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 811-21876
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FIRST TRUST TAX-ADVANTAGED PREFERRED 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, Esq.
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, 2006
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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.
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FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME
FUND
ANNUAL REPORT
FOR THE PERIOD JUNE 20, 2006 TO OCTOBER 31, 2006
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TABLE OF CONTENTS
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FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND (FPI)
ANNUAL REPORT
OCTOBER 31, 2006
Shareholder Letter........................................................ 1
Portfolio Commentary...................................................... 2
Portfolio Components...................................................... 4
Portfolio of Investments.................................................. 5
Statement of Assets and Liabilities....................................... 7
Statement of Operations................................................... 8
Statement of Changes in Net Assets........................................ 9
Financial Highlights...................................................... 10
Notes to Financial Statements............................................. 11
Report of Independent Registered Public Accounting Firm................... 16
Additional Information.................................................... 17
Dividend Reinvestment Plan
Proxy Voting Policies and Procedures
Portfolio Holdings
Tax Information
By-Law Amendments
Advisory and Sub-Advisory Agreements
Board of Trustees and Officers............................................ 20
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, as amended.
Forward-looking statements include statements regarding the goals, beliefs,
plans or current expectations of First Trust Advisors L.P. ("First Trust" or the
"Advisor") and/or Stonebridge Advisors LLC ("Stonebridge" or the "Sub-Advisor")
and their respective representatives, taking into account the information
currently available to them. Forward-looking statements include all statements
that do not relate solely to current or historical fact. For example,
forward-looking statements include the use of words such as "anticipate,"
"estimate," "intend," "expect," "believe," "plan," "may," "should," "would" or
other words that convey uncertainty of future events or outcomes.
Forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
First Trust Tax-Advantage Preferred Income Fund (the "Fund") to be materially
different from any future results, performance or achievements expressed or
implied by the forward-looking statements. When evaluating the information
included in this Annual Report, you are cautioned not to place undue reliance on
these forward-looking statements, which reflect the judgment of the Advisor
and/or Stonebridge 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 may help you evaluate your investment. It
includes details about the Fund and presents data and analysis that provide
insight into the Fund's performance and investment approach.
By reading the 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, you may obtain an understanding of how the market environment
affected the Fund's performance. The statistical information that follows may
help you understand the Fund's performance compared to that of relevant market
benchmarks.
It is important to keep in mind that the opinions expressed by Mr. Bowen and
personnel of the Advisor and Stonebridge 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 TAX-ADVANTAGED PREFERRED INCOME FUND (FPI)
ANNUAL REPORT
OCTOBER 31, 2006
Dear Shareholders:
We are pleased to present you with the initial annual report of First Trust
Tax-Advantaged Preferred Income Fund (American Stock Exchange Symbol: FPI),
which commenced trading on June 27, 2006 on the American Stock Exchange. The
Fund's primary investment objective is to seek current income. As a secondary
investment objective, the Fund seeks preservation of capital. The Fund intends
to achieve its investment objectives by investing in securities that the
Sub-Advisor believes at the time of investment are eligible to pay dividends
that qualify for certain favorable federal income tax treatment as
"tax-advantaged" when received by shareholders of the Fund.
Since FPI's inception in June, the Treasury market rallied, resulting in an
inverted yield curve. This created a challenging environment for FPI to get
fully invested at attractive yields. Due to its high cash position, the Fund's
performance lagged that of longer-term fixed-income securities during the market
rally. The Fund is now fully invested and we believe that it is well-positioned
for a flat to inverted yield curve over the near term.
First Trust is the investment advisor of the Fund. First Trust managed or
supervised approximately $27.5 billion in assets as of October 31, 2006. The
Sub-Advisor is a niche asset management firm that provides highly specialized
expertise in the management of preferred securities. The Sub-Advisor was formed
in December 2004 and served as investment advisor or portfolio manager to
investment portfolios with approximately $373 million in assets which it managed
or supervised as of October 31, 2006.
For a discussion of the specific market conditions that affected the Fund and
how the Fund performed, please review the portfolio commentary found on the
following pages. We thank you for your investment in First Trust Tax-Advantaged
Preferred Income Fund and remain dedicated to assisting you in achieving your
financial goals.
Sincerely,
/S/ JAMES A. BOWEN
James A. Bowen
President of First Trust Tax-Advantaged Preferred Income Fund
December 18, 2006
Page 1
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PORTFOLIO COMMENTARY
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OVERVIEW:
First Trust Tax-Advantaged Preferred Income Fund commenced trading on the
American Stock Exchange on June 27, 2006 under the ticker symbol "FPI". The
initial offering price of the Fund was $20.00 per share, and the net asset value
("NAV") at inception was $19.10. The Fund's initial quarterly dividend was
$0.375 and was paid on September 30, 2006. This translates to a 7.81% annualized
distribution rate based on the market price as of October 31, 2006. FPI traded
at a 1.6% discount to NAV on October 31, 2006.
PERFORMANCE:
The Fund posted a market price total return of -2.1% and a NAV total return of
4.3% for the fiscal period ended October 31, 2006. Over the fiscal period of
June 20 through October 31, 2006, the Merrill Lynch DRD Preferred Index returned
7.6% and the Merrill Lynch Floating Rate Preferred Index returned 3.8%.
Although the Fund return for the fiscal period was good on an absolute basis,
when comparing to the benchmarks, the time to become fully invested and the
introduction of the leverage hindered our relative returns. Also contributing to
the negative relative performance was the difficulty in locating and closing
investments in private preferred securities which normally have higher yields.
Tax-advantaged preferred securities are an asset class with a market cap in the
$100 billion range, which is significantly smaller in size compared to the
municipal bonds, corporate bonds and Treasury markets. Given that it is a small
niche market, the period of time to become fully invested generally takes much
longer than investing in the other asset classes, somewhere between 60 to 90
days on average. During the period from June 27 through October 31, 2006,
interest rates rallied across the yield curve, which caused some price
appreciation in all fixed-income markets, including preferreds. Given our high
cash position during this period, the Fund's performance lagged that of
longer-term fixed-income securities. The proceeds from the leverage were not
available for investment until September 15, 2006, leading to additional
relative underperformance versus the Merrill Lynch DRD Preferred Index. Interest
rates had already made the majority of the decline, which meant that the Fund
was investing the proceeds of the leverage at much lower yields and after
preferred prices already rallied.
The Fund is now fully invested, including the leverage portion, so performance
versus the benchmarks will have the same market factors impacting returns. Going
forward, this will result in a more meaningful comparison of the Fund
performance to that of the benchmarks.
INVESTMENT STRATEGY:
The Fund's primary investment objective is to seek current income, with a
secondary objective of capital preservation. Under normal market conditions, the
Fund will invest at least 80% of its Managed Assets in tax-advantaged preferred
securities, eligible to pay dividends that qualify for favorable Federal income
tax treatment as "tax-advantaged" when received by shareholders of the Fund.
This treatment is characterized as Qualified Dividend Income to individuals. It
is anticipated that over 50% of the income will also qualify for the Dividend
Received Deduction ("DRD"), which allows corporations to be entitled to a 70%
DRD with respect to a portion of the dividends received from the Fund.
The portfolio is made up of both floating-rate and fixed-rate preferred
securities with an average credit rating of BBB+ on October 31, 2006 as measured
by Moody's Investors Service. Since inception, the Fund has had difficulty
finding private preferred securities, however, the goal is to purchase some
lower-rated private preferred securities that will increase the portfolio yield
while having the effect of lowering the weighted-average credit rating to
approximately BBB. A portion of these private preferred securities are
anticipated to be floating-rate issues. The Fund strategy is to carry a
percentage of floating-rate issues to match the leverage of approximately 28%,
thus helping to offset the risk of leverage costs increasing and cutting into
the Fund's yield.
MARKET AND ECONOMIC OVERVIEW:
New issuance in hybrid preferred securities has picked up significantly during
2006, with an expected total of over $60 billion for the year. This is about 30%
more than the average of the previous five years. The tax-advantaged portion has
also experienced a meaningful increase, thus allowing for better diversification
and more opportunities to add value by trading the portfolio. Part of the new
tax-advantaged issuance has come in the form of floating-rate securities. The
dividend on these floating-rate securities generally changes every 90 days based
on a spread to the three-month LIBOR. Additionally, the portfolio has some
protection from declining short-term rates because these floaters have a floor
built in that prevents the yield from going below a certain level. For public
floaters the floor is between 3-4% and for private preferred securities the
floor is around 6%. We believe that having these structures available allows us
to manage the duration of the portfolio based on our forecast of the yield
curve.
Since FPI's inception at the end of June 2006, the Treasury market has rallied,
sending yields on the ten-year Treasury Note down 62 basis points (bps) to 4.62%
and the thirty-year Treasury Bond down 58 bps, to 4.70%. The two-year Treasury
Note declined by 50 bps, inverting the already flat yield curve and creating a
challenging environment for FPI to get fully invested at attractive yields. We
anticipate that the rates will remain in a tight range through year-end and that
the yield curve will remain inverted. Current economic data suggests that the
Federal Reserve Board is close to or at the end of the rate tightening cycle.
Gross Domestic Product growth slowed to 2.9% year-over-year in the third quarter
of 2006, down from 3.5% in the second quarter of 2006. The housing market and
commodity prices have cooled, adding to the signs of an economic slowdown.
Conversely, the year-over-year increase in October Core Consumer Price Index
(although declining 0.2% from the previous report) was +2.7%, suggesting that
inflationary pressures still exist. Furthermore,
Page 2
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PORTFOLIO COMMENTARY - (CONTINUED)
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third quarter 2006 corporate earnings across sectors were very robust, sending
mixed signals on the direction of the economy. Taking all indicators into
consideration, we anticipate that the Federal Reserve Board will reverse their
stance sometime during the first half of 2007 and begin lowering rates as the
economy begins to fully reflect the slowing effects of the rate tightening.
OUTLOOK:
Looking ahead, the Fund portfolio is positioned for a flat to slightly inverted
yield curve over the near term and lower short-term rates by the middle of 2007.
The Sub-Advisor will continue to add value to the Fund's performance through
security selection and taking advantage of market inefficiencies. A top priority
for the investment team at Stonebridge is to find the right private placement
preferred securities to fit into the portfolio. Although these private preferred
securities have proven to be difficult to find on a timely basis and may
continue to be difficult to find, due in part to the small block sizes the Fund
can purchase, the risk-adjusted yield pick up they would bring to the Fund
should be worth the wait.
Page 3
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
PORTFOLIO COMPONENTS+
OCTOBER 31, 2006
[GRAPHIC OMITTED]
EDGAR REPRESENTATION OF DATA POINTS
Canadian Income Trusts 9.1%
Capital Markets 3.2%
Commercial Banks 34.6%
Diversified Financial Services 12.5%
Electric Utilities 5.3%
Gas Utilities 0.7%
Insurance 19.5%
Oil, Gas & Consumable Fuels 3.3%
Thrifts & Mortgage Finance 8.5%
Trading Companies & Distributors 3.3%
+ Percentages are based on total investments. Please note that the
percentages shown on the Portfolio of Investments are based on net
assets.
Page 4 See Notes to Financial Statements.
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 2006
MARKET
SHARES DESCRIPTION VALUE
- ---------- --------------------------------------------- ---------------
PREFERRED SECURITIES - 121.7%
CAPITAL MARKETS - 4.3%
20,100 Lehman Brothers Holdings, Inc., Series G, 6.07% +....... $ 517,575
20,000 Merrill Lynch & Company, Series H, 6.05% +.............. 515,400
58,000 Merrill Lynch Preferred Capital Trust, Series G, 6.15%+. 1,500,460
------------
2,533,435
------------
COMMERCIAL BANKS - 46.3%
19,700 Abbey National PLC, Series B, 7.38%..................... 511,018
150,000 ABN Amro Capital Fund Trust V, Series E, 5.90%.......... 3,619,500
24,000 Banco Santander Central Hispano SA, Series 1, 6.41%..... 612,480
140,000 Barclays Bank PLC, Series 2, 6.63%...................... 3,655,400
93,000 Deutsche Bank Capital Funding Trust VIII, 6.38% *....... 2,371,500
150,000 HSBC Holdings PLC, Series A, 6.20%...................... 3,771,000
7,900 Royal Bank of Scotland PLC, Series M, 6.40%............. 201,924
82,300 Royal Bank of Scotland PLC, Series N, 6.35%............. 2,092,889
50,000 Royal Bank of Scotland PLC, Series Q, 6.75%............. 1,312,500
100,000 Santander Finance Preferred SA Unipersonal, 6.80% ***... 2,500,000
135,000 SunTrust Banks, Series A, 5.92% +....................... 3,513,375
101,400 U.S. Bancorp, Series B, 5.97%........................... 2,676,960
------------
26,838,546
------------
DIVERSIFIED FINANCIAL SERVICES - 16.7%
40,000 Bank of America Corp., Series D, 6.20%.................. 1,035,600
100,000 Bank of America Corp., Series E, 5.72% *+............... 2,500,000
40,000 CIT Group Inc., Series A, 6.35%......................... 1,040,800
40,000 Citigroup Inc., Series M, 5.86%......................... 2,026,000
104,000 ING Groep NV, 6.13%..................................... 2,597,920
20,000 ING Groep NV, 7.05%..................................... 509,600
------------
9,709,920
------------
ELECTRIC UTILITIES - 7.1%
80,000 PPL Electric Utilities Corp., 6.25%..................... 2,067,504
10,000 Southern California Edison Company, 6.13%............... 1,017,813
10,000 Southern California Edison Company, Series C, 6.00%..... 1,015,313
------------
4,100,630
------------
GAS UTILITIES - 0.9%
20,000 Southern Union Company, 7.55% 522,400
------------
INSURANCE - 26.1%
90,000 Aegon NV, 6.88%*........................................ 2,336,400
85,000 Arch Capital Group Ltd., Series B, 7.88%................ 2,181,100
115,000 Axis Capital Holdings Ltd., Series A, 7.25%............. 2,938,250
80,000 Endurance Specialty Holdings Ltd., Series A, 7.75%...... 2,048,000
13,500 Prudential PLC, 6.50%................................... 343,575
47,137 Renaissancere Holdings Ltd., Series A, 8.10%............ 1,197,751
40,000 Renaissancere Holdings Ltd., Series B, 7.30%............ 1,040,000
120,000 XL Capital Ltd., Series B, 7.63%........................ 3,055,200
------------
15,140,276
------------
OIL, GAS & CONSUMABLE FUELS - 4.5%
100,000 GMX Resources Inc., Series B, 9.25%..................... 2,605,000
------------
See Notes to Financial Statements. Page 5
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
PORTFOLIO OF INVESTMENTS - (CONTINUED)
OCTOBER 31, 2006
MARKET
SHARES DESCRIPTION VALUE
- ---------- --------------------------------------------- ---------------
PREFERRED SECURITIES - CONTINUED
THRIFTS & MORTGAGE FINANCE - 11.4%
40,000 Franklin Bank Corp., Series A, 7.50%.................... $ 1,020,000
40,000 Freddie Mac, Series U, 5.90% *.......................... 1,024,400
40,000 Freddie Mac, Series S, 5.87% +.......................... 2,200,000
10,000 Freddie Mac, Series T, 6.42%............................ 535,700
67,100 Sovereign Bancorp, Inc., Series C, 7.30%................ 1,817,739
-----------
6,597,839
-----------
TRADING COMPANIES & DISTRIBUTORS - 4.4%
250,400 Willis Lease Finance Corp., Series A, 9.00%............. 2,541,560
-----------
TOTAL PREFERRED SECURITIES.............................. 70,589,606
-----------
(Cost $68,929,039)
CANADIAN INCOME TRUSTS - 12.1%
110,000 Atlantic Power Corp., IPS............................... 1,047,152
78,000 Boralex Power Income Fund............................... 716,820
119,500 CanWest MediaWorks Income Fund.......................... 835,367
60,000 Crescent Point Energy Trust............................. 1,080,369
18,500 Telus Corp.............................................. 1,061,160
115,000 Teranet Income Fund..................................... 1,080,413
90,000 Yellow Pages Income Fund................................ 1,211,808
-----------
TOTAL CANADIAN INCOME TRUSTS............................ 7,033,089
-----------
(Cost $6,984,359)
TOTAL INVESTMENTS - 133.8%.............................. 77,622,695
-----------
(Cost $75,913,398)**
NET OTHER ASSETS & LIABILITIES - 4.1%................... 2,361,994
-----------
AUCTION PREFERRED SHARES, AT LIQUIDATION VALUE - (37.9)% (22,000,000)
-----------
NET ASSETS - 100.0% .................................... $57,984,689
===========
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* As of October 31, 2006, this security has not paid a distribution to
the Fund.
