.07%
------------------------------------------------------------------------------------------------------------------------------
2030 Transportation 2.10% 1.50% 3.60% 2.44% 2.22% 4.66%
------------------------------------------------------------------------------------------------------------------------------
2510 Automobiles & Components 2.10% 1.37% 3.48% 2.90% 2.28% 5.18%
------------------------------------------------------------------------------------------------------------------------------
2520 Consumer Durables & Apparel 2.40% 1.51% 3.90% 3.42% 2.79% 6.21%
------------------------------------------------------------------------------------------------------------------------------
2530 Hotels Restaurants & Leisure 2.39% 1.08% 3.48% 3.30% 2.87% 6.17%
------------------------------------------------------------------------------------------------------------------------------
2540 Media 2.34% 1.50% 3.84% 4.12% 2.89% 7.01%
------------------------------------------------------------------------------------------------------------------------------
2550 Retailing 2.89% 1.95% 4.84% 4.26% 3.50% 7.75%
------------------------------------------------------------------------------------------------------------------------------
3010 to 3030 Food & Staples Retailing 1.98% 1.50% 3.48% 3.37% 3.32% 6.68%
------------------------------------------------------------------------------------------------------------------------------
3510 Health Care Equipment & Services 3.24% 1.96% 5.20% 4.55% 3.24% 7.79%
------------------------------------------------------------------------------------------------------------------------------
3520 Pharmaceuticals & Biotechnology 3.60% 1.72% 5.32% 5.77% 4.15% 9.92%
------------------------------------------------------------------------------------------------------------------------------
4010 Banks 1.44% 1.17% 2.61% 1.65% 1.60% 3.25%
------------------------------------------------------------------------------------------------------------------------------
4020 Diversified Financials 3.12% 2.54% 5.66% 5.03% 3.53% 8.55%
------------------------------------------------------------------------------------------------------------------------------
4030 Insurance 1.45% 0.88% 2.32% 2.47% 1.77% 4.24%
------------------------------------------------------------------------------------------------------------------------------
4040 Real Estate 1.01% 0.89% 1.90% 1.51% 1.50% 3.01%
------------------------------------------------------------------------------------------------------------------------------
4510 Software & Services 5.44% 3.05% 8.49% 8.08% 6.01% 14.10%
------------------------------------------------------------------------------------------------------------------------------
4520 Technology Hardware & Equipment 4.00% 2.69% 6.68% 5.87% 4.25% 10.12%
------------------------------------------------------------------------------------------------------------------------------
4530 Semiconductors & Semiconductor Equipmen 5.12% 2.86% 7.97% 6.79% 3.95% 10.74%
------------------------------------------------------------------------------------------------------------------------------
5010 Telecommunication Services 2.56% 2.39% 4.95% 4.66% 3.90% 8.56%
------------------------------------------------------------------------------------------------------------------------------
5510 Utilities 0.90% 0.65% 1.55% 3.74% 4.63% 8.38%
------------------------------------------------------------------------------------------------------------------------------
A company with high three-year average burn rates may avoid triggering the burn
rate policy by committing to the industry average over the next years.
However, the above general voting guidelines for pay for performance may change
if the compensation committee members can demonstrate that they have improved
committee performance based on additional public filing such as an DEFA 14A or
8K. The additional filing needs to present strong and compelling evidence of
improved performance with new information that has not been disclosed in the
original proxy statement. The reiteration of the compensation committee report
will not be sufficient evidence of improved committee performance.
Evidence of improved compensation committee performance includes all of the
following:
o The compensation committee has reviewed all components of the CEO's
compensation, including the following:
- Base salary, bonus, long-term incentives
- Accumulative realized and unrealized stock option and restricted stock
gains
- Dollar value of perquisites and other personal benefits to the CEO and the
cost to the company
- Earnings and accumulated payment obligations under the company's
nonqualified deferred compensation program
- Actual projected payment obligations under the company's supplemental
executive retirement plan (SERPs)
A tally sheet setting forth all the above components was prepared and reviewed
affixing dollar amounts under the various payout scenarios.
o A tally sheet with all the above components should be disclosed for the
following termination scenarios:
- Payment if termination occurs within 12 months: $_____
- Payment if "not for cause" termination occurs within 12 months: $_____
- Payment if "change of control" termination occurs within 12 months: $_____
o The compensation committee is committed to provide additional information
on the named executives' annual cash bonus program and/or long-term
incentive cash plan for the current fiscal year. The compensation
committee will provide full disclosure of the qualitative and quantitative
performance criteria and hurdle rates used to determine the payouts of the
cash program. From this disclosure, shareholders will know the minimum
level of performance required for any cash bonus to be delivered as well
as the maximum cash bonus payable for superior performance.
The repetition of the compensation committee report does not meet ISS'
requirement of compelling and strong evidence of improved disclosure. The level
of transparency and disclosure is at the highest level where shareholders can
understand the mechanics of the annual cash bonus and/or long-term incentive
cash plan based on the additional disclosure.
o The compensation committee is committed to grant a substantial portion of
performance-based equity awards to the named executive officers. A
substantial portion of performance-based awards would be at least 50
percent of the shares awarded to each of the named executive officers.
Performance-based equity awards are earned or paid out based on the
achievement of company performance targets. The company will disclose the
details of the performance criteria (e.g., return on equity) and the
hurdle rates (e.g., 15 percent) associated with the performance targets.
From this disclosure, shareholders will know the minimum level of
performance required for any equity grants to be made. The
performance-based equity awards do not refer to non-qualified stock
options(1) or performance-accelerated grants(2). Instead,
performance-based equity awards are performancecontingent grants where the
individual will not receive the equity grant by not meeting the target
performance and vice versa.
