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 811-22039
First Trust Specialty Finance and Financial Opportunities Fund (formerly First
Trust/Gallatin Specialty Finance and Financial Opportunities Fund)
(Exact name of registrant as specified in charter)
120 East Liberty Drive
Wheaton, IL 60187
(Address of principal executive offices) (Zip code)
W. Scott Jardine, Esq.
First Trust Portfolios L.P.
120 East Liberty Drive
Wheaton, IL 60187
(Name and address of agent for service)
registrant's telephone number, including area code: 630-765-8000
Date of fiscal year end: November 30
Date of reporting period: November 30, 2008
Form N-CSR is to be used by management investment companies to file reports with
the Commission not later than 10 days after the transmission to stockholders of
any report that is required to be transmitted to stockholders under Rule 30e-1
under the Investment Company Act of 1940 (17 CFR 270.30e-1). The Commission may
use the information provided on Form N-CSR in its regulatory, disclosure review,
inspection, and policymaking roles.
A registrant is required to disclose the information specified by Form N-CSR,
and the Commission will make this information public. A registrant is not
required to respond to the collection of information contained in Form N-CSR
unless the Form displays a currently valid Office of Management and Budget
("OMB") control number. Please direct comments concerning the accuracy of the
information collection burden estimate and any suggestions for reducing the
burden to Secretary, Securities and Exchange Commission, 100 F Street, NE,
Washington, DC 20549. The OMB has reviewed this collection of information under
the clearance requirements of 44 U.S.C. Section 3507.
ITEM 1. REPORTS TO STOCKHOLDERS.
The Report to Shareholders is attached herewith.
(GRAPHIC)
FIRST TRUST
SPECIALTY FINANCE
AND FINANCIAL
OPPORTUNITIES FUND
ANNUAL REPORT
FOR THE PERIOD ENDED
NOVEMBER 30, 2008
(CONFLUENCE INVESTMENT MANAGEMENT LOGO)
TABLE OF CONTENTS
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND (FGB)
ANNUAL REPORT
NOVEMBER 30, 2008
Shareholder Letter ....................................... 1
At a Glance .............................................. 2
Portfolio Commentary ..................................... 3
Portfolio of Investments ................................. 6
Statement of Assets and Liabilities ...................... 8
Statement of Operations .................................. 9
Statements of Changes in Net Assets ...................... 10
Statement of Cash Flows .................................. 11
Financial Highlights ..................................... 12
Notes to Financial Statements ............................ 13
Report of Independent Registered Public Accounting Firm .. 18
Additional Information ................................... 19
Board of Trustees and Officers ........................... 23
Privacy Policy ........................................... 27
CAUTION REGARDING FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements within the meaning of
the Securities Act of 1933, as amended and the Securities Exchange Act of 1934,
as amended. Forward-looking statements include statements regarding the goals,
beliefs, plans or current expectations of First Trust Advisors L.P. ("First
Trust" or the "Advisor") and/or Confluence Investment Management LLC
("Confluence" 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 Specialty Finance and Financial Opportunities 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 report, you are cautioned not to place undue
reliance on these forward-looking statements, which reflect the judgment of the
Advisor and Sub-Advisor and their respective representatives only as of the date
hereof. We undertake no obligation to publicly revise or update these
forward-looking statements to reflect events and circumstances that arise after
the date hereof.
PERFORMANCE AND RISK DISCLOSURE
There is no assurance that the Fund will achieve its investment objectives. The
Fund is subject to market risk, which is the possibility that the market values
of securities owned by the Fund will decline and that the value of the Fund
shares may therefore be less than what you paid for them. Accordingly, you can
lose money investing in the Fund. See "Risk Considerations" in the Notes to
Financial Statements for a discussion of other risks of investing in the Fund.
Performance data quoted represents past performance, which is no guarantee of
future results, and current performance may be lower or higher than the figures
shown. For the most recent month-end performance figures, please visit
http://www.ftportfolios.com or speak with your financial advisor. Investment
returns, net asset value and common share price will fluctuate and Fund shares,
when sold, may be worth more or less than their original cost.