** Aggregate cost for federal income tax purposes is $75,914,005.
*** Security is restricted and cannot be offered for public sale without
first being registered under the Securities Act of 1933, as amended.
Prior to registration, restricted securities may only be resold in
transactions exempt from registration. At October 31, 2006, this
security was valued at $2,500,000, or 4.31% of net assets (Note 2D).
+ Variable rate security. The interest rate shown reflects the rate in
effect at October 31, 2006.
IPS Income Participating Securities
SCHEDULE OF FOREIGN CURRENCY FUTURES CONTRACTS
UNREALIZED
NUMBER OF APPRECIATION/
CONTRACTS DESCRIPTION VALUE (DEPRECIATION)
- -------------- ------------------------------------------------------ ------------- -----------------
FUTURES CONTRACTS - SHORT POSITION
28 Canadian Dollar December 2006......................... $ 2,499,560 $ 2,500
28 Canadian Dollar March 2007............................ 2,506,560 (35,000)
------------ -------------
$ 5,006,120 $ (32,500)
============ =============
Page 6 See Notes to Financial Statements.
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 2006
ASSETS:
Investments, at value
(Cost $75,913,398).............................................. $ 77,622,695
Cash............................................................... 4,140,493
Cash segregated as collateral for open futures contracts........... 150,000
Prepaid expenses................................................... 13,426
Receivables:
Investment securities sold.................................... 5,319,337
Dividends and interest........................................ 220,329
------------
Total Assets............................................... 87,466,280
------------
LIABILITIES:
Payables:
Investment securities purchased............................... 7,022,772
Offering costs................................................ 285,797
Audit and legal fees.......................................... 43,916
Investment advisory fees...................................... 43,910
Variation margin.............................................. 32,500
Printing fees................................................. 31,932
Administrative fees........................................... 8,333
Accumulated unpaid dividends on Auction Preferred Shares...... 2,597
Custodian fees................................................ 1,702
Transfer agent fees........................................... 3,883
Trustees' fees and expenses................................... 3,333
Accrued expenses................................................... 916
------------
Total Liabilities.......................................... 7,481,591
------------
NET ASSETS INCLUDING AUCTION PREFERRED SHARES...................... $ 79,984,689
------------
AUCTION PREFERRED SHARES:
($0.01 par value, 880 shares issued with liquidation
preference of $25,000 per share, unlimited number of
Auction Preferred Shares has been authorized)...................... 22,000,000
------------
NET ASSETS (APPLICABLE TO COMMON SHAREHOLDERS)..................... $ 57,984,689
============
NET ASSETS CONSIST OF:
Accumulated net investment loss.................................... $ (2,597)
Accumulated net realized gain on investments sold.................. 112,004
Net unrealized appreciation of investments......................... 1,676,588
Par value.......................................................... 29,707
Paid-in capital.................................................... 56,168,987
------------
Net Assets (Applicable to Common Shareholders)............. $ 57,984,689
============
NET ASSET VALUE, applicable to Common Shares outstanding
(par value $0.01 per Common Share).............................. $ 19.52
============
Number of Common Shares outstanding (unlimited number
of Common Shares has been authorized).............................. 2,970,712
============
See Notes to Financial Statements. Page 7
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
STATEMENT OF OPERATIONS
FOR THE PERIOD ENDED OCTOBER 31, 2006*
INVESTMENT INCOME:
Dividends (net of foreign withholding tax of $24,986)...................................................... $ 1,267,949
Interest................................................................................................... 196,317
------------
Total investment income................................................................................. 1,464,266
------------
EXPENSES:
Investment advisory fees................................................................................... 226,032
Audit and legal fees....................................................................................... 55,551
Administration fees........................................................................................ 34,166
Printing fees.............................................................................................. 32,055
Trustees' fees and expenses................................................................................ 13,394
Transfer agent fees........................................................................................ 19,414
Custodian fees............................................................................................. 6,809
Auction Preferred Shares commission fees................................................................... 6,595
Interest and fees on outstanding loan payable.............................................................. 703
Other...................................................................................................... 7,117
------------
Total expenses.......................................................................................... 401,836
Fees waived by the investment advisor................................................................... (79,111)
------------
Net expenses............................................................................................... 322,725
------------
NET INVESTMENT INCOME...................................................................................... 1,141,541
------------
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS, FUTURES CONTRACTS
AND FOREIGN CURRENCIES:
Net realized gain/(loss) on:
Investments............................................................................................. 208,837
Foreign currencies...................................................................................... (2,479)
------------
Net realized gain on investments and foreign currencies during the period................................. 206,358
------------
Net change in unrealized appreciation/(depreciation) of:
Investments............................................................................................. 1,709,297
Futures contracts....................................................................................... (32,500)
Foreign currencies...................................................................................... (209)
------------
Net change in unrealized appreciation/(depreciation) of investments, futures contracts and foreign
currencies during the period............................................................................ 1,676,588
------------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS, FUTURES CONTRACTS
AND FOREIGN CURRENCIES.................................................................................. 1,882,946
------------
AUCTION PREFERRED SHARE DIVIDENDS......................................................................... (126,528)
------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS...................................................... $ 2,897,959
============
<FN>
- --------------------------------------------------------------------------------
* The Fund commenced operations on June 20, 2006.
</FN>
Page 8 See Notes to Financial Statements.
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
STATEMENT OF CHANGES IN NET ASSETS
PERIOD
ENDED
10/31/2006*
-----------
OPERATIONS:
Net investment income................................................................... $ 1,141,541
Net realized gain on investments and foreign currencies during the period............... 206,358
Net change in unrealized appreciation/(depreciation) of investments, futures contracts
and foreign currencies during the period............................................. 1,676,588
Distributions to Auction Preferred Shareholders:
Dividends paid from net investment income............................................ (126,528)
------------
Net increase in net assets resulting from operations.................................... 2,897,959
DISTRIBUTIONS TO COMMON SHAREHOLDERS FROM:
Dividends paid from net investment income............................................ (1,111,964)
------------
Total distributions to Common Shareholders.............................................. (1,111,964)
CAPITAL TRANSACTIONS:
Net proceeds from sale of 2,965,236 Common Shares....................................... 56,636,008
Net proceeds from 5,476 shares reinvested............................................... 105,296
Offering costs.......................................................................... (542,610)
------------
Total capital transactions.............................................................. 56,198,694
------------
Net increase in net assets.............................................................. 57,984,689
NET ASSETS (APPLICABLE TO COMMON SHAREHOLDERS):
Beginning of period..................................................................... --
------------
End of period........................................................................... $ 57,984,689
============
Accumulated net investment loss at end of period........................................ $ (2,597)
============
<FN>
- --------------------------------------------------
* The Fund commenced operations on June 20, 2006.
</FN>
See Notes to Financial Statements. Page 9
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT THE PERIOD
PERIOD
ENDED
10/31/2006*
------------
Net asset value, beginning of period................................................... $ 19.10(a)
------------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income.................................................................. 0.38
Net realized and unrealized gain on investments........................................ 0.64
Distributions paid to Auction Preferred Shares Shareholders:
Dividends paid from net investment income........................................... (0.04)
------------
Total from investment operations....................................................... 0.98
------------
DISTRIBUTIONS PAID TO COMMON SHAREHOLDERS:
Dividends paid from net investment income........................................... (0.38)
------------
Total distributions to Common Shareholders............................................. (0.38)
------------
Dilutive impact from the offering of Auction Preferred Shares++........................ (0.14)
------------
Common share offering costs charged to paid-in capital................................. (0.04)
------------
Net asset value, end of period......................................................... $ 19.52
============
Market value, end of period............................................................ $ 19.21
============
TOTAL RETURN BASED ON NET ASSET VALUE (B)+............................................. 4.25%
============
TOTAL RETURN BASED ON MARKET VALUE (C)+................................................ (2.08)%
============
RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON SHAREHOLDERS:
Ratio of net expenses to average net assets excluding interest expense................. 1.63%**
Ratio of net expenses to average net assets............................................ 1.64%**
Ratio of total expenses to average net assets.......................................... 2.04%**
Ratio of net investment income to average net assets................................... 5.79%**
Ratio of net investment income to average net assets net of Auction Preferred Shares
dividends (d)....................................................................... 5.15%**
SUPPLEMENTAL DATA:
Portfolio turnover rate................................................................ 119%
Net assets, end of period (in 000's)................................................... $ 57,985
Ratio of net expenses to total average Managed Assets excluding interest expense....... 1.42%**
Ratio of net expenses to total average Managed Assets.................................. 1.43%**
Ratio of total expenses to total average Managed Assets................................ 1.78%**
PREFERRED SHARES:
Total Auction Preferred Shares outstanding............................................. 880
Liquidation and market value per Auction Preferred Share (e)........................... $ 25,003
Asset coverage per share (f)........................................................... $ 90,892
<FN>
- --------------------------------------------------
* The Fund commenced operations on June 20, 2006.
** Annualized.
(a) Net of sales load of $0.90 per share on initial shares issued.
(b) Total return based on net asset value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in net
asset value per share and does not reflect sales load.
(c) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in Common
Share market price per share, all based on Common Share market price per
share.
(d) The net investment income ratio reflects income net of operating expenses
and payments and changes in unpaid dividends to Auction Preferred Shares
Shareholders.
(e) Includes accumulated and unpaid dividends.
(f) Calculated by subtracting the Fund's total liabilities (not including the
Auction Preferred Shares) from the Fund's total assets, and dividing by the
number of Auction Preferred Shares outstanding.
+ Total return is not annualized for periods less than one year.
++ The expenses associated with the offering of the Auction Preferred Shares
had a $(0.14) impact on the Common Share NAV.
</FN>
Page 10 See Notes to Financial Statements.
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006
1. FUND DESCRIPTION
First Trust Tax-Advantaged Preferred Income Fund (the "Fund") is a diversified
closed-end management investment company organized as a Massachusetts business
trust on March 9, 2006 and is registered with the Securities and Exchange
Commission ("SEC") under the Investment Company Act of 1940, as amended (the
"1940 Act"). The Fund trades under the ticker symbol FPI on the American Stock
Exchange ("AMEX").
The Fund's primary investment objective is to seek a high level of current
income. The Fund seeks capital preservation as a secondary objective. The Fund
intends to achieve its investment objectives primarily by investing in preferred
securities that Stonebridge Advisors LLC ("Stonebridge" or the "Sub-Advisor")
believes at the time of investment are eligible to pay dividends that qualify
for certain favorable federal income tax treatments as "tax-advantaged" when
received by shareholders of the Fund. There can be no assurance that the Fund
will achieve its investment objectives. The Fund may not be appropriate for all
investors.
2. SIGNIFICANT ACCOUNTING POLICIES
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts and disclosures in
the financial statements. Actual results could differ from those estimates.
A. PORTFOLIO VALUATION:
The Fund determines the net asset value ("NAV") of its shares daily, as of the
close of regular session trading on the New York Stock Exchange ("NYSE"),
normally 4:00 p.m. Eastern Time, on each day the NYSE is open for trading.
Domestic debt securities and foreign securities are priced using data reflecting
the earlier closing of the principal markets for those securities. The Fund
calculates NAV per Common Share by subtracting the Fund's liabilities (including
accrued expenses, dividends payable and any borrowings of the Fund) and the
liquidation value of any outstanding Preferred Shares from the Fund's Total
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 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. (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.
B. FUTURES CONTRACTS:
Upon entering into a futures contract, the Fund is required to deposit with the
broker an amount of cash or cash equivalents equal to a certain percentage of
the contract amount (known as an initial margin deposit). Subsequent payments
(known as variation margin) are made or received by the Fund each day, depending
on the daily fluctuation of the value of the contract. The daily changes in
contract value are recorded as unrealized gains or losses, and the Fund
recognizes a realized gain or loss when the contract is closed. Should market
conditions change unexpectedly, the Fund may not achieve the anticipated
benefits of the futures contracts and may realize a loss. The use of futures
transactions involves the risk of imperfect correlation in movements in the
price of futures contracts, interest rates and the underlying hedged assets.
Page 11
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NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006
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. Amortization of premiums and accretion of discounts are
recorded using the effective interest method.
Securities purchased or sold on a when-issued or delayed-delivery basis may be
settled a month or more after the trade date; interest income on such securities
is not accrued until settlement date. The Fund maintains liquid assets with a
current value at least equal to the amount of its when-issued or
delayed-delivery purchase commitments.
D. FOREIGN CURRENCY:
The books and records of the Fund are maintained in U.S.dollars. Foreign
currencies, investments and other assets and liabilities are translated into
U.S. dollars at the exchange rates prevailing at the end of the period.
Purchases and sales of investment securities and items of income and expense are
translated on the respective dates of such transactions. Unrealized gains and
losses which result from changes in foreign currency exchange rates have been
included in "Net change in unrealized appreciation/(depreciation) of foreign
currencies" on the Statement of Operations. Net realized foreign currency gains
and losses include the effect of changes in exchange rates between trade date
and settlement date on investment security transactions, foreign currency
transactions and interest and dividends received. The portion of foreign
currency gains and losses related to fluctuations in exchange rates between the
initial purchase trade date and subsequent sale trade date is included in "Net
realized gain/(loss) on foreign currencies" on the Statement of Operations.
E. RESTRICTED SECURITIES:
The Fund invests in restricted securities, which are defined as securities that
may not be offered for public sale without first being registered under the
Securities Act of 1933, as amended. Prior to registration, restricted securities
may only be resold in transactions exempt from registration. As of October 31,
2006, the Fund held a restricted security as shown in the following table. The
Fund does not have the right to demand that such securities be registered. This
security is valued according to the valuation procedures as stated in the
Portfolio Valuation footnote (Note 2A) and is not expressed as a discount to the
carrying value of a comparable unrestricted security.
ACQUISITION CARRYING VALUE
SECURITY DATE PER UNIT COST
- -------- ---- -------- ----
Santander Finance Preferred SA Unipersonal, 6.80% 10/31/06 $ 25.00 $ 2,500,000
F. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
The Fund will distribute to holders of its Common Shares quarterly 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 fiscal period ended
October 31, 2006, resulting in book and tax accounting differences, have been
reclassified at year end to reflect a decrease in accumulated net investment
loss by $94,354 and a decrease in accumulated net realized gain on investments
by $94,354. Net assets were not affected by this reclassification.
The tax character of distributions paid during the fiscal period ended October
31, 2006 is as follows:
Distributions paid from: 2006
----
Ordinary Income ............................... $ 1,238,492
Long-Term Capital Gains........................ $ --
As of October 31, 2006, the components of distributable earnings on a tax basis
were as follows:
Undistributed Ordinary Income.................. $ 80,112
Undistributed Long-Term Capital Gains.......... $ --
Net Unrealized Appreciation.................... $ 1,675,980
Page 12
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NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006
G. 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.
H. EXPENSES:
The Fund pays all expenses directly related to its operations.
I. 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
Stonebridge 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, $118,610, was recorded as a reduction of
the proceeds from the sale of Common Shares.
J. NEW ACCOUNTING PRONOUNCEMENTS:
In July 2006, the Financial Accounting Standards Board ("FASB") issued FASB
Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes."
This pronouncement provides guidance on the recognition, measurement,
classification, and disclosures related to uncertain tax positions, along with
any related interest and penalties. FIN 48 is effective for fiscal years
beginning after December 15, 2006. At this time, management is evaluating the
implications of FIN 48 and its impact on the financial statements has not yet
been determined.
In addition, in September 2006, Statement of Financial Accounting Standards No.
157 Fair Value Measurements ("SFAS 157") was issued by the FASB and is effective
for fiscal years beginning after November 15, 2007. SFAS 157 defines fair value,
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. Management is currently evaluating the impact the
adoption of SFAS 157 will have on the Fund's financial statement disclosures.