The level of transparency and disclosure is at the highest level where
shareholders can understand the mechanics of the performance-based equity awards
based on the additional disclosure.
o The compensation committee has the sole authority to hire and fire outside
compensation consultants. The role of the outside compensation consultant
is to assist the compensation committee to analyze executive pay packages
or contracts and understand the company's financial measures.
BASED ON THE ADDITIONAL DISCLOSURE OF IMPROVED PERFORMANCE OF THE COMPENSATION
COMMITTEE, ISS WILL GENERALLY VOTE FOR THE COMPENSATION COMMITTEE MEMBERS UP FOR
ANNUAL ELECTION AND VOTE FOR THE EMPLOYEE-BASED STOCK PLAN IF THERE IS ONE ON
THE BALLOT. HOWEVER, ISS IS NOT LIKELY TO VOTE FOR THE COMPENSATION COMMITTEE
MEMBERS AND/OR THE EMPLOYEE-BASED STOCK PLAN IF ISS BELIEVES THE COMPANY HAS NOT
PROVIDED COMPELLING AND SUFFICIENT EVIDENCE OF TRANSPARENT ADDITIONAL DISCLOSURE
OF EXECUTIVE COMPENSATION BASED ON THE ABOVE REQUIREMENTS.
DIRECTOR COMPENSATION
Votes on compensation plans for directors are determined on a CASE-BY-CASE
basis, using a proprietary, quantitative model developed by ISS.
On occasion, director stock plans that set aside a relatively small of shares
when combined with employee or executive stock compensation plans exceed the
allowable cap. In such cases, starting proxy season 2005, ISS will supplement
the analytical approach with a qualitative review of board compensation for
companies, taking into consideration:
o Director stock ownership guidelines
- A minimum of three times the annual cash retainer.
o Vesting schedule or mandatory holding/deferral period
- A minimum vesting of three years for stock options or restricted stock, or
- Deferred stock payable at the end of a three-year deferral period.
o Mix between cash and equity
- A balanced mix of cash and equity, for example 40% cash/60% equity or 50%
cash/50% equity.
- If the mix is heavier on the equity component, the vesting schedule or
deferral period should be more stringent, with the lesser of five years or
the term of directorship.
----------
(1) Non-qualified stock options are not performance-based awards unless the
grant or the vesting of the stock options is tied to the achievement of a
pre-determined and disclosed performance measure. A rising stock market
will generally increase share prices of all companies, despite of the
company's underlying performance.
(2) Performance-accelerated grants are awards that vest earlier based on the
achievement of a specified measure. However, these grants will ultimately
vest over time even without the attainment of the goal(s).
o Retirement/Benefit and Perquisites programs
- No retirement/benefits and perquisites provided to non-employee directors.
o Quality of disclosure
- Provide detailed disclosure on cash and equity compensation delivered to
each non-employee director for the most recent fiscal year in a table. The
column headers for the table may include the following: name of each
non-employee director, annual retainer, board meeting fees, committee
retainer, committee-meeting fees, and equity grants.
For ISS to recommend a vote FOR director equity plans based on the above
qualitative features, a company needs to demonstrate that it meets all the above
qualitative features in its proxy statement.
STOCK PLANS IN LIEU OF CASH
Votes for plans which provide participants with the option of taking all or a
portion of their cash compensation in the form of stock are determined on a
CASE-BY-CASE basis.
Vote FOR plans which provide a dollar-for-dollar cash for stock exchange.
Votes for plans which do not provide a dollar-for-dollar cash for stock exchange
should be determined on a CASE-BY-CASE basis using a proprietary, quantitative
model developed by ISS. In cases where the exchange is not dollar-for-dollar,
the request for new or additional shares for such equity program will be
considered in the quantitative model. However, the cost would be lower than
full-value awards since part of the deferral compensation is in-lieu-of cash
compensation.
DIRECTOR RETIREMENT PLANS
Vote AGAINST retirement plans for nonemployee directors.
Vote FOR shareholder proposals to eliminate retirement plans for nonemployee
directors.
MANAGEMENT PROPOSALS SEEKING APPROVAL TO REPRICE OPTIONS
Votes on management proposals seeking approval to reprice options are evaluated
on a CASE-BY-CASE basis giving consideration to the following:
o Historic trading patterns
o Rationale for the repricing
o Value-for-value exchange
o Treatment of surrendered options
o Option vesting
o Term of the option
o Exercise price
o Participation.
QUALIFIED EMPLOYEE STOCK PURCHASE PLANS
Votes on qualified employee stock purchase plans should be determined on a
CASE-BY-CASE basis.
Vote FOR employee stock purchase plans where all of the following apply:
o Purchase price is at least 85 percent of fair market value
o Offering period is 27 months or less, and
o The number of shares allocated to the plan is ten percent or less of the
outstanding shares
Vote AGAINST qualified employee stock purchase plans where any of the following
apply:
o Purchase price is less than 85 percent of fair market value, or
o Offering period is greater than 27 months, or
o The number of shares allocated to the plan is more than ten percent of the
outstanding shares
NONQUALIFIED EMPLOYEE STOCK PURCHASE PLANS
Votes on nonqualified employee stock purchase plans should be determined on a
CASE-BY-CASE basis.
Vote FOR nonqualified employee stock purchase plans with all the following
features:
o Broad-based participation (i.e., all employees of the company with the
exclusion of individuals with 5 percent or more of beneficial ownership of
the company).
o Limits on employee contribution, which may be a fixed dollar amount or
expressed as a percent of base salary.
o Company matching contribution up to 25 percent of employee's contribution,
which is effectively a discount of 20 percent from market value.
o No discount on the stock price on the date of purchase since there is a
company matching contribution.