HOW TO READ THIS REPORT
This report contains information that may help you evaluate your investment. It
includes details about the Fund and presents data and analysis that provide
insight into the Fund's performance and investment approach.
By reading the portfolio commentary by the portfolio management team of the
Fund, you may obtain an understanding of how the market environment affected the
Fund's performance. The statistical information that follows may help you
understand the Fund's performance compared to that of the relevant market
benchmarks.
It is important to keep in mind that the opinions expressed by personnel of
Confluence are just that: informed opinions. They should not be considered to be
promises or advice. The opinions, like the statistics, cover the period through
the date on the cover of this report. The risks of investing in the Fund are
spelled out in the prospectus, the statement of additional information, this
report, and other regulatory filings.
SHAREHOLDER LETTER
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND (FGB)
ANNUAL REPORT
NOVEMBER 30, 2008
Dear Shareholders:
The year ended November 30, 2008 has been challenging for the financial markets
and for many investors. Yet, First Trust Advisors L.P. ("First Trust") believes
that, regardless of the market, in order to be successful in reaching your
financial goals, you should be invested for the long term. We also believe that
investors should seek professional help from a financial advisor who has been
through many types of markets, knows the range of investments available, and is
committed to bringing you investments suitable to your particular situation.
Our goal at First Trust has always been to offer a wide range of investment
products, including our family of closed-end funds, to help financial advisors
give you the opportunity to meet your financial objectives. We have continued to
expand our product line to ensure that you have many choices to fit your
investment needs.
The report you hold contains detailed information about your investment in the
First Trust Specialty Finance and Financial Opportunities Fund (the "Fund"). It
contains a portfolio commentary from the Fund's portfolio management team that
provides a market recap for the period, a performance analysis and a market and
Fund outlook. Additionally, the report provides the Fund's financial statements
for the period covered by the report. I encourage you to read this document and
discuss it with your financial advisor.
First Trust has been through many types of markets and remains committed to
bringing you quality investment solutions regardless of the inevitable ups and
downs experienced in the market. We offer a variety of products that may fit
many financial plans to help those investors seeking long-term investment
success. As well, we are committed to making available up-to-date reports about
your investments so you and your financial advisor have current information on
your portfolio.
We continue to value our relationship with you, and we thank you for the
opportunity to assist you in achieving your financial goals.
Sincerely,
/s/ James A. Bowen
James A. Bowen
President of First Trust Specialty
Finance and Financial Opportunities Fund
Page 1
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
"AT A GLANCE" (UNAUDITED)
AS OF NOVEMBER 30, 2008
FUND STATISTICS
Symbol on New York Stock Exchange FGB
Common Share Price $ 3.29
Common Share Net Asset Value ("NAV") $ 4.51
Premium (Discount) to NAV (27.05)%
Net Assets Applicable to Common Shares $64,207,696
Current Quarterly Distribution per Common Share (1) $ 0.250
Current Annualized Distribution per Common Share $ 1.0000
Current Distribution Rate on Closing Common Share Price (2) 30.40%
Current Distribution Rate on NAV (2) 22.17%