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 (the value of
the securities and other investments the Fund holds plus cash or other assets,
including interest accrued but not yet received, minus accrued liabilities other
than the principal amount of borrowings).
Stonebridge, an affiliate of First Trust, serves as the Fund's sub-advisor and
manages the Fund's portfolio subject to First Trust's supervision. The
Sub-Advisor receives a portfolio management fee at an annual rate of 0.50% of
Managed Assets that is paid monthly by First Trust from its investment advisory
fee.
First Trust has agreed to waive fees in an amount equal to 0.35% of the average
daily Managed Assets of the Fund for the first two years of the Fund's
operations through June 27, 2008. The Sub-Advisor has agreed to bear a portion
of this waiver obligation by reducing the amount of its full sub-advisory fee by
0.20%. Waivers are reported as "Fees waived by the investment advisor" on 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, also an indirect,
majority-owned subsidiary of The PNC Financial Services Group, Inc., serves as
the Fund's Custodian in accordance with certain fee arrangements.
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 board meetings and committee meetings. Trustees are also reimbursed for
travel and out-of-pocket expenses in connection with all meetings.
Page 13
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006
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 fiscal period ended October
31, 2006, aggregated amounts were $133,538,946 and $57,834,388, respectively.
As of October 31, 2006, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was $1,874,619
and the aggregate gross unrealized depreciation for all securities in which
there was an excess of tax cost over value was $165,929.
5. COMMON SHARES
As of October 31, 2006, 2,970,712 of $0.01 par value Common Shares were issued.
An unlimited number of Common Shares has been authorized under the Fund's
Dividend Reinvestment Plan.
COMMON SHARE TRANSACTIONS WERE AS FOLLOWS:
PERIOD ENDED
OCTOBER 31, 2006
SHARES AMOUNT
---------- ------------
Proceeds from Common Shares sold.................. 2,965,236 $56,636,008
Common Shares issued as reinvestment of dividends
under the Dividend Reinvestment Plan............ 5,476 105,296
Offering costs.................................... -- (542,610)
---------- -----------
2,970,712 $56,198,694
========== ===========
6. AUCTION PREFERRED SHARES
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, 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, 2006, the Fund
has 880 Series M Auction Preferred Shares ("Preferred Shares") outstanding at a
liquidation value of $25,000 per share. The Preferred Shares offering costs of
$204,000 and commissions of $220,000 were charged to capital of Common Shares
for the period ended October 31, 2006.
The Fund is required to meet certain asset coverage tests with respect to the
Preferred Shares. If the Fund fails to maintain eligible assets having an
aggregated discounted value at least equal to the Preferred Shares basic
maintenance amount as of any valuation date and the failure is not cured on or
before the related asset coverage cure date, the Fund will be required in
certain circumstances to redeem certain Preferred Shares.
An auction of the Preferred Shares is generally held every 7 days. Existing
shareholders may submit an order to hold, bid or sell such shares at par value
on each auction date.
The annual dividend rate in effect as of October 31, 2006 was 4.25%. The
dividend rate, as set by the auction process, is generally expected to vary with
short-term interest rates. The high and low annual dividend rates during the
period ended October 31, 2006, were 4.45% and 4.20%, respectively, and the
average dividend rate was 4.31%. These rates may vary in a manner not related
directly to the income received on the Fund's assets, which could have either a
beneficial or detrimental impact on net investment income and gains available to
Common Shareholders.
Under Emerging Issues Task Force (EITF) promulgating Topic D-98, Classification
and Measurement of Redeemable Securities, which was issued on July 19, 2001,
preferred securities that are redeemable for cash or other assets are to be
classified outside of permanent equity to the extent that the redemption is at a
fixed or determinable price and at the option of the holder or upon the
occurrence of an event that is not solely within the control of the issuer.
Subject to guidance of the EITF, the Fund's Preferred Shares are classified
outside of permanent equity (net assets attributable to Common Shares) in the
accompanying financial statements.
Page 14
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006
7. CREDIT AGREEMENT
The Fund has a credit agreement with the Custodial Trust Company of Bear
Stearns, under which the Fund may borrow from the Custodial Trust Company an
aggregate amount of up to the lesser of $20,000,000 or the maximum amount the
Fund is permitted to borrow under the 1940 Act. For the period ended October 31,
2006, the average amount outstanding was $29,851 with a weighted average
interest rate of 6.33%. This credit agreement has no maturity date and can be
paid or called at any time. As of October 31, 2006, the Fund had no outstanding
borrowings under this credit agreement.
8. 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 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.
LOSS OF "QUALIFIED DIVIDEND INCOME" STATUS:
Without further legislation, the tax advantage associated with "qualified
dividend income" is set to expire for tax years beginning January 1, 2011. The
loss of such tax advantage would reduce the after-tax yield of any income from
the Fund's investments that would otherwise constitute "qualified dividend
income," thereby reducing the overall level of tax-advantaged current income
available to individual and other non-corporate holders of Common Shares.
NON-INVESTMENT GRADE SECURITIES RISK:
The Fund may invest up to 50% of its Managed Assets in non-investment grade
securities. Below-investment grade securities are rated below "Baa" by Moody's
Investors Service, Inc., below "BBB" by Standard & Poor's Ratings Group,
comparably rated by another nationally recognized statistical rating
organization or, if unrated, determined to be of comparable credit quality by
the Sub-Advisor. Below-investment grade debt instruments are commonly referred
to as "high-yield" or "junk" bonds and are considered speculative with respect
to the issuer's capacity to pay interest and repay principal and are susceptible
to default or decline in market value due to adverse economic and business
developments. The market values for high-yield securities tend to be volatile,
and these securities are less liquid than investment grade debt securities.
Page 15
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
- --------------------------------------------------------------------------------
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST TAX-ADVANTAGED
PREFERRED INCOME FUND:
We have audited the accompanying statement of assets and liabilities of First
Trust Tax-Advantaged Preferred Income Fund (the "Fund"), including the portfolio
of investments, as of October 31, 2006, the related statements of operations,
changes in net assets and the financial highlights for the period June 20, 2006
(inception) through October 31, 2006. 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, 2006, by correspondence with the Fund's
custodian and brokers; where replies were not received, 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 the
Fund as of October 31, 2006, the results of its operations, the changes in its
net assets, and the financial highlights for the period June 20, 2006
(inception) through October 31, 2006, in conformity with accounting principles
generally accepted in the United States of America.
[GRAPHIC OMITTED]
DELOITTE & TOUCHE LLP SIG
Chicago, Illinois
December 18, 2006
Page 16
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ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006 (UNAUDITED)
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Shares will be automatically reinvested by 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 dividend paying agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
(1) If Common Shares are trading at or above 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 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 AMEX or elsewhere,
for the participants' accounts. It is possible that the market price
for the Common Shares may increase before the Plan Agent has
completed its purchases. Therefore, the average purchase price per
share paid by the Plan Agent may exceed the market price at the time
of valuation, resulting in the purchase of fewer shares than if the
dividend or distribution had been paid in Common Shares issued by the
Fund. The Plan Agent will use all dividends and distributions
received in cash to purchase Common Shares in the open market within
30 days of the valuation date except where temporary curtailment or
suspension of purchases is necessary to comply with federal
securities laws. Interest will not be paid on any uninvested cash
payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (800) 334-1710, in
accordance with such reasonable requirements as the Plan Agent and Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized, although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing 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 voted proxies relating to
portfolio securities during the most recent 12-month period ended June 30 is
available (1) without charge, upon request, by calling (800) 988-5891; (2) on
the Fund's website located at http://www.ftportfolios.com; and (3) on the
Securities and Exchange Commission's website at http://www.sec.gov.
Page 17
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ADDITIONAL INFORMATION - (CONTINUED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006 (UNAUDITED)
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available (1) by calling (800)
988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3)
on the SEC's website at http://www.sec.gov; and (4) for review and copying at
the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding
the operation of the PRR may be obtained by calling 1-800-SEC-0330.
TAX INFORMATION
Of the ordinary income (including short-term capital gain) distributions made by
the Fund during the year ended October 31, 2006, 56.37% qualify for the
corporate dividend received deduction available to corporate shareholders.
The Fund hereby designates as qualified dividend income distributions 100% of
the ordinary income distributions (including short-term capital gain), for the
year ended October 31, 2006.
BY-LAW AMENDMENTS
On June 12, 2006 and again on December 10, 2006, the Board of Trustees of the
Fund approved certain changes to the By-Laws of the Fund that may have the
effect of developing or preventing a change of control of the Fund including the
implementation of a staggered Board of Trustees. These changes were not required
to be, and were not, approved by the Fund's Shareholders. To receive a copy of
the amended By-Laws, investors may call the Fund at (800) 988-5891.
ADVISORY AND SUB-ADVISORY AGREEMENTS
BOARD CONSIDERATIONS REGARDING APPROVAL OF INVESTMENT MANAGEMENT AND
SUB-ADVISORY AGREEMENTS
The Board of Trustees approved the Investment Management Agreement (the
"Agreement") between the Fund and First Trust Advisors L.P. (the "Advisor") and
the Investment Sub-Advisory Agreement (the "Sub-Advisory Agreement") among the
Fund, the Advisor and Stonebridge Advisors, LLC (the "Sub-Advisor"), at a
meeting held on April 17, 2006. The Board received and reviewed data from the
Advisor and Sub-Advisor, which was provided in response to a request from
counsel to the Independent Trustees made in advance of the meeting. The
Independent Trustees discussed these responses in a conference call prior to the
meeting. At the meeting, the Trustees discussed the materials with
representatives of the Advisor, the Sub-Advisor, Fund counsel and independent
counsel. The Independent Trustees met with independent counsel to review their
duties and responsibilities in connection with their consideration of the
Agreement and the Sub-Advisory Agreement. The Board concluded that the terms of
the Agreement and the Sub-Advisory Agreement are fair and reasonable and that
the Agreement and Sub-Advisory Agreement are in the best interests of the Fund.
No single factor was determinative in the Board's analysis.
The Trustees considered the nature, extent and quality of services to be
provided under the Agreement, noting that the Advisor's 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
the Advisor and the skills of its employees who would be working with the Fund.
The Trustees concluded they were comfortable that the Advisor had the
capabilities and resources to oversee the operations of the Fund, including
overseeing the Sub-Advisor, which they viewed as particularly important since
the Sub-Advisor was recently formed and was in the process of hiring a new Chief
Compliance Officer.
The Trustees reviewed information compiled by Lipper Inc., an independent
source, on management and advisory fees charged to ten other income and
preferred stock closed-end funds using preferred stock leverage, and information
provided by Lipper Inc. on a second larger peer group selected by the Advisor,
and they discussed with representatives of the Advisor certain differences
between the funds in each peer group and the Fund. The Trustees noted that the
management fee to be paid to the Advisor was above the median, but was only 10
basis points higher than the management fee of the fund included in both the
Lipper peer group and the Advisor-selected peer group that management stated was
most similar to the Fund. Since the Fund is newly organized, the Board did not
consider investment performance of the Fund. The Trustees concluded that the
fees to be paid under the Agreement were reasonable.
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 management team. At the meeting, the Trustees received a presentation
from the Sub-Advisor's President and Chief Investment Officer and the Senior
Vice President and Portfolio Manager of the Sub-Advisor, who described the
Sub-Advisor's experience and investment style. With respect to the Sub-Advisor's
experience, the Trustees noted in particular that the Portfolio Manager had
previously managed certain portfolio managers of other funds in the Lipper and
Advisor-selected peer groups, as well as successfully
Page 18
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION - (CONTINUED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006 (UNAUDITED)
managed preferred securities. The Independent Trustees noted that the
Sub-Advisor was an affiliate of the Advisor and had some common officers, but
they noted that that the Sub-Advisor's President indicated he would be hiring a
new Chief Compliance Officer. The Independent Trustees concurred that it was
preferable for the Advisor and Sub-Advisor to have different Chief Compliance
Officers. The Trustees also considered that the Sub-Advisor would not use any
portion of Fund commissions to pay for research. The Trustees concluded that the
Sub-Advisor had the capability to provide the necessary investment advisory
services to the Fund.
The Trustees considered the fees to be paid under the Sub-Advisory Agreement and
noted that the fees would be paid by the Advisor from its advisory fee. The
Sub-Advisor provided information on fees charged to clients for which it
provides discretionary investment management services of preferred securities
portfolios, and the Trustees noted that those fees generally were lower than the
fees to be paid under the Sub-Advisory Agreement, but that the Sub-Advisor had
indicated that it does not provide investment advisory services to institutional
clients that have similar investment objectives and policies to the Fund's. The
Trustees also noted that the fees to be paid under the Sub-Advisory Agreement
were above the median of the few other sub-advised funds in the Lipper and
Advisor-selected peer groups, but were not significantly higher. The Trustees
concluded that the fees to be paid under the Sub-Advisory Agreement were
reasonable in light of the Sub-Advisor's experience, but the Independent
Trustees recommended, and the Board approved, that the Sub-Advisory Agreement be
for an initial one-year term.
The Trustees considered the Advisor's representation that the Fund's overall fee
structure is not structured to pass the benefits of economies of scale on to
shareholders as assets grow, but noted that assets are not expected to grow
significantly after the initial issuance of shares since additional shares are
expected to be issued only through the Fund's dividend reinvestment plan. The
Trustees noted that the Advisor intended to continue to make investments in
infrastructure and personnel. The Board considered the estimated level of profit
to the Advisor under the Agreement and noted that a portion of the fee payable
by the Fund to the Advisor would then be paid to the Sub-Advisor. They took this
and other costs to be borne by the Advisor in connection with its services to be
performed under the Agreement into consideration in analyzing the estimated
profitability. The Trustees noted that the Advisor was unable to estimate the
profitability of the Agreement to the Advisor, but they concluded that the
anticipated profitability was not unreasonable. The Board did not consider an
estimated level of profit to the Sub-Advisor under the Sub-Advisory Agreement,
although the Trustees did review the pro forma income statement prepared by the
Sub-Advisor. The Board considered that the Advisor and Sub-Advisor had
identified as a fall out benefit their exposure to investors and brokers who, in
the absence of the Fund, may have had no dealings with them.
After discussion, the Board of Trustees, including the Independent Trustees,
concluded that the Advisor and Sub-Advisor had the capabilities, resources and
personnel necessary to manage the Fund. Based upon such information as they
considered necessary to the exercise of their reasonable business judgment, the
Trustees concluded unanimously that it was in the best interests of the Fund to
approve the Agreement and the Sub-Advisory Agreement.
Page 19
- --------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS (UNAUDITED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006
Information pertaining to the Trustees and officers* of the Fund is set forth below.
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
- ---------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
- ---------------------------------------------------------------------------------------------------------------------------
Richard E. Erickson, Trustee o One year term Physician; 34 portfolios None
D.O.B. 04/51 o 7 months served President, Wheaton
c/o First Trust Advisors L.P. Orthopedics;
1001 Warrenville Road Co-owner and
Suite 300 Co-Director, Sports
Lisle, IL 60532 Med Center for
Fitness; Limited
Partner, Gundersen
Real Estate
Partnership
Thomas R. Kadlec, Trustee o One year term Vice President and 34 portfolios None
D.O.B. 11/57 o 7 months served Chief Financial
c/o First Trust Advisors L.P. Officer (1990 to
1001 Warrenville Road present), ADM
Suite 300 Investor Services,
Lisle, IL 60532 Inc. (Futures
Commission
Merchant);
Registered
Representative (2000
to present),
Segerdahl & Company,
Inc., an NASD member
(Broker-Dealer);
President, ADM
Derivatives, Inc.