Vote AGAINST nonqualified employee stock purchase plans when any of the plan
features do not meet the above criteria.
INCENTIVE BONUS PLANS AND TAX DEDUCTIBILITY PROPOSALS (OBRA-RELATED COMPENSATION
PROPOSALS)
Vote FOR proposals that simply amend shareholder-approved compensation plans to
include administrative features or place a cap on the annual grants any one
participant may receive to comply with the provisions of Section 162(m).
Vote FOR proposals to add performance goals to existing compensation plans to
comply with the provisions of Section 162(m) unless they are clearly
inappropriate.
Votes to amend existing plans to increase shares reserved and to qualify for
favorable tax treatment under the provisions of Section 162(m) should be
considered on a CASE-BY-CASE basis using a proprietary, quantitative model
developed by ISS.
Generally vote FOR cash or cash and stock bonus plans that are submitted to
shareholders for the purpose of exempting compensation from taxes under the
provisions of Section 162(m) if no increase in shares is requested.
EMPLOYEE STOCK OWNERSHIP PLANS (ESOPS)
Vote FOR proposals to implement an ESOP or increase authorized shares for
existing ESOPs, unless the number of shares allocated to the ESOP is excessive
(more than five percent of outstanding shares.)
401(K) EMPLOYEE BENEFIT PLANS
Vote FOR proposals to implement a 401(k) savings plan for employees.
SHAREHOLDER PROPOSALS REGARDING EXECUTIVE AND DIRECTOR PAY
Generally, vote FOR shareholder proposals seeking additional disclosure of
executive and director pay information, provided the information requested is
relevant to shareholders' needs, would not put the company at a competitive
disadvantage relative to its industry, and is not unduly burdensome to the
company.
Vote AGAINST shareholder proposals seeking to set absolute levels on
compensation or otherwise dictate the amount or form of compensation.
Vote AGAINST shareholder proposals requiring director fees be paid in stock
only.
Vote FOR shareholder proposals to put option repricings to a shareholder vote.
Vote on a CASE-BY-CASE basis for all other shareholder proposals regarding
executive and director pay, taking into account company performance, pay level
versus peers, pay level versus industry, and long term corporate outlook.
OPTION EXPENSING
Generally vote FOR shareholder proposals asking the company to expense stock
options, unless the company has already publicly committed to expensing options
by a specific date.
PERFORMANCE-BASED AWARDS
Generally vote FOR shareholder proposals advocating the use of performance-based
awards like indexed, premium-priced, and performance-vested options or
performance-based shares, unless:
o The proposal is overly restrictive (e.g., it mandates that awards to all
employees must be performance-based or all awards to top executives must
be a particular type, such as indexed options)
o The company demonstrates that it is using a substantial portion of
performance-based awards for its top executives
GOLDEN PARACHUTES AND EXECUTIVE SEVERANCE AGREEMENTS
Vote FOR shareholder proposals to require golden parachutes or executive
severance agreements to be submitted for shareholder ratification, unless the
proposal requires shareholder approval prior to entering into employment
contracts.
Vote on a CASE-BY-CASE basis on proposals to ratify or cancel golden parachutes.
An acceptable parachute should include the following:
o The triggering mechanism should be beyond the control of management
o The amount should not exceed three times base amount (defined as the
average annual taxable W-2 compensation during the five years prior to the
year in which the change of control occurs
o Change-in-control payments should be double-triggered, i.e., (1) after a
change in control has taken place, and (2) termination of the executive as
a result of the change in control. ISS defines change in control as a
change in the company ownership structure.
PENSION PLAN INCOME ACCOUNTING
Generally vote FOR shareholder proposals to exclude pension plan income in the
calculation of earnings used in determining executive bonuses/compensation.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLANS (SERPS)
Generally vote FOR shareholder proposals requesting to put extraordinary
benefits contained in SERP agreements to a shareholder vote unless the company's
executive pension plans do not contain excessive benefits beyond what is offered
under employee-wide plans.
9. SOCIAL AND ENVIRONMENTAL ISSUES
CONSUMER ISSUES AND PUBLIC SAFETY
ANIMAL RIGHTS
Vote CASE-BY-CASE on proposals to phase out the use of animals in product
testing, taking into account:
o The nature of the product and the degree that animal testing is necessary
or federally mandated (such as medical products),
o The availability and feasibility of alternatives to animal testing to
ensure product safety, and
o The degree that competitors are using animal-free testing.
o Generally vote FOR proposals seeking a report on the company's animal
welfare standards unless:
o The company has already published a set of animal welfare standards and
monitors compliance
o The company's standards are comparable to or better than those of peer
firms, and
o There are no serious controversies surrounding the company's treatment of
animals
DRUG PRICING
Vote CASE-BY-CASE on proposals asking the company to implement price restraints
on pharmaceutical products, taking into account:
o Whether the proposal focuses on a specific drug and region
o Whether the economic benefits of providing subsidized drugs (e.g., public
goodwill) outweigh the costs in terms of reduced profits, lower R&D
spending, and harm to competitiveness
o The extent that reduced prices can be offset through the company's
marketing budget without affecting R&D spending
o Whether the company already limits price increases of its products
o Whether the company already contributes life -saving pharmaceuticals to
the needy and Third World countries
o The extent that peer companies implement price restraints
GENETICALLY MODIFIED FOODS
Vote AGAINST proposals asking companies to voluntarily label genetically
engineered (GE) ingredients in their products or alternatively to provide
interim labeling and eventually eliminate GE ingredients due to the costs and
feasibility of labeling and/or phasing out the use of GE ingredients.