COMMON SHARE PRICE & NAV (WEEKLY CLOSING PRICE)
(PERFORMANCE GRAPH)
Market NAV
------ -----
11/30/07 14.23 13.74
12/7/07 13.49 14.35
12/14/07 12.6 13.74
12/21/07 11.85 14.21
12/28/07 12.1 13.86
1/4/08 12.09 13.08
1/11/08 12.08 13.02
1/18/08 11.24 12.32
1/25/08 12.32 13.23
2/1/08 13.49 14.34
2/8/08 13.23 13.66
2/15/08 12.54 13.42
2/22/08 13.39 13.06
2/29/08 13.67 12.93
3/7/08 11.84 11.67
3/14/08 12.19 11.5
3/20/08 12.61 12.05
3/28/08 13.05 11.87
4/4/08 13.05 12.55
4/11/08 12.69 11.77
4/18/08 12.51 12.54
4/25/08 13.25 12.52
5/2/08 13.53 13.04
5/9/08 13.77 12.67
5/16/08 14.03 13
5/23/08 12.57 12.4
5/30/08 12.46 12.44
6/6/08 11.48 12.22
6/13/08 11.05 11.71
6/20/08 10.67 11.05
6/27/08 9.11 10.12
7/3/08 8.51 9.14
7/11/08 7.4 9.1
7/18/08 8.72 9.3
7/25/08 8.65 9.5
8/1/08 9.35 9.51
8/8/08 9.2 9.61
8/15/08 9.37 9.8
8/22/08 8.89 9.44
8/29/08 9.2 9.53
9/5/08 9.27 9.49
9/12/08 8.36 9.29
9/19/08 8.74 9.92
9/26/08 8.02 9.5
10/3/08 6.72 7.81
10/10/08 4.3 5.53
10/17/08 5.67 5.96
10/24/08 4.9 5.16
10/31/08 5.38 6.19
11/7/08 4.8 5.61
11/14/08 3.71 4.56
11/21/08 2.35 3.52
11/30/08 3.29 4.51
PERFORMANCE
Average Annual
Total Return
1 Year Ended Inception (5/25/2007)
11/30/2008 to 11/30/2008
------------ ---------------------
Fund Performance
NAV (3) -61.38% -55.61%
Market Value (4) -72.80% -65.02%
Index Performance
Blended Benchmark (5) -55.46% -53.40%
MSCI U.S. Investable Market Financials Index -54.05% -46.75%
% OF TOTAL
TOP 10 HOLDINGS INVESTMENTS
---------------------------------------- -----------
Prospect Energy Corp. 12.3%
MVC Capital, Inc. 10.1
BlackRock Kelso Capital Corp. 9.8
Ares Capital Corp. 7.5
Annaly Capital Management, Inc. 7.0
Apollo Investment Corp. 5.1
NGP Capital Resources Co. 4.8
NorthStar Realty Finance Corp. 4.7
Hercules Technology Growth Capital, Inc. 4.5
Medallion Financial Corp. 4.4
----
Total 70.2%
====
% OF TOTAL
INDUSTRY INVESTMENTS
---------------------------------------- -----------
Capital Markets 75.1%
Real Estate Investment Trusts (REITs) 23.9
Diversified Financial Services 1.0
-----
Total 100.0%
=====
% OF TOTAL
ASSET CLASSIFICATION INVESTMENTS
---------------------------------------- -----------
Business Development Companies 75.1%
Residential Mortgage REITs 16.0
Domestic Common Stock 1.0
Specialty Finance/Hybrid REITs 7.9
-----
Total 100.0%
=====
(1) Most recent distribution paid or declared through 11/30/08. Subject to
change in the future.
(2) Distribution rates are calculated by annualizing the most recent
distribution paid or declared through the report date and then dividing by
Common Share price or NAV, as applicable, as of 11/30/08. Subject to change
in the future.
(3) Total return based on NAV is the combination of reinvested dividend
distributions and reinvested capital gain distributions, if any, at prices
obtained by the Dividend Reinvestment Plan and changes in NAV per share and
does not reflect sales load. Past performance is not indicative of future
results.
(4) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in Common
Share price. Past performance is not indicative of future results.
(5) Blended benchmark consists of the following (Source: Bloomberg):
Red Rocks Listed Private Equity Index (40%)
FTSE NAREIT Mortgage REIT Index (20%)
FTSE NAREIT Hybrid REIT Index (20%)
Merrill Lynch Preferred Stock Hybrid Securities Index (10%)
Russell 2000 Financial Services Index (10%)
Page 2
PORTFOLIO COMMENTARY (UNAUDITED)
SUB-ADVISOR
Confluence Investment Management LLC, a newly-formed registered investment
advisor ("Confluence" or "Sub-Advisor") located in St. Louis, Missouri, has
served as the Sub-Advisor to First Trust Specialty Finance and Financial
Opportunities Fund, formerly known as the First Trust/Gallatin Specialty Finance
and Financial Opportunities Fund (NYSE:FGB) (the "Fund"), since July 29, 2008.