(May 2005 to present)
Robert F. Keith, Trustee o One year term President, Hibs 22 portfolios None
D.O.B. 11/56 o 5 months served Enterprises
c/o First Trust Advisors L.P. (Financial and
1001 Warrenville Road Management
Suite 300 Consulting) (2003 to
Lisle, IL 60532 present); Aramark
Service Master
Management (2001 to
2003); President and
Chief Operating
Officer, Service
Master Management
Services (1998 to
2003)
Niel B. Nielson, Trustee o One year term President, Covenant 34 portfolios Director of Good News
D.O.B. 03/54 o 7 months served College (June 2002 Publishers-Crossway
c/o First Trust Advisors L.P. to resent); Pastor, Books; Covenant
1001 Warrenville Road College Church in Transport, Inc.
Suite 300 Wheaton (1997 to
Lisle, IL 60532 June 2002)
Page 20
- --------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS (UNAUDITED) - (CONTINUED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006
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
- ---------------------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
- ---------------------------------------------------------------------------------------------------------------------------
James A. Bowen, Trustee, o One year Trustee President, First 34 portfolios Trustee of Wheaton
President, Chairman of the term and indefinite Trust Advisors L.P. College
Board and CEO officer term and First Trust
D.O.B. 09/55 o 7 months served Portfolios L.P.;
1001 Warrenville Road Chairman of the
Suite 300 Board, BondWave LLC
Lisle, IL 60532 (software
development
company/Broker-Dealer)
and Stonebridge
Advisors LLC
- ---------------------------------------------------------------------------------------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES
- ---------------------------------------------------------------------------------------------------------------------------
Mark R. Bradley, Treasurer, o Indefinite term Chief Financial N/A N/A
Controller, Chief Financial o 7 months served Officer, Managing
Officer, Chief Accounting Director, First
Officer Trust Advisors L.P.
D.O.B. 11/57 and First Trust
1001 Warrenville Road Portfolios L.P.;
Suite 300 Chief Financial
Lisle, IL 60532 Officer, BondWave
LLC and Stonebridge
Advisors LLC
Susan M. Brix o Indefinite term Representative, N/A N/A
Assistant Vice President o 7 months served First Trust
D.O.B. 01/60 Portfolios L.P.;
1001 Warrenville Road Assistant Portfolio
Suite 300 Manager, First Trust
Lisle, IL 60532 Advisors L.P.
Robert F. Carey o Indefinite term Senior Vice N/A N/A
Vice President o 7 months served President, First
D.O.B. 07/63 Trust Advisors L.P.
1001 Warrenville Road and First Trust
Suite 300 Portfolios L.P.
Lisle, IL 60532
James M. Dykas o Indefinite term Vice President, N/A N/A
Assistant Treasurer o 7 months served First Trust Advisors
D.O.B. 01/66 L.P. and First Trust
1001 Warrenville Road Portfolios L.P.
Suite 300 (January 2005 to
Lisle, IL 60532 present); Executive
Director, Van Kampen
Asset Management and
Morgan Stanley
Investment
Management
(1999-2005)
Page 21
- --------------------------------------------------------------------------------
BOARD OF TRUSTEES AND OFFICERS (UNAUDITED) - (CONTINUED)
- --------------------------------------------------------------------------------
FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
OCTOBER 31, 2006
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
- ---------------------------------------------------------------------------------------------------------------------------
OFFICERS WHO ARE NOT TRUSTEES- (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------------------
W. Scott Jardine, Secretary o Indefinite term General Counsel, N/A N/A
and Chief Compliance o 7 months served First Trust Advisors
Officer L.P. 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
Daniel J. Lindquist o Indefinite term Senior Vice N/A N/A
Vice President o 7 months served President, First
D.O.B. 02/70 Trust Advisors L.P.
1001 Warrenville Road and First Trust
Suite 300 Portfolios L.P.
Lisle, IL 60532 (April 2004 to
present); Chief
Operating Officer,
Mina Capital
Management, LLC
(January 2004-April
2004); Chief
Operating Officer,
Samaritan Asset
Management Services,
Inc. (April
2000-January 2004)
Kristi A. Maher o Indefinite term Assistant General N/A N/A
Assistant Secretary o 7 months served Counsel, First Trust
D.O.B.12/66 Advisors L.P. and
1001 Warrenville Road First Trust
Suite 300 Portfolios L.P.
Lisle, IL 60532 (March 2004 to
present); Associate,
Chapman and Cutler
LLP (1995-2004)
Roger F. Testin o Indefinite term Senior Vice N/A N/A
Vice President o 7 months served President, First
D.O.B 06/66 Trust Advisors L.P.
1001 Warrenville Road and First Trust
Suite 300 Portfolios L.P.
Lisle, IL 60532 (August 2001 to
present); Analyst,
Dolan Capital
Management
(1998-2001)
- -----------------------------------------
* The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 22
This Page Left Blank Intentionally.
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 and Robert F. Keith are qualified
to serve as audit committee financial experts serving on its audit committee and
that each of them is "independent," as defined by Item 3 of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) AUDIT FEES (REGISTRANT) -- The aggregate fees billed from
Registrant's inception on June 27, 2006 through October 31, 2006, 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 years were $35,000.
(b) AUDIT-RELATED FEES (REGISTRANT) -- The aggregate fees billed from
Registrant's inception on June 27, 2006 through October 31, 2006, 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 Registrant's inception on June 27, 2006 through October 31, 2006,
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.
(c) TAX FEES (REGISTRANT) -- The aggregate fees billed from
Registrant's inception on June 27, 2006 through October 31, 2006 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
Registrant's inception on June 27, 2006 through October 31, 2006 for
professional services rendered by the principal accountant for tax compliance,
tax advice, and tax planning to the Registrant's investment adviser were $0.
(d) ALL OTHER FEES (REGISTRANT) -- The aggregate fees billed from
Registrant's inception on June 27, 2006 through October 31, 2006, 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 Registrant's inception on June 20, 2006 through October 31, 2006, 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, both amended as of December 10, 2006, 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 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) 0%
(d) 0%
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most
recent fiscal year that were attributed to work performed by persons
other than the principal accountant's full-time, permanent employees
was less than fifty percent.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's
investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen by
another investment adviser), and any entity controlling, controlled by,
or under common control with the adviser that provides ongoing services
to the Registrant from the Registrant's inception on June 27, 2006
through October 31, 2006 were $0 for the Registrant and $25,000 for the
Registrant's investment adviser.
(h) On December 10, 2006, the Registrant's audit committee of its Board of
Trustees determined that the provision of non-audit services that were
rendered to the Registrant's investment adviser (not including any
sub-adviser whose role is primarily portfolio management and is
subcontracted with or overseen by another investment adviser), and any
entity controlling, controlled by, or under common control with the
investment adviser that provides ongoing services to the Registrant
that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X is compatible with maintaining the principal
accountant's independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
(a) The Registrant has a separately designated audit committee consisting of
all the independent directors of the Registrant. The members of the audit
committee are: Thomas R. Kadlec, Niel B. Nielson, Richard E. Erickson and
Robert F. Keith.
ITEM 6. 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.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Proxy Voting Policies are attached herewith.
FIRST TRUST ADVISORS, L.P.
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
- --------------------------------------------------------------------------------
ISS 2006 US PROXY VOTING GUIDELINES
SUMMARY
- --------------------------------------------------------------------------------
[LOGO] ISS
INSTITUTIONAL SHAREHOLDER SERVICES
2099 GAITHER ROAD
SUITE 501
ROCKVILLE, MD 20850-4045
(301) 556-0500
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WWW.ISSPROXY.COM
Copyright (C) 2005 by Institutional Shareholder Services.
All rights reserved. No part of this publication may be reproduced or
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Requests for permission to make copies of any part of this work should be sent
to:
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ISS is a trademark used herein under license.
================================================================================
ISS 2006 PROXY VOTING GUIDELINES SUMMARY
EFFECTIVE FOR MEETINGS FEB 1, 2006
UPDATED DEC 19, 2005
The following is a condensed version of the proxy voting recommendations
contained in the ISS Proxy Voting Manual.
1. OPERATIONAL ITEMS ........................................................ 6
Adjourn Meeting ....................................................... 6
Amend Quorum Requirements ............................................. 6
Amend Minor Bylaws .................................................... 6
Change Company Name ................................................... 6
Change Date, Time, or Location of Annual Meeting ...................... 6
Ratifying Auditors .................................................... 6
Transact Other Business ............................................... 6
2. BOARD OF DIRECTORS: ...................................................... 7
Voting on Director Nominees in Uncontested Elections .................. 7
2006 Classification of Directors ...................................... 9
Age Limits ............................................................ 10
Board Size ............................................................ 10
Classification/Declassification of the Board .......................... 10
Cumulative Voting ..................................................... 10
Director and Officer Indemnification and Liability Protection ......... 11
Establish/Amend Nominee Qualifications ................................ 11
Filling Vacancies/Removal of Directors ................................ 11
Independent Chair (Separate Chair/CEO) ................................ 11
Majority of Independent Directors/Establishment of Committees ......... 12
Majority Vote Shareholder Proposals ................................... 12
Office of the Board ................................................... 13
Open Access ........................................................... 13
Stock Ownership Requirements .......................................... 13
Term Limits ........................................................... 13
3. PROXY CONTESTS ........................................................... 14
Voting for Director Nominees in Contested Elections ................... 14
Reimbursing Proxy Solicitation Expenses ............................... 14
Confidential Voting ................................................... 14
4. ANTITAKEOVER DEFENSES AND VOTING RELATED ISSUES .......................... 15
Advance Notice Requirements for Shareholder Proposals/Nominations ..... 15
Amend Bylaws without Shareholder Consent .............................. 15
Poison Pills .......................................................... 15
Shareholder Ability to Act by Written Consent ......................... 15
Shareholder Ability to Call Special Meetings .......................... 15
Supermajority Vote Requirements ....................................... 15
5. MERGERS AND CORPORATE RESTRUCTURINGS ..................................... 16
Overall Approach ...................................................... 16
================================================================================
(C) 2005 Institutional Shareholder Services Inc. All Rights Reserved. 2
================================================================================
Appraisal Rights ...................................................... 16
Asset Purchases ....................................................... 16
Asset Sales ........................................................... 17
Bundled Proposals ..................................................... 17
Conversion of Securities .............................................. 17
Corporate Reorganization/Debt Restructuring/Prepackaged Bankruptcy
Plans/Reverse Leveraged Buyouts/Wrap Plans ............................ 17
Formation of Holding Company .......................................... 17
Going Private Transactions (LBOs, Minority Squeezeouts, and
Going Dark) .......................................................... 18
Joint Ventures ....................................................... 18
Liquidations ......................................................... 18
Mergers and Acquisitions/ Issuance of Shares to Facilitate Merger
or Acquisition ....................................................... 18
Private Placements/Warrants/Convertible Debentures ................... 18
Spinoffs ............................................................. 19
Value Maximization Proposals ......................................... 19
6. STATE OF INCORPORATION .................................................. 20
Control Share Acquisition Provisions ................................. 20
Control Share Cash-out Provisions .................................... 20
Disgorgement Provisions .............................................. 20
Fair Price Provisions ................................................ 20
Freeze-out Provisions ................................................ 20
Greenmail ............................................................ 20
Reincorporation Proposals ............................................ 21
Stakeholder Provisions ............................................... 21
State Antitakeover Statutes .......................................... 21
7. CAPITAL STRUCTURE ....................................................... 22
Adjustments to Par Value of Common Stock ............................. 22
Common Stock Authorization ........................................... 22
Dual-Class Stock ..................................................... 22
Issue Stock for Use with Rights Plan ................................. 22
Preemptive Rights .................................................... 22
Preferred Stock ...................................................... 22
Recapitalization ..................................................... 23
Reverse Stock Splits ................................................. 23
Share Repurchase Programs ............................................ 23
Stock Distributions: Splits and Dividends ............................ 23
Tracking Stock ....................................................... 23
8. EXECUTIVE AND DIRECTOR COMPENSATION ...................................... 24
Equity Compensation Plans ................................................ 24
Cost of Equity Plans .................................................. 24
Repricing Provisions .................................................. 24
Pay-for Performance Disconnect ........................................ 24
Three-Year Burn Rate/Burn Rate Commitment ............................. 26
Poor Pay Practices .................................................... 27
Specific Treatment of Certain Award Types in Equity Plan Evaluations:..... 28
Dividend Equivalent Rights ............................................ 28
Liberal Share Recycling Provisions .................................... 28
Transferable Stock Option Awards ...................................... 28
Other Compensation Proposals and Policies ................................ 28
401(k) Employee Benefit Plans ......................................... 28
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(C) 2005 Institutional Shareholder Services Inc. All Rights Reserved. 3
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Director Compensation ................................................. 28
Director Retirement Plans ............................................. 29
Disclosure of CEO Compensation-Tally Sheet ............................ 29
Employee Stock Ownership Plans (ESOPs) ................................ 30
Employee Stock Purchase Plans-- Qualified Plans ....................... 30
Employee Stock Purchase Plans-- Non-Qualified Plans ................... 31
Incentive Bonus Plans and Tax Deductibility Proposals (OBRA-Related ... 31
Compensation Proposals) ............................................... 31
Option Exchange Programs/Repricing Options ............................ 31
Stock Plans in Lieu of Cash ........................................... 32
Transfer Programs of Stock Options .................................... 32
Shareholder Proposals on Compensation .................................... 32
Disclosure/Setting Levels or Types of Compensation for Executives
and Directors ......................................................... 32
Option Expensing ...................................................... 33
Option Repricing ...................................................... 33
Pension Plan Income Accounting ........................................ 33
Performance-Based Awards .............................................. 33
Severance Agreements for Executives/Golden Parachutes ................. 33
Supplemental Executive Retirement Plans (SERPs) ....................... 33
9. CORPORATE RESPONSIBILITY ................................................. 34
Consumer Issues and Public Safety ........................................ 34
Animal Rights ......................................................... 34
Drug Pricing .......................................................... 34
Drug Reimportation .................................................... 34
Genetically Modified Foods ............................................ 34
Handguns .............................................................. 35
HIV/AIDS .............................................................. 35
Predatory Lending ..................................................... 35
Tobacco ............................................................... 36
Toxic Chemicals ....................................................... 36
Environment and Energy ................................................... 37
Arctic National Wildlife Refuge ....................................... 37
CERES Principles ...................................................... 37
Concentrated Area Feeding Operations (CAFOs) .......................... 37
Environmental-Economic Risk Report .................................... 37
Environmental Reports ................................................. 37
Global Warming ........................................................ 37
Kyoto Protocol Compliance ............................................. 38
Land Use .............................................................. 38
Nuclear Safety ........................................................ 38
Operations in Protected Areas ......................................... 38
Recycling ............................................................. 38
Renewable Energy ...................................................... 38
Sustainability Report ................................................. 39
General Corporate Issues ................................................. 39
Charitable/Political Contributions .................................... 39
Link Executive Compensation to Social Performance ..................... 39
Outsourcing/Offshoring ................................................ 40
Labor Standards and Human Rights ......................................... 40
China Principles ...................................................... 40
Country-specific Human Rights Reports ................................. 40
International Codes of Conduct/Vendor Standards ....................... 40
MacBride Principles ................................................... 41
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Military Business ....................................................... 41
Foreign Military Sales/Offsets ....................................... 41
Landmines and Cluster Bombs .......................................... 41
Nuclear Weapons ...................................................... 41
Operations in Nations Sponsoring Terrorism (e.g., Iran) .............. 42
Spaced-Based Weaponization ........................................... 42
Workplace Diversity ..................................................... 42
Board Diversity ..................................................... 42
Equal Employment Opportunity (EEO) ................................... 42
Glass Ceiling ........................................................ 42
Sexual Orientation ................................................... 43
10. MUTUAL FUND PROXIES .................................................... 44
Election of Directors ................................................ 44
Converting Closed-end Fund to Open-end Fund .......................... 44
Proxy Contests ....................................................... 44
Investment Advisory Agreements ....................................... 44
Approving New Classes or Series of Shares ............................ 44
Preferred Stock Proposals ............................................ 44
1940 Act Policies .................................................... 44
Changing a Fundamental Restriction to a Nonfundamental Restriction ... 45
Change Fundamental Investment Objective to Nonfundamental ............ 45
Name Change Proposals ................................................ 45
Change in Fund's Subclassification ................................... 45
Disposition of Assets/Termination/Liquidation ........................ 45
Changes to the Charter Document ...................................... 45
Changing the Domicile of a Fund ...................................... 46
Authorizing the Board to Hire and Terminate Subadvisors Without
Shareholder Approval ................................................. 46
Distribution Agreements .............................................. 46
Master-Feeder Structure .............................................. 46
Mergers .............................................................. 46
Shareholder Proposals for Mutual Funds ..................................... 46
Establish Director Ownership Requirement ............................. 46
Reimburse Shareholder for Expenses Incurred .......................... 46
Terminate the Investment Advisor ..................................... 46
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1. OPERATIONAL ITEMS
ADJOURN MEETING
Generally vote AGAINST proposals to provide management with the authority to
adjourn an annual or special meeting absent compelling reasons to support the
proposal.