Vote CASE-BY-CASE on proposals asking for a report on the feasibility of
labeling products containing GE ingredients taking into account:
o The relevance of the proposal in terms of the company's business and the
proportion of it affected by the resolution
o The quality of the company's disclosure on GE product labeling and related
voluntary initiatives and how this disclosure compares with peer company
disclosure
o Company's current disclosure on the feasibility of GE product labeling,
including information on the related costs
o Any voluntary labeling initiatives undertaken or considered by the
company.
Vote CASE-BY-CASE on proposals asking for the preparation of a report on the
financial, legal, and environmental impact of continued use of GE
ingredients/seeds.
o The relevance of the proposal in terms of the company's business and the
proportion of it affected by the resolution
o The quality of the company's disclosure on risks related to GE product use
and how this disclosure compares with peer company disclosure
o The percentage of revenue derived from international operations,
particularly in Europe, where GE products are more regulated and consumer
backlash is more pronounced.
Vote AGAINST proposals seeking a report on the health and environmental effects
of genetically modified organisms (GMOs). Health studies of this sort are better
undertaken by regulators and the scientific community.
Vote AGAINST proposals to completely phase out GE ingredients from the company's
products or proposals asking for reports outlining the steps necessary to
eliminate GE ingredients from the company's products. Such resolutions
presuppose that there are proven health risks to GE ingredients (an issue better
left to federal regulators) that outweigh the economic benefits derived from
biotechnology.
HANDGUNS
Generally vote AGAINST requests for reports on a company's policies aimed at
curtailing gun violence in the United States unless the report is confined to
product safety information. Criminal misuse of firearms is beyond company
control and instead falls within the purview of law enforcement agencies.
HIV/AIDS
Vote CASE-BY-CASE on requests for reports outlining the impact of the health
pandemic (HIV/AIDS, malaria and tuberculosis) on the company's Sub-Saharan
operations and how the company is responding to it, taking into account:
o The nature and size of the company's operations in Sub-Saharan Africa and
the number of local employees
o The company's existing healthcare policies, including benefits and
healthcare access for local workers
o Company donations to healthcare providers operating in the region
Vote AGAINST proposals asking companies to establish, implement, and report on a
standard of response to the HIV/AIDS, TB, and Malaria health pandemic in Africa
and other developing countries, unless the company has significant operations in
these markets and has failed to adopt policies and/or procedures to address
these issues comparable to those of industry peers.
PREDATORY LENDING
Vote CASE-BY CASE on requests for reports on the company's procedures for
preventing predatory lending, including the establishment of a board committee
for oversight, taking into account:
o Whether the company has adequately disclosed mechanisms in place to
prevent abusive lending practices
o Whether the company has adequately disclosed the financial risks of its
subprime business
o Whether the company has been subject to violations of lending laws or
serious lending controversies
o Peer companies' policies to prevent abusive lending practices.
TOBACCO
Most tobacco-related proposals should be evaluated on a CASE-BY-CASE basis,
taking into account the following factors:
Second-hand smoke:
o Whether the company complies with all local ordinances and regulations
o The degree that voluntary restrictions beyond those mandated by law might
hurt the company's competitiveness
o The risk of any health-related liabilities. Advertising to youth:
o Whether the company complies with federal, state, and local laws on the
marketing of tobacco or if it has been fined for violations
o Whether the company has gone as far as p eers in restricting advertising
o Whether the company entered into the Master Settlement Agreement, which
restricts marketing of tobacco to youth
o Whether restrictions on marketing to youth extend to foreign countries
Cease production of tobacco-related products or avoid selling products to
tobacco companies:
o The percentage of the company's business affected
o The economic loss of eliminating the business versus any potential
tobacco-related liabilities.
o Spinoff tobacco-related businesses:
o The percentage of the company's business affected
o The feasibility of a spinoff
o Potential future liabilities related to the company's tobacco business.
Stronger product warnings:
Vote AGAINST proposals seeking stronger product warnings. Such decisions are
better left to public health authorities.
Investment in tobacco stocks:
Vote AGAINST proposals prohibiting investment in tobacco equities. Such
decisions are better left to portfolio managers.
ENVIRONMENT AND ENERGY
ARCTIC NATIONAL WILDLIFE REFUGE
Generally vote AGAINST request for reports outlining potential environmental
damage from drilling in the Arctic National Wildlife Refuge (ANWR) unless:
o New legislation is adopted allowing development and drilling in the ANWR
region;
o The company intends to pursue operations in the ANWR; and
o The company does not currently disclose an environmental risk report for
their operations in the ANWR.
CERES PRINCIPLES
Vote CASE-BY-CASE on proposals to adopt the CERES Principles, taking into
account:
o The company's current environmental disclosure beyond legal requirements,
including environmental health and safety (EHS) audits and reports that
may duplicate CERES
o The company's environmental performance record, including violations of
federal and state regulations, level of toxic emissions, and accidental
spills
o Environmentally conscious practices of peer companies, including
endorsement of CERES
o Costs of membership and implementation.
ENVIRONMENTAL-ECONOMIC RISK REPORT
Vote CASE BY CASE on proposals requesting an economic risk assessment of
environmental performance considering:
o The feasibility of financially quantifying environmental risk factors,
o The company's compliance with applicable legislation and/or regulations
regarding environmental performance,
o The costs associated with implementing improved standards,
o The potential costs associated with remediation resulting from poor
environmental performance, and
o The current level of disclosure on environmental policies and initiatives.
ENVIRONMENTAL REPORTS
Generally vote FOR requests for reports disclosing the company's environmental
policies unless it already has well-documented environmental management systems
that are available to the public.