PORTFOLIO MANAGEMENT TEAM
MARK A. KELLER, CFA - CHIEF EXECUTIVE OFFICER AND CHIEF INVESTMENT OFFICER
Mr. Keller has nearly 30 years of investment experience with a focus on
value-oriented equity analysis and management. From 1994 to May 2008, he was the
Chief Investment Officer of Gallatin Asset Management, Inc., and its predecessor
organization, A.G. Edwards Asset Management, the investment management arm of
A.G. Edwards, Inc. From 1999 to 2008, Mr. Keller was Chairman of the A.G.
Edwards Investment Strategy Committee, which set investment policy and
established asset allocation models for the entire organization. Mr. Keller was
a founding member of the A.G. Edwards Investment Strategy Committee, on which he
served for over 20 years, the last ten years as Chairman. He began his career
with A.G. Edwards in 1978, serving as an equity analyst for the firm's
Securities Research Department from 1979 to 1994. During his last five years in
Securities Research, Mr. Keller was Equity Strategist and manager of the firm's
Focus List. Mr. Keller was a Senior Vice President of A.G. Edwards & Sons, Inc.
and of Gallatin Asset Management, Inc., and was a member of the Board of
Directors of both companies. Mr. Keller received a Bachelor of Arts from Wheaton
College (Illinois) and is a CFA charterholder.
DAVID B. MIYAZAKI, CFA - SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER
Prior to joining Confluence in May 2008, Mr. Miyazaki served as a Portfolio
Manager and Analyst with Gallatin Asset Management, Inc. Mr. Miyazaki was
responsible for equity investments in value-oriented separately managed
accounts. He also co-managed the Fund during the time the Fund was sub-advised
by Gallatin Asset Management, Inc., as well as A.G. Edwards' ETF-based asset
allocation program. In addition to portfolio management, Mr. Miyazaki served as
a member of the A.G. Edwards Investment Strategy Committee. As a strategist, he
was responsible for the firm's quantitative asset allocation models, including
its Cyclical Asset Allocation program. Prior to joining A.G. Edwards in 1999,
Mr. Miyazaki was a Portfolio Manager at Koch Industries in Wichita, Kansas. His
previous experience includes working as an Investment Analyst at Prudential
Capital Group in Dallas, Texas, and as a Bond Trader at Barre & Company, also in
Dallas. Mr. Miyazaki received a Bachelor of Business Administration from Texas
Christian University and is a CFA charterholder.
DANIEL T. WINTER, CFA - SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER
Prior to joining Confluence in May 2008, Mr. Winter served as a Portfolio
Manager and Analyst with Gallatin Asset Management, Inc. While at Gallatin, Mr.
Winter chaired the portfolio management team responsible for the firm's six
value-oriented equity strategies. His responsibilities included directing the
strategy implementation and trading execution for the equity portfolios.
Additionally, Mr. Winter co-managed the Fund during the time the Fund was
sub-advised by Gallatin Asset Management, Inc. Mr. Winter also served as a
portfolio manager for the Cyclical Growth ETF Portfolio and the Cyclical Growth
and Income ETF Portfolio which were offered through variable annuities. He was
also a member of the firm's Allocation Advisor Committee which oversaw the A.G.
Edwards exchange-traded fund focused strategies. Prior to joining the firm's
Asset Management division in 1996, Mr. Winter served as a portfolio manager for
A.G. Edwards Trust Company. Mr. Winter earned a Bachelor of Arts in business
management from Eckerd College and a Master of Business Administration from
Saint Louis University. Mr. Winter is a CFA charterholder.
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
The primary investment objective of the First Trust Specialty Finance and
Financial Opportunities Fund ("FGB" or the "Fund") is to seek a high level of
current income. As a secondary objective, the Fund seeks an attractive total
return. The Fund pursues its investment objectives by investing at least 80% of
its managed assets in a portfolio of securities of specialty finance and other
financial companies that the Fund's Sub-Advisor believes offer attractive
opportunities for income and capital appreciation. There can be no assurance
that the Fund's investment objectives will be achieved. The Fund may not be
appropriate for all investors.