Vote FOR proposals that relate specifically to soliciting votes for a merger or
transaction if supporting that merger or transaction. Vote AGAINST proposals if
the wording is too vague or if the proposal includes "other business."
AMEND QUORUM REQUIREMENTS
Vote AGAINST proposals to reduce quorum requirements for shareholder meetings
below a majority of the shares outstanding unless there are compelling reasons
to support the proposal.
AMEND MINOR BYLAWS
Vote FOR bylaw or charter changes that are of a housekeeping nature (updates or
corrections).
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 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, or
o Fees for non-audit services ("Other" fees) are excessive.
Non-audit fees are excessive if:
Non-audit ("other") fees >audit fees + audit-related fees + tax
compliance/preparation fees
Tax compliance and preparation include the preparation of original and amended
tax returns, refund claims and tax payment planning. All other services in the
tax category, such as tax advice, planning or consulting should be added to
"Other" fees. If the breakout of tax fees cannot be determined, add all tax fees
to "Other" fees.
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.
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2. BOARD OF DIRECTORS:
VOTING ON DIRECTOR NOMINEES IN UNCONTESTED ELECTIONS
Vote CASE-BY-CASE on director nominees, examining, but not limited to, the
following factors:
o Composition of the board and key board committees;
o Attendance at board and committee meetings;
o Corporate governance provisions and takeover activity;
o Disclosures under Section 404 of Sarbanes-Oxley Act;
o Long-term company performance relative to a market and peer index;
o Extent of the director's investment in the company;
o Existence of related party transactions;
o Whether the chairman is also serving as CEO;
o Whether a retired CEO sits on the board;
o Number of outside boards at which a director serves.
WITHHOLD from individual directors who:
o Attend less than 75 percent of the board and committee meetings
without a valid excuse (such as illness, service to the nation, work
on behalf of the company);
o Sit on more than six public company boards;
o Are CEOs of public companies who sit on the boards of more than two
public companies besides their own-- withhold only at their outside
boards.
WITHHOLD from the entire board of directors, (excepting new nominees, who should
be considered on a CASE-BY-CASE basis) if:
o The company's poison pill has a dead-hand or modified dead-hand
feature. Withhold every year until this feature is removed;
o The board adopts or renews a poison pill without shareholder
approval since the beginning of 2005, does not commit to putting it
to shareholder vote within 12 months of adoption or reneges on a
commitment to put the pill to a vote and has not yet been withheld
from for this issue;
o The board failed to act on a shareholder proposal that received
approval by a majority of the shares outstanding the previous year;
o The board failed to act on a shareholder proposal that received
approval of the majority of shares cast for the previous two
consecutive years;
o The board failed to act on takeover offers where the majority of the
shareholders tendered their shares;
o At the previous board election, any director received more than 50
percent withhold votes of the shares cast and the company has failed
to address the issue(s) that caused the high withhold rate;
o A Russell 3000 company underperformed its industry group (GICS
group). The test will consist of the bottom performers within each
industry group (GICS) based on a weighted average TSR. The
weightings are as follows: 20 percent weight on 1-year TSR; 30
percent weight on 3-year TSR; and 50 percent weight on 5-year TSR.
Company's response to performance issues will be considered before
withholding.
WITHHOLD from Inside Directors and Affiliated Outside Directors (per the
Classification of Directors below) when:
o The inside or affiliated outside director serves on any of the three
key committees: audit, compensation, or nominating;
o The company lacks an audit, compensation, or nominating committee so
that the full board functions as that committee;
o The full board is less than majority independent.
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WITHHOLD from the members of the Audit Committee if:
o The non -audit fees paid to the auditor are excessive (see
discussion under Ratifying Auditors);
o A material weakness identified in the Section 404 Sarbanes-Oxley Act
disclosures rises to a level of serious concern; there are chronic
internal control issues and an absence of established effective
control mechanisms.
WITHHOLD from the members of the Compensation Committee if:
o There is a negative correlation between chief executive pay and
company performance (see discussion under Equity Compensation
Plans);
o The company fails to submit one-time transfers of stock options to a
shareholder vote;
o The company fails to fulfill the terms of a burn rate commitment
they made to shareholders;
o The company has poor compensation practices, which include, but are
not limited to:
- Egregious employment contracts including excessive severance
provisions;
- Excessive perks that dominate compensation;
- Huge bonus payouts without justifiable performance linkage;
- Performance metrics that are changed during the performance
period;
- Egregious SERP (Supplemental Executive Retirement Plans)
payouts;
- New CEO with overly generous new hire package;
- Internal pay disparity;
- Other excessive compensation payouts or poor pay practices at
the company.
WITHHOLD from directors, individually or the entire board, for egregious actions
or failure to replace management as appropriate.
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2006 CLASSIFICATION OF DIRECTORS
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INSIDE DIRECTOR (I)
o Employee of the company or one of its affiliates; 1
o Non-employee officer of the company if among the five most highly
paid individuals (excluding interim CEO);
o Listed as a Section 16 officer; 2
o Current interim CEO;
o Beneficial owner of more than 50 percent of the company's voting
power (this may be aggregated if voting power is distributed among
more than one member of a defined group).
AFFILIATED OUTSIDE DIRECTOR (AO)
o Board attestation that an outside director is not independent;
o Former CEO of the company;
o Former CEO of an acquired company within the past five years;
o Former interim CEO if the service was longer than 18 months. If the
service was between twelve and eighteen months an assessment of the
interim CEO's employment agreement will be made; 3
o Former executive of the company, an affiliate or an acquired firm
within the past five years;
o Executive of a former parent or predecessor firm at the time the
company was sold or split off from the parent/predecessor within the
past five years;
o Executive, former executive, general or limited partner of a joint
venture or partnership with the company;
o Relative 4 of a current employee of company or its affiliates;
o Relative 4 of former executive, including CEO, of company or its
affiliate within the last five years;
o Currently provides (or a relative provides) professional services
directly to the company, to an affiliate of the company or an
individual officer of the company or one of its affiliates;
o Employed by (or a relative is employed by) a significant customer or
supplier; 5
o Has (or a relative has) any transactional relationship with the
company or its affiliates excluding investments in the company
through a private placement; 5
o Any material financial tie or other related party transactional
relationship to the company;
o Party to a voting agreement to vote in line with management on
proposals being brought to shareholder vote;
o Has (or a relative has) an interlocking relationship as defined by
the SEC involving members of the board of directors or its
Compensation and Stock Option Committee; 6
o Founder 7 of the company but not currently an employee;
o Is (or a relative is) a trustee, director or employee of a
charitable or non-profit organization that receives grants or
endowments 5 from the company or its affiliates. 1
INDEPENDENT OUTSIDE DIRECTOR (IO)
o No material 8 connection to the company other than a board seat.
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FOOTNOTES:
1 "Affiliate" includes a subsidiary, sibling company, or parent company. ISS
uses 50 percent control ownership by the parent company as the standard
for applying its affiliate designation.
2 "Executives" (officers subject to Section 16 of the Securities and
Exchange Act of 1934) include the chief executive, operating, financial,
legal, technology, and accounting officers of a company (including the
president, treasurer, secretary, controller, or any vice president in
charge of a principal business unit, division or policy function).
3 ISS will look at the terms of the interim CEO's employment contract to
determine if it contains severance pay, long-term health and pension
benefits or other such standard provisions typically contained in
contracts of permanent, non-temporary CEOs. ISS will also consider if a
formal search process was underway for a full-time CEO at the time.
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4 "Relative" follows the NYSE definition of "immediate family members" which
covers: spouses, parents, children, siblings, in-laws, and anyone sharing
the director's home.
5 If the company makes or receives annual payments exceeding the greater of
$200,000 or five percent of the recipient's gross revenues. (The recipient
is the party receiving the financial proceeds from the transaction).
6 Interlocks include: (a) executive officers serving as directors on each
other's compensation or similar committees (or, in the absence of such a
committee, on the board) or (b) executive officers sitting on each other's
boards and at least one serves on the other's compensation or similar
committees (or, in the absence of such a committee, on the board).
7 The operating involvement of the Founder with the company will be
considered. Little to no operating involvement may cause ISS to deem the
Founder as an independent outsider.
8 For purposes of ISS' director independence classification, "material" will
be defined as a standard of relationship (financial, personal or
otherwise) that a reasonable person might conclude could potentially
influence one's objectivity in the boardroom in a manner that would have a
meaningful impact on an individual's ability to satisfy requisite
fiduciary standards on behalf of shareholders.
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AGE LIMITS
Vote AGAINST shareholder or management proposals to limit the tenure of outside
directors through mandatory retirement ages.
BOARD SIZE
Vote FOR proposals seeking to fix the board size or designate a range for the
board size. Vote AGAINST proposals that give management the ability to alter the
size of the board outside of a specified range without shareholder approval.
CLASSIFICATION/DECLASSIFICATION OF THE BOARD
Vote AGAINST proposals to classify the board.
Vote FOR proposals to repeal classified boards and to elect all directors
annually.
CUMULATIVE VOTING
Generally vote AGAINST proposals to eliminate cumulative voting. Vote
CASE-BY-CASE if the company has in place one of the three corporate governance
structures that are listed below.
Vote CASE-BY-CASE on proposals to restore or permit cumulative voting. If one of
these three structures is present, vote AGAINST the proposal:
o the presence of a majority threshold voting standard;
o a proxy access provision in the company's bylaws or governance
documents; or
o a counterbalancing governance structure coupled with acceptable
relative performance.
The counterbalancing governance structure coupled with acceptable relative
performance should include all of the following:
o Annually elected board;
o Two-thirds of the board composed of independent directors;
o Nominating committee composed solely of independent directors;
o Confidential voting; however, there may be a provision for
suspending confidential voting during proxy contests;
o Ability of shareholders to call special meetings or act by written
consent with 90 days' notice;
o Absence of superior voting rights for one or more classes of stock;
o Board does not have the right to change the size of the board beyond
a stated range that has been approved by shareholders;
o The company has not under-performed its peers and index on a
one-year and three-year basis, unless there has been a change in the
CEO position within the last three years;
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o No director received WITHHOLD votes of 35% or more of the votes cast
in the previous election.
DIRECTOR AND OFFICER INDEMNIFICATION AND LIABILITY PROTECTION
Vote CASE-BY-CASE on proposals on director and officer indemnification and
liability protection using Delaware law as the standard.
Vote AGAINST proposals to eliminate entirely directors' and officers' liability
for monetary damages for violating the duty of care.
Vote AGAINST indemnification proposals that would expand coverage beyond just
legal expenses to 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 If only 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 shareholders' ability to remove directors with or
without cause.
Vote AGAINST proposals that provide that only continuing directors may elect
replacements to fill board vacancies.
Vote FOR proposals that permit shareholders to elect directors to fill board
vacancies.
INDEPENDENT CHAIR (SEPARATE CHAIR/CEO)
Generally vote FOR shareholder proposals requiring the position of chair 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; however the director must serve a minimum
of one year in order to qualify as a lead director.) At a minimum
these should include:
- Presides at all meetings of the board at which the chairman is
not present, including executive sessions of the independent
directors,
- Serves as liaison between the chairman and the independent
directors,
- Approves information sent to the board,
- Approves meeting agendas for the board,
- Approves meetings schedules to assure that there is sufficient
time for discussion of all agenda items,
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- Has the authority to call meetings of the independent
directors,
- If requested by major shareholders, ensures that he is
available for consultation and direct communication;
o Two-thirds independent board;
o All-independent key committees;
o Established governance guidelines;
o The company does not under-perform 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.
MAJORITY VOTE SHAREHOLDER PROPOSALS
Generally vote FOR reasonably crafted shareholders proposals calling for
directors to be elected with an affirmative majority of votes cast and/or the
elimination of the plurality standard for electing directors (including binding
resolutions requesting that the board amend the company's bylaws), provided the
proposal includes a carve-out for a plurality voting standard when there are
more director nominees than board seats (e.g. contested elections).
Consider voting AGAINST the shareholder proposal if the company has adopted
formal corporate governance principles that present a meaningful alternative to
the majority voting standard and provide an adequate response to both new
nominees as well as incumbent nominees who fail to receive a majority of votes
cast.
Policies should address the specific circumstances at each company. At a
minimum, a company's policy should articulate the following elements to
adequately address each director nominee who fails to receive an affirmative of
majority of votes cast in an election:
o Established guidelines disclosed annually in the proxy statement
concerning the process to follow for nominees who receive majority
withhold votes;
o The policy needs to outline a clear and reasonable timetable for all
decision-making regarding the nominee's status;
o The policy needs to specify that the process of determining the
nominee's status will be managed by independent directors and must
exclude the nominee in question;
o An outline of a range of remedies that can be considered concerning
the nominee needs to be in the policy (for example, acceptance of
the resignation, maintaining the director but curing the underlying
causes of the withheld votes, etc.);
o The final decision on the nominee's status should be promptly
disclosed via an SEC filing. The policy needs to include the
timeframe in which the decision will be disclosed and a full
explanation of how the decision was reached.
In addition, the company should articulate to shareholders why this alternative
to a full majority threshold voting standard is the best structure at this time
for demonstrating accountability to shareholders. Also evaluate the company's
history of accountability to shareholders in its governance structure and in its
actions. In particular, a classified board structure or a history of ignoring
majority supported shareholder proposals will be considered at a company which
receives a shareholder proposal requesting the elimination of plurality voting
in favor of majority threshold for electing directors.
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OFFICE OF THE BOARD
Generally vote FOR shareholders proposals requesting that the board establish an
Office of the Board of Directors in order to facilitate direct communications
between shareholders and non-management directors, unless the company has all of
the following:
o Established a communication structure that goes beyond the exchange
requirements to facilitate the exchange of information between
shareholders and members of the board;
o Effectively disclosed information with respect to this structure to
its shareholders;
o Company has not ignored majority supported shareholder proposals or
a majority WITHHOLD on a director nominee; and
o The company has an independent chairman or a lead/presiding
director, according to ISS' definition. This individual must be made
available for periodic consultation and direct communication with
major shareholders.
OPEN ACCESS
Generally vote FOR reasonably crafted shareholder proposals providing
shareholders with the ability to nominate director candidates to be included on
management's proxy card, provided the proposal substantially mirrors the SEC's
proposed two-trigger formulation (see the proposed "Security Holder Director
Nominations" rule (HTTP://WWW.SEC.GOV/RULES/PROPOSED/34-48626.HTM) or ISS'
comment letter to the SEC dated 6/13/2003, available on ISS website under
Governance Center- ISS Position Papers).
STOCK OWNERSHIP REQUIREMENTS
Generally vote AGAINST shareholder proposals that mandate a minimum amount of
stock that directors must own in order to qualify as a director or to remain on
the board. While stock ownership on the part of directors is desired, the
company should determine the appropriate ownership requirement.
Vote CASE-BY-CASE on shareholder proposals asking that the company adopt a
holding or retention period for its executives (for holding stock after the
vesting or exercise of equity awards), taking into account any stock ownership
requirements or holding period/retention ratio already in place and the actual
ownership level of executives.
TERM LIMITS
Vote AGAINST shareholder or management proposals to limit the tenure of outside
directors through term limits. However, scrutinize boards where the average
tenure of all directors exceeds 15 years for independence from management and
for sufficient turnover to ensure that new perspectives are being added to the
board.
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3. PROXY CONTESTS
VOTING FOR DIRECTOR NOMINEES IN CONTESTED ELECTIONS
Vote CASE-BY-CASE on the election of directors in contested elections,
considering the following factors:
o Long-term financial performance of the target company relative to
its industry;
o Management's track record;
o Background to the proxy contest;
o Qualifications of director nominees (both slates);
o Strategic plan of dissident slate and quality of critique against
management;
o Likelihood that the proposed goals and objectives can be achieved
(both slates);
o Stock ownership positions.
REIMBURSING PROXY SOLICITATION EXPENSES
Vote CASE-BY-CASE on proposals to reimburse proxy solicitation expenses. When
voting in conjunction with support of a dissident slate, vote FOR the
reimbursement of all appropriate proxy solicitation expenses associated with the
election.