GLOBAL WARMING
Generally vote FOR proposals requesting a report on greenhouse gas emissions
from company operations and/or products unless this information is already
publicly disclosed or such factors are not integral to the company's line of
business.
Generally vote AGAINST proposals that call for reduction in greenhouse gas
emissions by specified amounts or within a restrictive time frame unless the
company lags industry standards and has been the subject of recent, significant
fines or litigation resulting from greenhouse gas emissions.
RECYCLING
Vote CASE-BY-CASE on proposals to adopt a comprehensive recycling strategy,
taking into account:
o The nature of the company's business and the percentage affected
o The extent that peer companies are recycling
o The timetable prescribed by the proposal
o The costs and methods of implementation
o Whether the company has a poor environmental track record, such as
violations of federal and state regulations.
RENEWABLE ENERGY
In general, vote FOR requests for reports on the feasibility of developing
renewable energy sources unless the report is duplicative of existing disclosure
or irrelevant to the company's line of business.
Generally vote AGAINST proposals requesting that the company invest in renewable
energy sources. Such decisions are best left to management's evaluation of the
feasibility and financial impact that such programs may have on the company.
SUSTAINABILITY REPORT
Generally vote FOR proposals requesting the company to report on policies and
initiatives related to social, economic, and environmental sustainability,
unless:
o The company already discloses similar information through existing
reports or policies such as an Environment, Health, and Safety (EHS)
report; comprehensive Code of Corporate Conduct; and/or Diversity
Report; or
o The company has formally committed to the implementation of a
reporting program based on Global Reporting Initiative (GRI)
guidelines or a similar standard within a specified time frame.
GENERAL CORPORATE ISSUES
OUTSOURCING/ OFFSHORING
Vote CASE BY CASE on proposals calling for companies to report on the risks
associated with outsourcing, considering:
o Risks associated with certain international markets
o The utility of such a report to shareholders
o The existence of a publicly available code of corporate conduct that
applies to international operations
LINK EXECUTIVE COMPENSATION TO SOCIAL PERFORMANCE
Vote CASE-BY-CASE on proposals to review ways of linking executive compensation
to social factors, such as corporate downsizings, customer or employee
satisfaction, community involvement, human rights, environmental performance,
predatory lending, and executive/employee pay disparities. Such resolutions
should be evaluated in the context of:
o The relevance of the issue to be linked to pay
o The degree that social performance is already included in the company's
pay structure and disclosed
o The degree that social performance is used by peer companies in setting
pay
o Violations or complaints filed against the company relating to the
particular social performance measure
o Artificial limits sought by the proposal, such as freezing or capping
executive pay
o Independence of the compensation committee
o Current company pay levels.
CHARITABLE/POLITICAL CONTRIBUTIONS
Generally vote AGAINST proposals asking the company to affirm political
nonpartisanship in the workplace so long as:
o The company is in compliance with laws governing corporate political
activities, and
o The company has procedures in place to ensure that employee contributions
to company-sponsored political action committees (PACs) are strictly
voluntary and not coercive.
Vote AGAINST proposals to report or publish in newspapers the company's
political contributions. Federal and state laws restrict the amount of corporate
contributions and include reporting requirements.
Vote AGAINST proposals disallowing the company from making political
contributions. Businesses are affected by legislation at the federal, state, and
local level and barring contributions can put the company at a competitive
disadvantage.
Vote AGAINST proposals restricting the company from making charitable
contributions. Charitable contributions are generally useful for assisting
worthwhile causes and for creating goodwill in the community. In the absence of
bad faith, self-dealing, or gross negligence, management should determine which
contributions are in the best interests of the company.
Vote AGAINST proposals asking for a list of company executives, directors,
consultants, legal counsels, lobbyists, or investment bankers that have prior
government service and whether such service had a bearing on the business of the
company. Such a list would be burdensome to prepare without providing any
meaningful information to shareholders.
LABOR STANDARDS AND HUMAN RIGHTS
CHINA PRINCIPLES
Vote AGAINST proposals to implement the China Principles unless:
o There are serious controversies surrounding the company's China
operations, and
o The company does not have a code of conduct with standards similar to
those promulgated by the International Labor Organization (ILO).
COUNTRY-SPECIFIC HUMAN RIGHTS REPORTS
Vote CASE-BY-CASE on requests for reports detailing the company's operations in
a particular country and steps to protect human rights, based on:
o The nature and amount of company business in that country
o The company's workplace code of conduct
o Proprietary and confidential information involved
o Company compliance with U.S. regulations on investing in the country
o Level of peer company involvement in the country.
INTERNATIONAL CODES OF CONDUCT/VENDOR STANDARDS
Vote CASE-BY-CASE on proposals to implement certain human rights standards at
company facilities or those of its suppliers and to commit to outside,
independent monitoring. In evaluating these proposals, the following should be
considered:
o The company's current workplace code of conduct or adherence to other
global standards and the degree they meet the standards promulgated by the
proponent
o Agreements with foreign suppliers to meet certain workplace standards
o Whether company and vendor facilities are monitored and how
o Company participation in fair labor organizations
o Type of business
o Proportion of business conducted overseas
o Countries of operation with known human rights abuses
o Whether the company has been recently involved in significant labor and
human rights controversies or violations
o Peer company standards and practices
o Union presence in company's international factories
o Generally vote FOR reports outlining vendor standards compliance unless
any of the following apply:
o The company does not operate in countries with significant human rights
violations
o The company has no recent human rights controversies or violations, or
o The company already publicly discloses information on its vendor standards
compliance.