Page 3
PORTFOLIO COMMENTARY (UNAUDITED) (CONTINUED)
MARKET RECAP
FGB is a financial sector fund with a particular focus on business development
companies (BDCs). Accordingly, 75% of the Fund was invested in 17 different BDCs
on November 30, 2008. The balance of the portfolio was principally invested in
real estate investment trusts. The Fund pursues both income and growth
objectives, while maintaining a minimum allocation of 80% in the financial
sector, under normal circumstances.
The year ended November 30, 2008 was a very difficult one for financial sector
companies. Problems began in 2007 when risky subprime mortgages began to
default. Losses were substantial, and the magnitude of the problems was
compounded by the fact that the subprime loans were held by investors who had
borrowed heavily to fund their positions. As the year progressed, losses
continued to rise, forcing highly-leveraged investors to sell their positions.
This selling set in motion a downward spiral in pricing that spread far beyond
risky mortgages. Ultimately, even companies with quality investments and only
modest amounts of leverage were negatively impacted.
BDCs do not invest in subprime mortgages and have one of the lowest leverage
profiles among financial sectors. Nevertheless, BDCs were adversely affected by
the widespread collapse in the financial sector. Their stock prices declined
significantly, often without regard to how their loan and investment portfolios
actually performed. Prior to the turmoil, BDCs often traded at 20 to 60%
premiums to their net asset values ("NAVs"). At the end of November, 2008, the
majority of BDCs were trading at substantial discounts to their NAVs, often 30
to 80% or more.
Another industry in which the Fund invests is commercial finance REITs, which
represented 8% of the Fund on November 30, 2008. These companies struggled
throughout the year as debt financing for commercial real estate became scarce.
The ability to buy, sell or refinance commercial real estate became extremely
difficult because of the lack of capital. As a result, many companies in this
space were forced to substantially curtail their operations and experienced
dramatic declines in their stock prices.
A relatively bright area of the portfolio has been the prime residential
mortgage REITs, which were 16% of the Fund at November 30, 2008. These companies
do not invest in subprime mortgages, and instead focus on agency mortgages
backed by the U.S. government. The combination of high quality assets and access
to funding enabled these companies to earn and pay substantial dividends
throughout the year.
PERFORMANCE ANALYSIS (ONE YEAR ENDED 11/30/2008)
-------------------- ---------------------------
FGB Market Value Total Return -72.80%
FGB NAV Total Return -61.38%
Blended Benchmark* -55.46%
* Components of the blended benchmark: Red Rocks Listed Private Equity Index
(40%); FTSE NAREIT Mortgage REIT Index (20%); FTSE NAREIT Hybrid REIT Index
(20%); Merrill Lynch Preferred Stock Hybrid Securities Index (10%); Russell
2000 Financial Services Index (10%).
SOURCE:BLOOMBERG
Over the course of the fiscal year, BDCs and prime residential mortgage REITs
were positive contributors relative to the benchmark, while commercial finance
REITs performed negatively consistent with the benchmark component. The Fund's
relative performance also lagged due to the absence of preferred securities in
the portfolio. Because FGB has a unique profile as a BDC-focused fund, it is
significantly different than the blended benchmark due to differing
compositions.
Another significant contributor to negative relative performance was the Fund's
leverage. Although we managed through the year with limited amounts of leverage,
we elected to reduce the Fund's leverage even further as market turmoil rose. We
also note that the difference between market value and NAV total return was
affected by the fact that shares began the year at a modest premium and ended at
a significant discount.