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.
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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 UNLESS the company has: (1) A
shareholder approved poison pill in place; or (2) The company has adopted a
policy concerning the adoption of a pill in the future specifying that the board
will only adopt a shareholder rights plan if either:
o Shareholders have approved the adoption of the plan; or
o The board, in its exercise of its fiduciary responsibilities,
determines that it is in the best interest of shareholders under the
circumstances to adopt a pill without the delay in adoption that
would result from seeking stockholder approval (i.e. the "fiduciary
out" provision). A poison pill adopted under this fiduciary out will
be put to a shareholder ratification vote within twelve months of
adoption or expire. If the pill is not approved by a majority of the
votes cast on this issue, the plan will immediately terminate.
Vote FOR shareholder proposals calling for poison pills to be put to a vote
within a time period of less than one year after adoption. If the company has no
non-shareholder approved poison pill in place and has adopted a policy with the
provisions outlined above, vote AGAINST the proposal. If these conditions are
not met, vote FOR the proposal, but with the caveat that a vote within twelve
months would be considered sufficient.
Vote CASE-by-CASE on management proposals on poison pill ratification, focusing
on the features of the shareholder rights plan. Rights plans should contain the
following attributes:
o No lower than a 20% trigger, flip-in or flip-over;
o A term of no more than three years;
o No dead-hand, slow-hand, no-hand or similar feature that limits the
ability of a future board to redeem the pill;
o Shareholder redemption feature (qualifying offer clause); if the
board refuses to redeem the pill 90 days after a qualifying offer is
announced, ten percent of the shares may call a special meeting or
seek a written consent to vote on rescinding the pill.
SHAREHOLDER ABILITY TO ACT BY WRITTEN CONSENT
Vote AGAINST proposals to restrict or prohibit shareholder ability to take
action by written consent.
Vote FOR proposals to allow or make easier shareholder action by written
consent.
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.
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5. MERGERS AND CORPORATE RESTRUCTURINGS
OVERALL APPROACH
For mergers and acquisitions, review and evaluate the merits and drawbacks of
the proposed transaction, balancing various and sometimes countervailing factors
including:
o VALUATION - Is the value to be received by the target shareholders
(or paid by the acquirer) reasonable? While the fairness opinion may
provide an initial starting point for assessing valuation
reasonableness, emphasis is placed on the offer premium, market
reaction and strategic rationale.
o MARKET REACTION - How has the market responded to the proposed deal?
A negative market reaction should cause closer scrutiny of a deal.
o STRATEGIC RATIONALE - Does the deal make sense strategically? From
where is the value derived? Cost and revenue synergies should not be
overly aggressive or optimistic, but reasonably achievable.
Management should also have a favorable track record of successful
integration of historical acquisitions.
o NEGOTIATIONS AND PROCESS - Were the terms of the transaction
negotiated at arm's-length? Was the process fair and equitable? A
fair process helps to ensure the best price for shareholders.
Significant negotiation "wins" can also signify the deal makers'
competency. The comprehensiveness of the sales process (e.g., full
auction, partial auction, no auction) can also affect shareholder
value.
o CONFLICTS OF INTEREST - Are insiders benefiting from the transaction
disproportionately and inappropriately as compared to non-insider
shareholders? As the result of potential conflicts, the directors
and officers of the company may be more likely to vote to approve a
merger than if they did not hold these interests. Consider whether
these interests may have influenced these directors and officers to
support or recommend the merger. The CIC figure presented in the
"ISS Transaction Summary" section of this report is an aggregate
figure that can in certain cases be a misleading indicator of the
true value transfer from shareholders to insiders. Where such figure
appears to be excessive, analyze the underlying assumptions to
determine whether a potential conflict exists.
o GOVERNANCE - Will the combined company have a better or worse
governance profile than the current governance profiles of the
respective parties to the transaction? If the governance profile is
to change for the worse, the burden is on the company to prove that
other issues (such as valuation) outweigh any deterioration in
governance.
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 Non-completion risk.
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ASSET SALES
Vote CASE-BY-CASE on asset sales, 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
Vote CASE-BY-CASE on bundled or "conditional" proxy proposals. In the case of
items that are conditioned upon each other, examine the benefits and costs of
the packaged items. In instances when the joint effect of the conditioned items
is not in shareholders' best interests, vote AGAINST the proposals. If the
combined effect is positive, support such proposals.
CONVERSION OF SECURITIES
Vote CASE-BY-CASE on proposals regarding conversion of securities. When
evaluating these proposals the investor should review the dilution to existing
shareholders, the conversion price relative to market value, financial issues,
control issues, termination penalties, and conflicts of interest.
Vote FOR the conversion if it is expected that the company will be subject to
onerous penalties or will be forced to file for bankruptcy if the transaction is
not approved.
CORPORATE REORGANIZATION/DEBT RESTRUCTURING/PREPACKAGED BANKRUPTCY PLANS/REVERSE
LEVERAGED BUYOUTS/WRAP PLANS
Vote CASE-BY-CASE on proposals to increase common and/or preferred shares and to
issue shares as part of a debt restructuring plan, taking into consideration the
following:
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
Vote CASE-BY-CASE on proposals regarding the formation of a holding company,
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.
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:
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o Increases in common or preferred stock in excess of the allowable
maximum (see discussion under "Capital Structure");
o Adverse changes in shareholder rights.
GOING PRIVATE TRANSACTIONS (LBOS, MINORITY SQUEEZEOUTS, AND GOING DARK)
Vote CASE-BY-CASE on going private transactions, taking into account the
following: offer price/premium, fairness opinion, how the deal was negotiated,
conflicts of interest, other alternatives/offers considered, and non-completion
risk.
Vote CASE-BY-CASE on "going dark" transactions, determining whether the
transaction enhances shareholder value by taking into consideration:
o Whether the company has attained benefits from being publicly-traded
(examination of trading volume, liquidity, and market research of
the stock);
o Cash-out value;
o Whether the interests of continuing and cashed-out shareholders are
balanced; and
o The market reaction to public announcement of transaction.
JOINT VENTURES
Vote CASE-BY-CASE on proposals to form joint ventures, taking into account the
following:
o Percentage of assets/business contributed;
o Percentage ownership;
o Financial and strategic benefits;
o Governance structure;
o Conflicts of interest;
o Other alternatives;
o Noncompletion risk.
LIQUIDATIONS
Vote CASE-BY-CASE on liquidations, taking into account the following:
o Management's efforts to pursue other alternatives;
o Appraisal value of assets; and
o 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
Vote CASE-BY-CASE on mergers and acquisitions, determining whether the
transaction enhances shareholder value by giving consideration to items listed
under "Mergers and Corporate Restructurings: Overall Approach."
PRIVATE PLACEMENTS/WARRANTS/CONVERTIBLE DEBENTURES
Vote CASE-BY-CASE on proposals regarding private placements, taking into
consideration:
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.
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Vote FOR the private placement if it is expected that the company will file for
bankruptcy if the transaction is not approved.
SPINOFFS
Vote CASE-BY-CASE on spin-offs, considering:
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:
o Prolonged poor performance with no turnaround in sight;
o Signs of entrenched board and management;
o Strategic plan in place for improving value;
o Likelihood of receiving reasonable value in a sale or dissolution;
and
o Whether company is actively exploring its strategic options,
including retaining a financial advisor.
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6. STATE OF INCORPORATION
CONTROL SHARE ACQUISITION PROVISIONS
Control share acquisition statutes function by denying shares their voting
rights when they contribute to ownership in excess of certain thresholds. Voting
rights for those shares exceeding ownership limits may only be restored by
approval of either a majority or supermajority of disinterested shares. Thus,
control share acquisition statutes effectively require a hostile bidder to put
its offer to a shareholder vote or risk voting disenfranchisement if the bidder
continues buying up a large block of shares.
Vote FOR proposals to opt out of control share acquisition statutes unless doing
so would enable the completion of a takeover that would be detrimental to
shareholders.
Vote AGAINST proposals to amend the charter to include control share acquisition
provisions.
Vote FOR proposals to restore voting rights to the control shares.
CONTROL SHARE CASH-OUT PROVISIONS
Control share cash-out statutes give dissident shareholders the right to
"cash-out" of their position in a company at the expense of the shareholder who
has taken a control position. In other words, when an investor crosses a preset
threshold level, remaining shareholders are given the right to sell their shares
to the acquirer, who must buy them at the highest acquiring price.
Vote FOR proposals to opt out of control share cash-out statutes.
DISGORGEMENT PROVISIONS
Disgorgement provisions require an acquirer or potential acquirer of more than a
certain percentage of a company's stock to disgorge, or pay back, to the company
any profits realized from the sale of that company's stock purchased 24 months
before achieving control status. All sales of company stock by the acquirer
occurring within a certain period of time (between 18 months and 24 months)
prior to the investor's gaining control status are subject to these
recapture-of-profits provisions.
Vote FOR proposals to opt out of state disgorgement provisions.
FAIR PRICE PROVISIONS
Vote CASE-BY-CASE on proposals to adopt fair price provisions (provisions that
stipulate that an acquirer must pay the same price to acquire all shares as it
paid to acquire the control shares), evaluating factors such as the vote
required to approve the proposed acquisition, the vote required to repeal the
fair price provision, and the mechanism for determining the fair price.
Generally, vote AGAINST fair price provisions with shareholder vote requirements
greater than a majority of disinterested shares.
FREEZE-OUT PROVISIONS
Vote FOR proposals to opt out of state freeze-out provisions. Freeze-out
provisions force an investor who surpasses a certain ownership threshold in a
company to wait a specified period of time before gaining control of the
company.
GREENMAIL
Greenmail payments are targeted share repurchases by management of company stock
from individuals or groups seeking control of the company. Since only the
hostile party receives
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payment, usually at a substantial premium over the market value of its shares,
the practice discriminates against all other shareholders.
Vote FOR proposals to adopt anti-greenmail charter or bylaw amendments or
otherwise restrict a company's ability to make greenmail payments.
Vote CASE-BY-CASE on anti-greenmail proposals when they are bundled with other
charter or bylaw amendments.
REINCORPORATION PROPOSALS
Vote CASE-BY-CASE on proposals to change a company's state of incorporation,
taking into consideration both financial and corporate governance concerns,
including the reasons for reincorporating, a comparison of the governance
provisions, comparative economic benefits, and a comparison of the
jurisdictional laws.
Vote FOR re-incorporation when the economic factors outweigh any neutral or
negative governance changes.
STAKEHOLDER PROVISIONS
Vote AGAINST proposals that ask the board to consider non-shareholder
constituencies or other non-financial effects when evaluating a merger or
business combination.
STATE ANTITAKEOVER STATUTES
Vote CASE-BY-CASE on proposals to opt in or out of state takeover statutes
(including control share acquisition statutes, control share cash-out statutes,
freezeout provisions, fair price provisions, stakeholder laws, poison pill
endorsements, severance pay and labor contract provisions, anti-greenmail
provisions, and disgorgement provisions).
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7. CAPITAL STRUCTURE
ADJUSTMENTS TO PAR VALUE OF COMMON STOCK
Vote FOR management proposals to reduce the par value of common stock.
COMMON STOCK AUTHORIZATION
Vote CASE-BY-CASE on proposals to increase the number of shares of common stock
authorized for issuance using a model developed by ISS.
Vote FOR proposals to approve increases beyond the allowable increase when a
company's shares are in danger of being delisted or if a company's ability to
continue to operate as a going concern is uncertain.
In addition, for capital requests less than or equal to 300 percent of the
current authorized shares that marginally fail the calculated allowable cap
(i.e., exceed the allowable cap by no more than 5 percent), on a CASE-BY-CASE
basis, vote FOR the increase based on the company's performance and whether the
company's ongoing use of shares has shown prudence. Factors should include, at a
minimum, the following:
o Rationale;
o Good performance with respect to peers and index on a five-year
total shareholder return basis;
o Absence of non-shareholder approved poison pill;
o Reasonable equity compensation burn rate;
o No non-shareholder approved pay plans; and
o Absence of egregious equity compensation practices.
DUAL-CLASS STOCK
Vote AGAINST proposals to create a new class of common stock with superior
voting rights.
Vote AGAINST proposals at companies with dual-class capital structures to
increase the number of authorized shares of the class of stock that has superior
voting rights.
Vote FOR proposals to create a new class of nonvoting or sub-voting common stock
if:
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 non-shareholder approved shareholder rights plan
(poison pill).
PREEMPTIVE RIGHTS
Vote CASE-BY-CASE on shareholder proposals that seek preemptive rights, taking
into consideration: the size of a company, the characteristics of its
shareholder base, and the liquidity of the stock.
PREFERRED STOCK
Vote AGAINST proposals authorizing the creation of new classes of preferred
stock with unspecified voting, conversion, dividend distribution, and other
rights ("blank check" preferred stock).
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Vote FOR proposals to create "declawed" blank check preferred stock (stock that
cannot be used as a takeover defense).
Vote FOR proposals to authorize preferred stock in cases where the company
specifies the voting, dividend, conversion, and other rights of such stock and
the terms of the preferred stock appear reasonable.
Vote AGAINST proposals to increase the number of blank check preferred stock
authorized for issuance when no shares have been issued or reserved for a
specific purpose.
Vote CASE-BY-CASE on proposals to increase the number of blank check preferred
shares after analyzing the number of preferred shares available for issue given
a company's industry and performance in terms of shareholder returns.
RECAPITALIZATION
Vote CASE-BY-CASE on recapitalizations (reclassifications of securities), taking
into account the following:
o More simplified capital structure;
o Enhanced liquidity;
o Fairness of conversion terms;
o Impact on voting power and dividends;
o Reasons for the reclassification;
o Conflicts of interest; and
o Other alternatives considered.
REVERSE STOCK SPLITS
Vote FOR management proposals to implement a reverse stock split when the number
of authorized shares will be proportionately reduced.
Vote FOR management proposals to implement a reverse stock split to avoid
delisting.
Vote CASE-BY-CASE on proposals to implement a reverse stock split that do not
proportionately reduce the number of shares authorized for issue based on the
allowable increased calculated using the Capital Structure model.
SHARE REPURCHASE PROGRAMS
Vote FOR management proposals to institute open-market share repurchase plans in
which all shareholders may participate on equal terms.
STOCK DISTRIBUTIONS: SPLITS AND DIVIDENDS
Vote FOR management proposals to increase the common share authorization for a
stock split or share dividend, provided that the increase in authorized shares
would not result in an excessive number of shares available for issuance as
determined using a model developed by ISS.
TRACKING STOCK
Vote CASE-BY-CASE on the creation of tracking stock, weighing the strategic
value of the transaction against such factors as:
o Adverse governance changes;
o Excessive increases in authorized capital stock;
o Unfair method of distribution;
o Diminution of voting rights;
o Adverse conversion features;
o Negative impact on stock option plans; and
o Alternatives such as spin-off.
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8. EXECUTIVE AND DIRECTOR COMPENSATION
EQUITY COMPENSATION PLANS
Vote CASE-BY-CASE on equity-based compensation plans. Vote AGAINST the equity
plan if any of the following factors apply:
o The total cost of the company's equity plans is unreasonable;
o The plan expressly permits the repricing of stock options without
prior shareholder approval;
o There is a disconnect between CEO pay and the company's performance;
o The company's three year burn rate exceeds the greater of 2% and the
mean plus 1 standard deviation of its industry group; or
o The plan is a vehicle for poor pay practices.
Each of these factors is further described below:
COST OF EQUITY PLANS
Generally, vote AGAINST equity plans if the cost is unreasonable. For
non-employee director plans, vote FOR the plan if certain factors are met (see
Director Compensation section).
The cost of the equity plans is expressed as Shareholder Value Transfer (SVT),
which is measured using a binomial option pricing model that assesses the amount
of shareholders' equity flowing out of the company to employees and directors.
SVT is expressed as both a dollar amount and as a percentage of market value,
and includes the new shares proposed, shares available under existing plans, and
shares granted but unexercised. All award types are valued. For omnibus plans,
unless limitations are placed on the most expensive types of awards (for
example, full value awards), the assumption is made that all awards to be
granted will be the most expensive types. See discussion of specific types of
awards.