MACBRIDE PRINCIPLES
Vote CASE-BY-CASE on proposals to endorse or increase activity on the MacBride
Principles, taking into account:
o Company compliance with or violations of the Fair Employment Act of 1989
o Company antidiscrimination policies that already exceed the legal
requirements
o The cost and feasibility of adopting all nine principles
o The cost of duplicating efforts to follow two sets of standards (Fair
Employment and the MacBride Principles)
o The potential for charges of reverse discrimination
o The potential that any company sales or contracts in the rest of the
United Kingdom could be negatively impacted
o The level of the company's investment in Northern Ireland
o The number of company employees in Northern Ireland
o The degree that industry peers have adopted the MacBride Principles
o Applicable state and municipal laws that limit contracts with companies
that have not adopted the MacBride Principles.
MILITARY BUSINESS
FOREIGN MILITARY SALES/OFFSETS
Vote AGAINST reports on foreign military sales or offsets. Such disclosures may
involve sensitive and confidential information. Moreover, companies must comply
with government controls and reporting on foreign military sales.
LANDMINES AND CLUSTER BOMBS
Vote CASE-BY-CASE on proposals asking a company to renounce future involvement
in antipersonnel landmine production, taking into account:
o Whether the company has in the past manufactured landmine components
o Whether the company's peers have renounced future production
o Vote CASE-BY-CASE on proposals asking a company to renounce future
involvement in cluster bomb production, taking into account:
o What weapons classifications the proponent views as cluster bombs
o Whether the company currently or in the past has manufactured cluster
bombs or their components
o The percentage of revenue derived from cluster bomb manufacture
o Whether the company's peers have renounced future production
NUCLEAR WEAPONS
Vote AGAINST proposals asking a company to cease production of nuclear weapons
components and delivery systems, including disengaging from current and proposed
contracts. Components and delivery systems serve multiple military and
non-military uses, and withdrawal from these contracts could have a negative
impact on the company's business.
OPERATIONS IN NATIONS SPONSORING TERRORISM (IRAN)
Vote CASE-BY-CASE on requests for a board committee review and report outlining
the company's financial and reputational risks from its operations in Iran,
taking into account current disclosure on:
o The nature and purpose of the Iranian operations and the amount of
business involved (direct and indirect revenues and expenses) that could
be affected by political disruption
o Compliance with U.S. sanctions and laws
SPACED-BASED WEAPONIZATION
Generally vote FOR reports on a company's involvement in spaced-based
weaponization unless:
o The information is already publicly available or
o The disclosures sought could compromise proprietary information.
WORKPLACE DIVERSITY
BOARD DIVERSITY
Generally vote FOR reports on the company's efforts to diversify the board,
unless:
o The board composition is reasonably inclusive in relation to companies of
similar size and business or
o The board already reports on its nominating procedures and diversity
initiatives.
Generally vote AGAINST proposals that would call for the adoption of specific
committee charter language regarding diversity initiatives unless the company
fails to publicly disclose existing equal opportunity or nondiscrimination
policies.
Vote CASE-BY-CASE on proposals asking the company to increase the representation
of women and minorities on the board, taking into account:
o The degree of board diversity
o Comparison with peer companies
o Established process for improving board diversity
o Existence of independent nominating committee
o Use of outside search firm
o History of EEO violations.
EQUAL EMPLOYMENT OPPORTUNITY (EEO)
Generally vote FOR reports outlining the company's affirmative action
initiatives unless all of the following apply:
o The company has well-documented equal opportunity programs
o The company already publicly reports on its company-wide affirmative
initiatives and provides data on its workforce diversity, and
o The company has no recent EEO-related violations or litigation.
Vote AGAINST proposals seeking information on the diversity efforts of suppliers
and service providers, which can pose a significant cost and administration
burden on the company.
GLASS CEILING
Generally vote FOR reports outlining the company's progress towards the Glass
Ceiling Commission's business recommendations, unless:
o The composition of senior management and the board is fairly inclusive
o The company has well-documented programs addressing diversity initiatives
and leadership development
o The company already issues public reports on its company-wide affirmative
initiatives and provides data on its workforce diversity, and
o The company has had no recent, significant EEO-related violations or
litigation
SEXUAL ORIENTATION
Vote FOR proposals seeking to amend a company's EEO statement in order to
prohibit discrimination based on sexual orientation, unless the change would
result in excessive costs for the company.
Vote AGAINST proposals to ext end company benefits to or eliminate benefits from
domestic partners. Benefits decisions should be left to the discretion of the
company.
10. MUTUAL FUND PROXIES
ELECTION OF DIRECTORS
Vote the election of directors on a CASE-BY-CASE basis, considering the
following factors: board structure; director independence and qualifications;
and compensation of directors within the fund and the family of funds attendance
at board and committee meetings.
Votes should be withheld from directors who:
o attend less than 75 percent of the board and committee meetings
o without a valid excuse for the absences. Valid reasons include illness or
o absence due to company business. Participation via telephone is
acceptable.
o In addition, if the director missed only one meeting or one day's
o meetings, votes should not be withheld even if such absence dropped the
o director's attendance below 75 percent.
o ignore a shareholder proposal that is approved by a majority of shares
o outstanding;
o ignore a shareholder proposal that is approved by a majority of the
o votes cast for two consecutive years;
o are interested directors and sit on the audit or nominating committee; or
o are interested directors and the full board serves as the audit or
o nominating committee or the company does not have one of these
o committees.
CONVERTING CLOSED-END FUND TO OPEN-END FUND
Vote conversion proposals on a CASE-BY-CASE basis, considering the following
factors: past performance as a closed-end fund; market in which the fund
invests; measures taken by the board to address the discount; and past
shareholder activism, board activity, and votes on related proposals.