Page 4
PORTFOLIO COMMENTARY (UNAUDITED) (CONTINUED)
MARKET AND FUND OUTLOOK
Although we expect the financial sector to remain volatile, we believe that
substantial progress is being made to move through the turmoil. Late in 2008,
the Federal Reserve strengthened its ability to direct short-term interest rates
and through coordinated efforts with the Treasury, policy decisions helped to
lower both LIBOR and residential mortgage rates. Substantial declines in these
two interest rates are very stimulative as they affect large portions of the
U.S. economy. Lower gasoline and other fuel prices are also very helpful in
restoring growth. Our expectation is for the U.S. economy to recover in the
middle to latter half of 2009. We also expect the financial markets to
anticipate a recovery, and begin moving in advance of the recovery.
As a group, the BDCs survived the 2007-2008 financial storm with varying amounts
of success. Some incurred substantial damage and are likely to spend significant
time repairing their businesses. Others were conservatively positioned going
into the downturn and should be well-positioned to grow and prosper during the
recovery. The Fund is focused on the latter group, which we expect to return to
market price premiums over NAV valuations and begin growing dividends.
It's also worth noting that, unlike the broader financial sector which has been
plagued with failures in industries from banking to insurance to brokerage
firms, none of the BDCs have been forced into bankruptcy. The durability of the
BDCs legitimizes their structure, and we expect the number and size of BDCs to
expand and grow as the markets stabilize. FGB has a unique profile as a
BDC-focused fund. Going forward we anticipate the Fund will deliver income and
NAV accretion from this attractive niche in the financial sector.
Page 5
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
PORTFOLIO OF INVESTMENTS (a) (g)
NOVEMBER 30, 2008
SHARES DESCRIPTION VALUE
--------- ------------------------------------------------ -----------
COMMON STOCKS - 112.6%
CAPITAL MARKETS - 79.6%
436,806 Apollo Investment Corp. ........................ $ 3,708,483
1,088,333 Ares Capital Corp. ............................. 5,419,898
690,000 BlackRock Kelso Capital Corp. .................. 7,072,500
503,000 Gladstone Capital Corp. ........................ 3,018,000
183,333 Gladstone Investment Corp. ..................... 903,832
50,500 GSC Investment Corp. ........................... 83,325
506,205 Hercules Technology Growth Capital, Inc. ....... 3,265,022
50,000 Highland Distressed Opportunities, Inc. ........ 78,000
571,667 Kohlberg Capital Corp. ......................... 2,343,835
432,000 MCG Capital Corp. .............................. 319,680
655,000 MVC Capital, Inc. .............................. 7,277,050
351,737 NGP Capital Resources Co. ...................... 3,457,575
590,000 Patriot Capital Funding, Inc. .................. 1,988,299
600,000 PennantPark Investment Corp. ................... 1,770,000
705,152 Prospect Energy Corp. .......................... 8,899,018
440,585 TICC Capital Corp. ............................. 1,520,018
------------
51,124,535
------------
DIVERSIFIED FINANCIAL SERVICES - 6.1%
10,000 Compass Diversified Holdings ................... 100,100
32,111 Financial Federal Corp. ........................ 617,174
459,504 Medallion Financial Corp. ...................... 3,216,528
------------
3,933,802
------------
REAL ESTATE INVESTMENT TRUSTS (REITS) - 26.9%
350,000 Annaly Capital Management, Inc. ................ 5,029,500
285,000 Arbor Realty Trust, Inc. ....................... 778,050
112,689 Capital Trust, Inc. - Class A .................. 563,445
21,806 CapitalSource, Inc. ............................ 113,609
192,307 Cypress Sharpridge Investments, Inc. (b) (c)
(e) ......................................... 2,419,222
259,900 Gramercy Capital Corp. ......................... 296,286
33,195 Hatteras Financial Corp ........................ 855,435
100,000 Hatteras Financial Corp. (d) ................... 2,577,000
220,000 iStar Financial, Inc. .......................... 297,000
104,000 MFA Mortgage Investments, Inc. ................. 643,760
1,005,000 NorthStar Realty Finance Corp. ................. 3,417,000
115,600 RAIT Financial Trust ........................... 273,972
------------
17,264,279
------------
TOTAL COMMON STOCKS
(Cost $185,656,430) ......................... 72,322,616
------------
CANADIAN INCOME TRUSTS - 0.0%
OIL, GAS & CONSUMABLE FUELS - 0.0%
100 ARC Energy Trust ............................... 1,592
100 Progress Energy Trust .......................... 723
------------
TOTAL CANADIAN INCOME TRUSTS
(Cost $3,346) ............................... 2,315
------------
See Notes to Financial Statements.