The Shareholder Value Transfer is reasonable if it falls below the
company-specific allowable cap. The allowable cap is determined as follows: The
top quartile performers in each industry group (using the Global Industry
Classification Standard GICS) are identified. Benchmark SVT levels for each
industry are established based on these top performers' historic SVT. Regression
analyses are run on each industry group to identify the variables most strongly
correlated to SVT. The benchmark industry SVT level is then adjusted upwards or
downwards for the specific company by plugging the company-specific performance
measures, size and cash compensation into the industry cap equations to arrive
at the company's allowable cap.
REPRICING PROVISIONS
Vote AGAINST plans that expressly permit the repricing of stock options without
prior shareholder approval, even if the cost of the plan is reasonable.
Vote AGAINST plans if the company has a history of repricing options without
shareholder approval, and the applicable listing standards would not preclude
them from doing so.
PAY-FOR PERFORMANCE DISCONNECT
Generally vote AGAINST plans in which:
o there is a disconnect between the CEO's pay and company performance
(an increase in pay and a decrease in performance);
o the main source of the pay increase (over half) is equity-based, and
o the CEO is a participant of the equity proposal.
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Performance decreases are based on negative one- and three-year total
shareholder returns. CEO pay increases are based on the CEO's total direct
compensation (salary, cash bonus, 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.
WITHHOLD votes from the Compensation Committee members when the company has a
pay for performance disconnect.
On a CASE-BY-CASE basis, vote for equity plans and FOR compensation committee
members with a pay-for-performance disconnect if compensation committee members
can present strong and compelling evidence of improved committee performance.
This evidence must go beyond the usual compensation committee report disclosure.
This additional evidence necessary includes all of the following:
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 total cost to the company;
- Earnings and accumulated payment obligations under the
company's nonqualified deferred compensation program;
- Actual projected payment obligations under the company's
supplemental executive retirement plan (SERPs).
A tally sheet setting forth all the above components was prepared and reviewed
affixing dollar amounts under the various payout scenarios. (A complete
breakdown of pay components also can be found in Disclosure of CEO Compensation
- - Tally Sheet.)
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 providing additional
information on the named executives' annual cash bonus program
and/or long-term incentive cash plan for the current fiscal year.
The compensation committee will provide full disclosure of the
qualitative and quantitative performance criteria and hurdle rates
used to determine the payouts of the cash program. From this
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 granting a substantial
portion of performance-based equity awards to the named executive
officers. A substantial portion of performance-based awards would be
at least 50 percent of the shares awarded to each of the named
executive officers. Performance-based equity awards are earned or
paid out based on the achievement of company performance targets.
The company will disclose the details of the performance criteria
(e.g., return on equity) and the hurdle
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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 performance-contingent grants
where the individual will not receive the equity grant by not
meeting the target performance and vice versa.
The level of transparency and disclosure is at the highest level where
shareholders can understand the mechanics of the performance-based equity awards
based on the additional disclosure.
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.
THREE-YEAR BURN RATE/BURN RATE COMMITMENT
Generally vote AGAINST plans if the company's most recent three-year burn rate
exceeds one standard deviation in excess of the industry mean (per the following
Burn Rate Table) and is over two percent of common shares outstanding. The
three-year burn rate policy does not apply to non-employee director plans unless
outside directors receive a significant portion of shares each year.
However, vote FOR equity plans if the company fails this burn rate test but the
company commits in a public filing to a three-year average burn rate equal to
its GICS group burn rate mean plus one standard deviation, assuming all other
conditions for voting FOR the plan have been met. If a company fails to fulfill
its burn rate commitment, vote to WITHHOLD from the compensation committee.
- ----------
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).
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2006 PROXY SEASON BURN RATE TABLE
RUSSELL 3000 NON-RUSSELL 3000
- --------------------------------------------------------------------------------------------------------------------------------
STANDARD STANDARD
GICS DESCRIPTION MEAN DEVIATION MEAN+STDEV MEAN DEVIATION MEAN+STDEV
- --------------------------------------------------------------------------------------------------------------------------------
1010 Energy 1.53% 0.96% 2.50% 2.03% 2.53% 4.56%
- --------------------------------------------------------------------------------------------------------------------------------
1510 Materials 1.37% 0.74% 2.11% 2.15% 2.01% 4.16%
- --------------------------------------------------------------------------------------------------------------------------------
2010 Capital Goods 1.84% 1.09% 2.93% 2.74% 2.63% 5.37%
- --------------------------------------------------------------------------------------------------------------------------------
2020 Commercial Services & Supplies 2.73% 1.60% 4.33% 3.43% 4.18% 7.61%
- --------------------------------------------------------------------------------------------------------------------------------
2030 Transportation 1.76% 1.71% 3.47% 2.18% 2.12% 4.30%
- --------------------------------------------------------------------------------------------------------------------------------
2510 Automobiles & Components 1.97% 1.27% 3.24% 2.23% 2.29% 4.51%
- --------------------------------------------------------------------------------------------------------------------------------
2520 Consumer Durables & Apparel 2.04% 1.22% 3.26% 2.86% 2.48% 5.35%
- --------------------------------------------------------------------------------------------------------------------------------
2530 Hotels Restaurants & Leisure 2.22% 1.09% 3.31% 2.71% 2.46% 5.17%
- --------------------------------------------------------------------------------------------------------------------------------
2540 Media 2.14% 1.24% 3.38% 3.26% 2.52% 5.77%
- --------------------------------------------------------------------------------------------------------------------------------
2550 Retailing 2.54% 1.59% 4.12% 4.01% 4.03% 8.03%
- --------------------------------------------------------------------------------------------------------------------------------
3010, 3020,
3030 Food & Staples Retailing 1.82% 1.31% 3.13% 2.20% 2.79% 4.99%
- --------------------------------------------------------------------------------------------------------------------------------
3510 Health Care Equipment & Services 3.20% 1.71% 4.91% 4.33% 3.20% 7.53%
- --------------------------------------------------------------------------------------------------------------------------------
3520 Pharmaceuticals & Biotechnology 3.70% 1.87% 5.57% 5.41% 4.74% 10.15%
- --------------------------------------------------------------------------------------------------------------------------------
4010 Banks 1.46% 1.00% 2.46% 1.38% 1.42% 2.79%
- --------------------------------------------------------------------------------------------------------------------------------
4020 Diversified Financials 3.00% 2.28% 5.28% 4.46% 4.01% 8.47%
- --------------------------------------------------------------------------------------------------------------------------------
4030 Insurance 1.52% 1.04% 2.56% 2.25% 2.85% 5.10%
- --------------------------------------------------------------------------------------------------------------------------------
4040 Real Estate 1.30% 1.01% 2.31% 1.12% 1.67% 2.79%
- --------------------------------------------------------------------------------------------------------------------------------
4510 Software & Services 5.02% 2.98% 8.00% 6.92% 6.05% 12.97%
- --------------------------------------------------------------------------------------------------------------------------------
4520 Technology Hardware & Equipment 3.64% 2.48% 6.11% 4.73% 4.02% 8.75%
- --------------------------------------------------------------------------------------------------------------------------------
4530 Semiconductors & Semiconductor Equip. 4.81% 2.86% 7.67% 5.01% 3.06% 8.07%
- --------------------------------------------------------------------------------------------------------------------------------
5010 Telecommunication Services 2.31% 1.61% 3.92% 3.70% 3.41% 7.11%
- --------------------------------------------------------------------------------------------------------------------------------
5510 Utilities 0.94% 0.62% 1.56% 2.11% 4.13% 6.24%
- --------------------------------------------------------------------------------------------------------------------------------
For companies that grant both full value awards and stock options to their
employees, apply a premium on full value awards for the past three fiscal years
as follows:
- -----------------------------------------------------------------------------------------------------
CHARACTERISTICS ANNUAL STOCK PRICE PREMIUM
VOLATILITY
- -----------------------------------------------------------------------------------------------------
High annual volatility 53% and higher 1 full-value award for 1.5 option shares
- -----------------------------------------------------------------------------------------------------
Moderate annual volatility 25% - 52% 1 full-value award for 2.0 option shares
- -----------------------------------------------------------------------------------------------------
Low annual volatility Less than 25% 1 full-value award for 4.0 option shares
- -----------------------------------------------------------------------------------------------------
POOR PAY PRACTICES
Vote AGAINST equity plans if the plan is a vehicle for poor compensation
practices.
WITHOLD from compensation committee members if the company has poor compensation
practices.
Poor compensation practices include, but are not limited to, the following:
o Egregious employment contracts including excessive severance
provisions;
o Excessive perks that dominate compensation;
o Huge bonus payouts without justifiable performance linkage;
o Performance metrics that are changed during the performance period;
o Egregious SERP (Supplemental Executive Retirement Plans) payouts;
o New CEO with overly generous hiring package;
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o Internal pay disparity;
o Other excessive compensation payouts or poor pay practices at the
company.
SPECIFIC TREATMENT OF CERTAIN AWARD TYPES IN EQUITY PLAN EVALUATIONS:
DIVIDEND EQUIVALENT RIGHTS
Equity plans that have Dividend Equivalent Rights (DERs) associated with them
will have a higher calculated award value than those without DERs under the
binomial model, based on the value of these dividend streams. The higher value
will be applied to new shares, shares available under existing plans, and shares
awarded but not exercised per the plan specifications. DERS transfer more
shareholder equity to employees and non-employee directors and this cost should
be captured.
LIBERAL SHARE RECYCLING PROVISIONS
Under net share counting provisions, shares tendered by an option holder to pay
for the exercise of an option, shares withheld for taxes or shares repurchased
by the company on the open market can be recycled back into the equity plan for
awarding again. All awards with such provisions should be valued as full-value
awards. Stock-settled stock appreciation rights (SSARs) will also be considered
as full-value awards if a company counts only the net shares issued to employees
towards their plan reserve.
TRANSFERABLE STOCK OPTION AWARDS
For transferable stock option award types within a new equity plan, calculate
the cost of the awards by setting their forfeiture rate to zero when comparing
to the allowable cap. In addition, in order to vote FOR plans with such awards,
the structure and mechanics of the ongoing transferable stock option program
must be disclosed to shareholders; and amendments to existing plans that allow
for introduction of transferability of stock options should make clear that only
options granted post-amendment shall be transferable.
OTHER COMPENSATION PROPOSALS AND POLICIES
401(K) EMPLOYEE BENEFIT PLANS
Vote FOR proposals to implement a 401(k) savings plan for employees.
DIRECTOR COMPENSATION
Vote CASE-BY-CASE on compensation plans for non-employee directors, based on the
cost of the plans against the company's allowable cap.
On occasion, director stock plans that set aside a relatively small number of
shares when combined with employee or executive stock compensation plans exceed
the allowable cap. Vote for the plan if ALL of the following qualitative factors
in the board's compensation are met and disclosed in the proxy statement:
o Director stock ownership guidelines with 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; or
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- 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.
o No retirement/benefits and perquisites provided to non-employee
directors; and
o Detailed disclosure provided on cash and equity compensation
delivered to each non- employee director for the most recent fiscal
year in a table. The column headers for the table may include the
following: name of each non-employee director, annual retainer,
board meeting fees, committee retainer, committee-meeting fees, and
equity grants.
DIRECTOR RETIREMENT PLANS
Vote AGAINST retirement plans for non-employee directors.
Vote FOR shareholder proposals to eliminate retirement plans for non-employee
directors.
DISCLOSURE OF CEO COMPENSATION-TALLY SHEET
Encourage companies to provide better and more transparent disclosure related to
CEO pay. Consider withhold votes in the future from the compensation committee
and voting against equity plans if compensation disclosure is not improved and a
tally sheet is not provided.
In addition to the current SEC requirements, the following table sets forth the
current minimum standard on CEO pay disclosure according to ISS's guidelines:
- -----------------------------------------------------------------------------------------------------------
COMPONENT AMOUNT EARNED/GRANTED DESCRIPTION
- -----------------------------------------------------------------------------------------------------------
Base Salary Current figure Explanation of any increase in
base salary
- -----------------------------------------------------------------------------------------------------------
Annual Incentive Target: Explanation of specific
Actual earned: performance measures and
actual deliverables.
State amount tied to actual
performance.
State any discretionary bonus.
- -----------------------------------------------------------------------------------------------------------
Stock Options Number granted: Rationale for determining the
Exercise price: number of stock options
Vesting: issued to CEO.
Grant value:
Accumulated dividend
equivalents (if any).
- -----------------------------------------------------------------------------------------------------------
Restricted Stock Number granted: Performance based or time
Vesting: based.
Grant value:
Rationale for determining the
number of restricted stock
issued to CEO.
Accumulated dividends on
vested and unvested portion.
- -----------------------------------------------------------------------------------------------------------
Performance Shares Minimum: Explanation of specific
Target: performance measures and
Maximum: actual deliverables.
Actual earned:
Grant value: Any dividends on unearned
performance shares.
- -----------------------------------------------------------------------------------------------------------
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- -----------------------------------------------------------------------------------------------------------
COMPONENT AMOUNT EARNED/GRANTED DESCRIPTION
- -----------------------------------------------------------------------------------------------------------
Deferred compensation Executive portion: Provide structure and terms of
Company match (if any): program.
Accumulated executive Explanation of interest,
portion: formulas, minimum
Accumulated company match guarantees or multipliers on
(if any): deferred compensation.
Any holding periods on the
company match portion.
Funding mechanism
- -----------------------------------------------------------------------------------------------------------
Supplemental retirement Actual projected payment Provide structure and terms of
benefit obligations program.
Explanation of formula,
additional credits for years not
worked, multipliers or interest
on SERPs.
Funding mechanism.
- -----------------------------------------------------------------------------------------------------------
Executive perquisites Breakdown of the market The types of perquisites
value of various perquisites provided. Examples: company
aircraft, company cars, etc.
- -----------------------------------------------------------------------------------------------------------
Gross-ups (if any) Breakdown of gross-ups for
any pay component
- -----------------------------------------------------------------------------------------------------------
Severance associated with Estimated payout amounts for Single trigger or double
change-in-control cash, equity and benefits trigger.
- -----------------------------------------------------------------------------------------------------------
Severance (Termination Estimated payout amounts for
scenario under "for cause" and cash, equity and benefits
"not for cause") under different scenarios
- -----------------------------------------------------------------------------------------------------------
Post retirement package Estimated value of consulting
agreement and continuation of
benefits
- -----------------------------------------------------------------------------------------------------------
ESTIMATED TOTAL PACKAGE $
- -----------------------------------------------------------------------------------------------------------
See the remedy for Pay for Performance disconnect for a more qualitative
description of certain pay components.
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).
EMPLOYEE STOCK PURCHASE PLANS-- QUALIFIED PLANS
Vote CASE-BY-CASE on qualified employee stock purchase plans. Vote FOR employee
stock purchase plans where all of the following apply:
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.
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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.
EMPLOYEE STOCK PURCHASE PLANS-- NON-QUALIFIED PLANS
Vote CASE-by-CASE on nonqualified employee stock purchase plans. Vote FOR
nonqualified employee stock purchase plans with all the following features:
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. If the company matching contribution
exceeds 25 percent of employee's contribution, evaluate the cost of the plan
against its allowable cap.
INCENTIVE BONUS PLANS AND TAX DEDUCTIBILITY PROPOSALS (OBRA-RELATED COMPENSATION
PROPOSALS)
Vote FOR proposals that simply amend shareholder-approved compensation plans to
include administrative features or place a cap on the annual grants any one
participant may receive to comply with the provisions of Section 162(m).
Vote FOR proposals to add performance goals to existing compensation plans to
comply with the provisions of Section 162(m) unless they are clearly
inappropriate.
Vote CASE-BY-CASE on amendments to existing plans to increase shares reserved
and to qualify for favorable tax treatment under the provisions of Section
162(m) as long as the plan does not exceed the allowable cap and the plan does
not violate any of the supplemental policies.
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.
OPTION EXCHANGE PROGRAMS/REPRICING OPTIONS
Vote CASE-by-CASE on management proposals seeking approval to exchange/reprice
options taking into consideration:
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.
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If the surrendered options are added back to the equity plans for re-issuance,
then also take into consideration the company's three-year average burn rate.