Proxy Contests
Votes on proxy contests should be determined on a CASE-BY-CASE basis,
considering the following factors:
o Past performance relative to its peers
o Market in which fund invests
o Measures taken by the board to address the issues
o Past shareholder activism, board activity, and votes on related proposals
o Strategy of the incumbents versus the dissidents
o Independence of directors
o Experience and skills of director candidates
o Governance profile of the company
o Evidence of management entrenchment
INVESTMENT ADVISORY AGREEMENTS
Votes on investment advisory agreements should be determined on a CASE-BY-CASE
basis, considering the following factors:
o Proposed and current fee schedules
o Fund category/investment objective
o Performance benchmarks
o Share price performance as compared with peers
o Resulting fees relative to peers
o Assignments (where the advisor undergoes a change of control)
APPROVING NEW CLASSES OR SERIES OF SHARES
Vote FOR the establishment of new classes or series of shares.
PREFERRED STOCK PROPOSALS
Votes on the authorization for or increase in preferred shares should be
determined on a CASE-BY-CASE basis, considering the following factors: stated
specific financing purpose, possible dilution for common shares, and whether the
shares can be used for antitakeover purposes
1940 ACT POLICIES
Votes on 1940 Act policies should be determined on a CASE-BY-CASE basis,
considering the following factors: potential competitiveness; regulatory
developments; current and potential returns; and current and potential risk.
Generally vote FOR these amendments as long as the proposed changes do not
fundamentally alter the investment focus of the fund and do comply with t he
current SEC interpretation.
CHANGING A FUNDAMENTAL RESTRICTION TO A NONFUNDAMENTAL RESTRICTION
Proposals to change a fundamental restriction to a nonfundamental restriction
should be evaluated on a CASE-BY- CASE basis, considering the following factors:
the fund's target investments, the reasons given by the fund for the change, and
the projected impact of the change on the portfolio.
CHANGE FUNDAMENTAL INVESTMENT OBJECTIVE TO NONFUNDAMENTAL
Vote AGAINST proposals to change a fund's fundamental investment objective to
nonfundamental.
NAME CHANGE PROPOSALS
Votes on name change proposals should be determined on a CASE-BY-CASE basis,
considering the following factors: political/economic changes in the target
market, consolidation in the target market, and current asset composition
CHANGE IN FUND'S SUBCLASSIFICATION
Votes on changes in a fund's subclassification should be determined on a
CASE-BY-CASE basis, considering the following factors: potential
competitiveness, current and potential returns, risk of concentration, and
consolidation in target industry
DISPOSITION OF ASSETS/TERMINATION/LIQUIDATION
Vote these proposals on a CASE-BY-CASE basis, considering the following factors:
strategies employed to salvage the company; the fund's past performance; and
terms of the liquidation.
CHANGES TO THE CHARTER DOCUMENT
Votes on changes to the charter document should be determined on a CASE-BY-CASE
basis, considering the following factors:
o The degree of change implied by the proposal
o The efficiencies that could result
o The state of incorporation
o Regulatory standards and implications
Vote AGAINST any of the following changes:
o Removal of shareholder approval requirement to reorganize or terminate the
trust or any of its series
o Removal of shareholder approval requirement for amendments to the new
declaration of trust
o Removal of shareholder approval requirement to amend the fund's management
contract, allowing the contract to be modified by the investment manager
and the trust management, as permitted by the 1940 Act
o Allow the trustees to impose other fees in addition to sales charges on
investment in a fund, such as deferred sales charges and redemption fees
that may be imposed upon redemption of a fund's shares
o Removal of shareholder approval requirement to engage in and terminate
subadvisory arrangements
o Removal of shareholder approval requirement to change the domicile of the
fund
CHANGING THE DOMICILE OF A FUND
Vote reincorporations on a CASE-BY-CASE basis, considering the following
factors: regulations of both states; required fundamental policies of both
states; and the increased flexibility available.
AUTHORIZING THE BOARD TO HIRE AND TERMINATE SUBADVISORS WITHOUT SHAREHOLDER
APPROVAL
Vote AGAINST proposals authorizing the board to hire/terminate subadvisors
without shareholder approval.
DISTRIBUTION AGREEMENTS
Vote these proposals on a CASE-BY-CASE basis, considering the following factors:
fees charged to comparably sized funds with similar objectives, the proposed
distributor's reputation and past performance, the competitiveness of the fund
in the industry, and terms of the agreement.
MASTER-FEEDER STRUCTURE
Vote FOR the establishment of a master-feeder structure.
MERGERS
Vote merger proposals on a CASE-BY-CASE basis, considering the following
factors: resulting fee structure, performance of both funds, continuity of
management personnel, and changes in corporate governance and their impact on
shareholder rights.
SHAREHOLDER PROPOSALS TO ESTABLISH DIRECTOR OWNERSHIP REQUIREMENT
Generally vote AGAINST shareholder proposals that mandate a specific minimum
amount of stock that directors must own in order to qualify as a director or to
remain on the board. While ISS favors stock ownership on the part of directors,
the company should determine the appropriate ownership requirement.
SHAREHOLDER PROPOSALS TO REIMBURSE SHAREHOLDER FOR EXPENSES INCURRED
Voting to reimburse proxy solicitation expenses should be analyzed on a
CASE-BY-CASE basis. In cases where ISS recommends in favor of the dissidents, we
also recommend voting for reimbursing proxy solicitation expenses.
SHAREHOLDER PROPOSALS TO TERMINATE THE INVESTMENT ADVISOR
Vote to terminate the investment advisor on a CASE-BY-CASE basis, considering
the following factors: performance of the fund's NAV, the fund's history of
shareholder relations, and the performance of other funds under the advisor's
management.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
Not yet applicable.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
On December 12, 2005, the Registrant's Board of Trustees adopted an
Amended Nominating and Governance Committee Charter which included some material
changes to the procedures by which shareholders may recommend nominees to the
Registrant's board of trustees as described below:
Any proposal to elect any person nominated by shareholders for election
as trustee may only be brought before an annual meeting of the Registrant if
timely written notice (the "Shareholder Notice") is provided to the secretary of
the Registrant. Unless a greater or lesser period is required under applicable
law, to be timely, the Shareholder Notice must be delivered to or mailed and
received at Registrant's address, 1001 Warrenville Road, Suite 300, Lisle,
Illinois 60532, Attn: W. Scott Jardine, not less than forty-five (45) days nor
more than sixty (60) days prior to the first anniversary date of the date of the
Registrant's proxy statement released to shareholders for the prior year's
annual meeting; provided, however, if and only if the annual meeting is not
scheduled to be held within a period that commences thirty (30) days before the
first anniversary date of the annual meeting for the preceding year and ends
thirty (30) days after such anniversary date (an annual meeting date outside
such period being referred to herein as an "Other Annual Meeting Date"), such
Shareholder Notice must be given in the manner provided herein by the later of
the close of business on (i) the date forty-five (45) days prior to such Other
Annual Meeting Date or (ii) the tenth (10th) business day following the date
such Other Annual Meeting Date is first publicly announced or disclosed.
Any shareholder submitting a nomination of any person or persons (as
the case may be) for election as a trustee or trustees of the Registrant shall
deliver, as part of such Shareholder Notice: (i) a statement in writing setting
forth (A) the name, age, date of birth, business address, residence address and
nationality of the person or persons to be nominated; (B) the class or series
and number of all shares of the Registrant owned of record or beneficially by
each such person or persons, as reported to such shareholder by such nominee(s);
(C) any other information regarding each such person required by paragraphs (a),
(d), (e) and (f) of Item 401 of Regulation S-K or paragraph (b) of Item 22 of
Rule 14a-101 (Schedule 14A) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act") (or any successor provision thereto); (D) any other
information regarding the person or persons to be nominated that would be
required to be disclosed in a proxy statement or other filings required to be
made in connection with solicitation of proxies for election of trustees or
directors pursuant to Section 14 of the Exchange Act and the rules and
regulations promulgated thereunder; and (E) whether such shareholder believes
any nominee is or will be an "interested person" of the Registrant (as defined
in the Investment Company Act of 1940) and, if not an "interested person,"
information regarding each nominee that will be sufficient for the Registrant to
make such determination; and (ii) the written and
signed consent of any person to be nominated to be named as a nominee and to
serve as a trustee if elected. In addition, the trustees may require any
proposed nominee to furnish such other information as they may reasonably
require or deem necessary to determine the eligibility of such proposed nominee
to serve as a trustee.
Without limiting the foregoing, any shareholder who gives a Shareholder
Notice of any matter proposed to be brought before a shareholder meeting
(whether or not involving nominees for trustees) shall deliver, as part of such
Shareholder Notice: (i) the description of and text of the proposal to be
presented; (ii) a brief written statement of the reasons why such shareholder
favors the proposal; (iii) such shareholder's name and address as they appear on
the Registrant's books; (iv) any other information relating to the shareholder
that would be required to be disclosed in a proxy statement or other filings
required to be made in connection with the solicitation of proxies with respect
to the matter(s) proposed pursuant to Section 14 of the Exchange Act; (v) the
class or series and number of all shares of the Registrant owned beneficially
and of record by such shareholder; (vi) any material interest of such
shareholder in the matter proposed (other than as a shareholder); (vii) a
representation that the shareholder intends to appear in person or by proxy at
the shareholder meeting to act on the matter(s) proposed; (viii) if the proposal
involves nominee(s) for trustees, a description of all arrangements or
understandings between the shareholder and each proposed nominee and any other
person or persons (including their names) pursuant to which the nomination(s)
are to be made by the shareholder; and (ix) in the case of a shareholder (a
"BENEFICIAL OWNER") that holds shares entitled to vote at the meeting through a
nominee or "street name" holder of record, evidence establishing such Beneficial
Owner's indirect ownership of, and entitlement to vote, shares at the meeting of
shareholders. As used herein, shares "beneficially owned" shall mean all shares
which such person is deemed to beneficially own pursuant to Rules 13d-3 and
13d-5 under the Exchange Act.
A copy of the amended Nominating and Governance Committee Charter is
available on the Registrant's website at www.ftportfolios.com.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The Registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
Registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these controls
and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR
270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities
Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the Registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17
CFR 270.30a-3(d)) that occurred during the Registrant's second fiscal
quarter of the period covered by this report that has materially
affected, or is reasonably likely to materially affect, the
Registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics, or any amendment thereto, that is the subject of
disclosure required by Item 2 is attached hereto.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act
and Section 302 of the Sarbanes-Oxley Act of 2002 are
attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act
and Section 906 of the Sarbanes-Oxley Act of 2002 are
attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) FIRST TRUST/FIDAC MORTGAGE INCOME FUND
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By (Signature and Title)* /S/ JAMES A. BOWEN
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James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date DECEMBER 22, 2005
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Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /S/ JAMES A. BOWEN
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James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date DECEMBER 22, 2005
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By (Signature and Title)* /S/ MARK R. BRADLEY
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Mark R. Bradley, Treasurer, Controller, Chief Financial
Officer and Chief Accounting Officer
(principal financial officer)
Date DECEMBER 22, 2005
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* Print the name and title of each signing officer under his or her signature.