Vote FOR shareholder proposals to put option repricings to a shareholder vote.
STOCK PLANS IN LIEU OF CASH
Vote CASE-by-CASE on plans which provide participants with the option of taking
all or a portion of their cash compensation in the form of stock.
Vote FOR non-employee director only equity plans which provide a
dollar-for-dollar cash for stock exchange.
Vote CASE-by-CASE on plans which do not provide a dollar-for-dollar cash for
stock exchange. In cases where the exchange is not dollar-for-dollar, the
request for new or additional shares for such equity program will be considered
using the binomial option pricing model. In an effort to capture the total cost
of total compensation, ISS will not make any adjustments to carve out the
in-lieu-of cash compensation.
TRANSFER PROGRAMS OF STOCK OPTIONS
One-time Transfers: WITHHOLD votes from compensation committee members if they
fail to submit one-time transfers for to shareholders for approval.
Vote CASE-BY-CASE on one-time transfers. Vote FOR if:
o Executive officers and non-employee directors are excluded from
participating;
o Stock options are purchased by third-party financial institutions at
a discount to their fair value using option pricing models such as
Black-Scholes or a Binomial Option Valuation or other appropriate
financial models;
o There is a two-year minimum holding period for sale proceeds (cash
or stock) for all participants.
Additionally, management should provide a clear explanation of why options are
being transferred and whether the events leading up to the decline in stock
price were beyond management's control. A review of the company's historic stock
price volatility should indicate if the options are likely to be back
"in-the-money" over the near term.
SHAREHOLDER PROPOSALS ON COMPENSATION
DISCLOSURE/SETTING LEVELS OR TYPES OF COMPENSATION FOR EXECUTIVES AND DIRECTORS
Generally, vote FOR shareholder proposals seeking additional disclosure of
executive and director pay information, provided the information requested is
relevant to shareholders' needs, would not put the company at a competitive
disadvantage relative to its industry, and is not unduly burdensome to the
company.
Vote AGAINST shareholder proposals seeking to set absolute levels on
compensation or otherwise dictate the amount or form of compensation.
Vote AGAINST shareholder proposals requiring director fees be paid in stock
only.
Vote CASE-BY-CASE on all other shareholder proposals regarding executive and
director pay, taking into account company performance, pay level versus peers,
pay level versus industry, and long term corporate outlook.
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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.
OPTION REPRICING
Vote FOR shareholder proposals to put option repricings to a shareholder vote.
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.
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, where substantial
portion would constitute 50 percent of the shares awarded to those
executives for that fiscal year.
SEVERANCE AGREEMENTS FOR EXECUTIVES/GOLDEN PARACHUTES
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, but is not limited to, 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. Change in
control is defined as a change in the company ownership structure.
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.
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9. CORPORATE RESPONSIBILITY
CONSUMER ISSUES AND PUBLIC SAFETY
ANIMAL RIGHTS
Generally vote AGAINST proposals to phase out the use of animals in product
testing unless:
o The company is conducting animal testing programs that are
unnecessary or not required by regulation;
o The company is conducting animal testing when suitable alternatives
are accepted and used at peer firms;
o The company has been the subject of recent, significant controversy
related to its testing programs.
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
Generally vote AGAINST proposals requesting that companies implement specific
price restraints on pharmaceutical products unless the company fails to adhere
to legislative guidelines or industry norms in its product pricing.
Vote CASE-BY-CASE on proposals requesting that the company evaluate their
product pricing considering:
o The existing level of disclosure on pricing policies;
o Deviation from established industry pricing norms;
o The company's existing initiatives to provide its products to needy
consumers;
o Whether the proposal focuses on specific products or geographic
regions.
DRUG REIMPORTATION
Generally vote FOR proposals requesting that companies report on the financial
and legal impact of their policies regarding prescription drug reimportation
unless such information is already publicly disclosed.
Generally vote AGAINST proposals requesting that companies adopt specific
policies to encourage or constrain prescription drug reimportation.
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;
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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. Evaluate the following:
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;
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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 peers 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.
Spin-off tobacco-related businesses:
o The percentage of the company's business affected;
o The feasibility of a spin-off;
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.
TOXIC CHEMICALS
Generally vote FOR resolutions requesting that a company discloses its policies
related to toxic chemicals.
Vote CASE-BY-CASE on resolutions requesting that companies evaluate and disclose
the potential financial and legal risks associated with utilizing certain
chemicals, considering:
o Current regulations in the markets in which the company operates;
o Recent significant controversy, litigation, or fines stemming from
toxic chemicals or ingredients at the company; and
o The current level of disclosure on this topic.
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Generally vote AGAINST resolutions requiring that a company reformulate its
products within a certain timeframe unless such actions are required by law in
specific markets.
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.
CONCENTRATED AREA FEEDING OPERATIONS (CAFOS)
Vote FOR resolutions requesting that companies report to shareholders on the
risks and liabilities associated with CAFOs unless:
o The company has publicly disclosed guidelines for its corporate and
contract farming operations, including compliance monitoring; or
o The company does not directly source from CAFOs.
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
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and has been the subject of recent, significant fines or litigation resulting
from greenhouse gas emissions.
KYOTO PROTOCOL COMPLIANCE
Generally vote FOR resolutions requesting that companies outline their
preparations to comply with standards established by Kyoto Protocol signatory
markets unless:
o The company does not maintain operations in Kyoto signatory markets;
o The company already evaluates and substantially discloses such
information; or,
o Greenhouse gas emissions do not significantly impact the company's
core businesses.
LAND USE
Generally vote AGAINST resolutions that request the disclosure of detailed
information on a company's policies related to land use or development unless
the company has been the subject of recent, significant fines or litigation
stemming from its land use.
NUCLEAR SAFETY
Generally vote AGAINST resolutions requesting that companies report on risks
associated with their nuclear reactor designs and/or the production and interim
storage of irradiated fuel rods unless:
o The company does not have publicly disclosed guidelines describing
its policies and procedures for addressing risks associated with its
operations;
o The company is non-compliant with Nuclear Regulatory Commission
(NRC) requirements; or
o The company stands out amongst its peers or competitors as having
significant problems with safety or environmental performance
related to its nuclear operations.
OPERATIONS IN PROTECTED AREAS
Generally vote FOR requests for reports outlining potential environmental damage
from operations in protected regions, including wildlife refuges unless:
o The company does not currently have operations or plans to develop
operations in these protected regions; or,
o The company provides disclosure on its operations and environmental
policies in these regions comparable to industry peers.
RECYCLING
Vote CASE-BY-CASE on proposals to adopt a comprehensive recycling strategy,
taking into account:
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.
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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; a comprehensive Code of Corporate Conduct; and/or a
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
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 publish in newspapers and public media the company's
political contributions as such publications could present significant cost to
the company without providing commensurate value to shareholders.
Vote CASE-BY-CASE on proposals to improve the disclosure of a company's
political contributions considering:
o Recent significant controversy or litigation related to the
company's political contributions or governmental affairs; and
o The public availability of a policy on political contributions.
Vote AGAINST proposals barring the company from making political contributions.
Businesses are affected by legislation at the federal, state, and local level
and barring contributions can put the company at a competitive disadvantage.
Vote AGAINST proposals 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.
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:
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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.
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.
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.
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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.
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.
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OPERATIONS IN NATIONS SPONSORING TERRORISM (E.G., 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 a
terrorism-sponsoring state, taking into account current disclosure on:
o The nature and purpose of the 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 non-discrimination
policies.
Vote CASE-BY-CASE on proposals asking the company to increase the representation
of women and minorities on the board, taking into account:
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;
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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.
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10. MUTUAL FUND PROXIES
ELECTION OF DIRECTORS
Vote CASE-BY-CASE on the election of directors and trustees, following the same
guidelines for uncontested directors for public company shareholder meetings.
However, mutual fund boards do not usually have compensation committees, so do
not withhold for the lack of this committee.
CONVERTING CLOSED-END FUND TO OPEN-END FUND
Vote CASE-BY-CASE on conversion proposals, considering the following factors:
o Past performance as a closed-end fund;
o Market in which the fund invests;
o Measures taken by the board to address the discount; and
o Past shareholder activism, board activity, and votes on related
proposals.
PROXY CONTESTS
Vote CASE-BY-CASE on proxy contests, 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
Vote CASE-BY-CASE on investment advisory agreements, 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
Vote CASE-BY-CASE on the authorization for or increase in preferred shares,
considering the following factors:
o Stated specific financing purpose;
o Possible dilution for common shares;
o Whether the shares can be used for antitakeover purposes.
1940 ACT POLICIES
Vote CASE-BY-CASE on policies under the Investment Advisor Act of 1940,
considering the following factors:
o Potential competitiveness;
o Regulatory developments;
o Current and potential returns; and
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o Current and potential risk.
Generally vote FOR these amendments as long as the proposed changes do not
fundamentally alter the investment focus of the fund and do comply with the
current SEC interpretation.
CHANGING A FUNDAMENTAL RESTRICTION TO A NONFUNDAMENTAL RESTRICTION
Vote CASE-BY-CASE on proposals to change a fundamental restriction to a
non-fundamental restriction, considering the following factors:
o The fund's target investments;
o The reasons given by the fund for the change; and
o The projected impact of the change on the portfolio.
CHANGE FUNDAMENTAL INVESTMENT OBJECTIVE TO NONFUNDAMENTAL
Vote AGAINST proposals to change a fund's fundamental investment objective to
non-fundamental.
NAME CHANGE PROPOSALS
Vote CASE-BY-CASE on name change proposals, considering the following factors:
o Political/economic changes in the target market;
o Consolidation in the target market; and
o Current asset composition.
CHANGE IN FUND'S SUBCLASSIFICATION
Vote CASE-BY-CASE on changes in a fund's sub-classification, considering the
following factors:
o Potential competitiveness;
o Current and potential returns;
o Risk of concentration;
o Consolidation in target industry.
DISPOSITION OF ASSETS/TERMINATION/LIQUIDATION
Vote CASE-BY-CASE on proposals to dispose of assets, to terminate or liquidate,
considering the following factors:
o Strategies employed to salvage the company;
o The fund's past performance;
o The terms of the liquidation.
CHANGES TO THE CHARTER DOCUMENT
Vote CASE-BY-CASE on changes to the charter document, 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;
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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 CASE-BY-CASE on re-incorporations, considering the following factors:
o Regulations of both states;
o Required fundamental policies of both states;
o The increased flexibility available.
AUTHORIZING THE BOARD TO HIRE AND TERMINATE SUBADVISORS WITHOUT SHAREHOLDER
APPROVAL
Vote AGAINST proposals authorizing the board to hire/terminate subadvisors
without shareholder approval.
DISTRIBUTION AGREEMENTS
Vote CASE-BY-CASE on distribution agreement proposals, considering the following
factors:
o Fees charged to comparably sized funds with similar objectives;
o The proposed distributor's reputation and past performance;
o The competitiveness of the fund in the industry;
o The terms of the agreement.
MASTER-FEEDER STRUCTURE
Vote FOR the establishment of a master-feeder structure.
MERGERS
Vote CASE-BY-CASE on merger proposals, considering the following factors:
o Resulting fee structure;
o Performance of both funds;
o Continuity of management personnel;
o Changes in corporate governance and their impact on shareholder
rights.
SHAREHOLDER PROPOSALS FOR MUTUAL FUNDS
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.
REIMBURSE SHAREHOLDER FOR EXPENSES INCURRED
Vote CASE-BY-CASE on shareholder proposals to reimburse proxy solicitation
expenses. When supporting the dissidents, vote FOR the reimbursement of the
proxy solicitation expenses.
TERMINATE THE INVESTMENT ADVISOR
Vote CASE-BY-CASE on proposals to terminate the investment advisor, considering
the following factors:
o Performance of the fund's Net Asset Value (NAV);
o The fund's history of shareholder relations;
o The performance of other funds under the advisor's management.
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ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
(A)(1) IDENTIFICATION OF PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBERS AND
DESCRIPTION OF ROLE OF PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBERS
Scott Fleming is the lead portfolio manager of the Registrant,
overseeing compliance and analysis of the Registrant. Robert DeRochie is also a
portfolio manager for the Registrant. Mr. Fleming is currently the President of
Stonebridge Advisors, LLC, the Registrant's sub-adviser ("Stonebridge"). Prior
to founding Stonebridge in December 2004, Mr. Fleming co-founded Spectrum Asset
Management, Inc., an investment advisor that specializes in preferred securities
asset management for institutional clients and mutual funds, where he served as
Chairman of the Board of Directors, Chief Financial Officer and Chief Investment
Officer. Prior to joining Stonebridge in December, 2004, where he is currently a
Sr. Vice President, Mr. De Rochie was Chief Financial Officer and Vice President
of Investor Relations for Startech Environmental Corporation. He previously
worked for Queensway Investment Counsel, Ltd. in Canada as Vice
President/Portfolio Manager where he managed fixed-income and preferred
securities. Before that, Mr. De Rochie was Assistant Vice President, Portfolio
Manager for National Reinsurance Corporation, where he also managed fixed-income
securities, more than half of which were preferred securities.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBER
AND POTENTIAL CONFLICTS OF INTEREST
OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBER
# of Accounts Total Assets
Managed for for which
Total # of which Advisory Advisory Fee
Name of Portfolio Manager or Accounts Total Fee is Based on is Based on
Team Member Type of Accounts* Managed Assets Performance Performance
1. Scott Fleming Registered Investment Companies: 0 $ 0 0 0
Other Pooled Investment Vehicles: 0 $ 0 0 0
Other Accounts: 2 $1MM 0 0
2. Robert DeRochie Registered Investment Companies: 0 $0 0 0
Other Pooled Investment Vehicles: 0 $0 0 0
Other Accounts: 1 $50,000 0 0
Information provided as of October 31, 2006
POTENTIAL CONFLICTS OF INTERESTS
The Registrant has a different strategy than other accounts managed by
Stonebridge. Specifically, the Registrant will invest nearly 50% of the
Registrant's portfolio in private placement preferred securities, which
Stonebridge's other accounts will not invest in. There will be some securities
in the Registrant that will be suitable for other separately managed accounts.
When investing in securities that more than one account may be involved, we
pro-rate partial fills. There may be circumstances where we buy smaller amounts
of a security and won't have enough to place into all accounts. In this case, we
place the purchase in whatever accounts make the most sense to own the security
based on a number of factors, including cash available. Then, we continue to
attempt to buy more shares until we have all accounts filled. If there are
different prices from one trade to the next, then on the next trade that
includes partial fills, we switch the order of which accounts get the first
trade fill.
(A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGERS OR MANAGEMENT TEAM MEMBERS
Compensation of the portfolio managers consists of a base salary plus
discretionary bonus. The bonus on the success of Stonebridge in meeting their
growth goals, the performance of the employee in handling their responsibilities
and the earnings available for employee bonuses. Compensation is based on the
growth of the overall assets of the firm. Additionally, Mr. Fleming is a
principal of the sub-advisor and receives compensation from his equity ownership
in Stonebridge.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
Information provided as of October 31, 2006
Dollar Range of Fund Shares
Name Beneficially Owned
Scott Fleming $ 0
Robert DeRochie $ 0
(B) Not applicable.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these controls
and procedures required by Rule 30a-3(b) under the 1940 Act (17 CFR
270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the Securities
Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act (17
CFR 270.30a-3(d)) that occurred during the registrant's second fiscal
quarter of the period covered by this report that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics, or any amendment thereto, that is the subject of
disclosure required by Item 2 is attached hereto.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Not applicable.
(b) Certifications pursuant to Rule 30a-2(b) under the 1940 Act and
Section 906 of the Sarbanes-Oxley Act of 2002 are attached hereto.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
(registrant) FIRST TRUST TAX-ADVANTAGED PREFERRED INCOME FUND
By (Signature and Title)* /S/ JAMES A. BOWEN
-------------------------------------------------------
James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date DECEMBER 18, 2006
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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
-------------------------------------------------------
James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date DECEMBER 18, 2006
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By (Signature and Title)* /S/ MARK R. BRADLEY
-------------------------------------------------------
Mark R. Bradley, Treasurer, Controller, Chief Financial
Officer and Chief Accounting Officer
(principal financial officer)
Date DECEMBER 18, 2006
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* Print the name and title of each signing officer under his or her signature.