Page 6
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
PORTFOLIO OF INVESTMENTS (a) (g) - (CONTINUED)
NOVEMBER 30, 2008
SHARES DESCRIPTION VALUE
--------- ------------------------------------------------ -----------
WARRANTS - 0.0%
REAL ESTATE INVESTMENT TRUST (REIT) - 0.0%
576,923 Cypress Sharpridge Investments, Inc., expires
04/30/11 (b) (c) (e) ........................ $ 0
------------
TOTAL WARRANTS
(Cost $0) ................................... 0
------------
TOTAL INVESTMENTS - 112.6%
(Cost $185,659,776) (f) ..................... 72,324,931
LOAN OUTSTANDING - (17.8)% .................... (11,450,000)
NET OTHER ASSETS AND LIABILITIES - 5.2% ....... 3,332,765
------------
NET ASSETS - 100.0% ........................... $ 64,207,696
============
----------
(a) All percentages shown in the Portfolio of Investments are based on net
assets.
(b) This security is fair valued in accordance with valuation procedures
adopted by the Fund's Board of Trustees.
(c) Non-income producing security.
(d) This security, sold within the terms of a private placement memorandum, is
exempt from registration under Rule 144A under the Securities Act of 1933,
as amended (the "1933 Act"), and may be resold in transactions exempt from
registration, normally to qualified institutional buyers. Pursuant to
procedures adopted by the Fund's Board of Trustees, this security has been
determined to be liquid by the Fund's investment advisor. At November 30,
2008, securities noted as such amounted to $2,577,000 or 4.0% of net
assets.
(e) This security, sold within the terms of a private placement memorandum, is
exempt from registration under Rule 144A under the Securities Act of 1933,
and may be resold in transactions exempt from registration, normally to
qualified institutional buyers. (See Note 2C - Restricted Securities in the
Notes to Financial Statements).
(f) Aggregate cost for federal income tax purposes is $186,255,080. As of
November 30, 2008, the aggregate gross unrealized appreciation for all
securities in which there was an excess of value over tax cost was
$1,314,190, and the aggregate gross unrealized depreciation for all
securities in which there was an excess of tax cost over value was
$115,244,339.
(g) All or a portion of the securities are available to serve as collateral on
loan outstanding.
SECURITY VALUATION INPUTS
A summary of the inputs used to value the Fund's investments as of November 30,
2008 is as follows (See Note 2A - Portfolio Valuation in Notes to Financial
Statements):
VALUATION INPUTS INVESTMENTS
---------------- -----------
Level 1 - Quoted Prices ......................... $69,905,709
Level 2 - Other Significant Observable Inputs ... --
Level 3 - Significant Unobservable Inputs ....... 2,419,222
-----------
TOTAL ........................................... $72,324,931
===========
The following table presents the Fund's assets measured at fair value on a
recurring basis using significant unobservable inputs (Level 3) for the period
presented November 30, 2008.
ASSETS AT FAIR VALUE USING
UNOBSERVABLE INPUTS (LEVEL 3) INVESTMENTS
----------------------------- -----------
Balance as of November 30, 2007 ................. $ --
Net purchases and sales ......................... 2,999,989
Net unrealized gains/losses ..................... (580,767)
----------
Balance as of November 30, 2008 ................. $2,419,222
==========
See Notes to Financial Statements.
Page 7
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENT OF ASSETS AND LIABILITIES
NOVEMBER 30, 2008
ASSETS:
Investments, at value
(Cost $185,659,776) ......................................... $ 72,324,931
Cash ........................................................... 5,588,203
Prepaid expenses ............................................... 3,830
Receivables:
Investment securities sold .................................. 2,218,018
Dividends ................................................... 321,325
-------------
Total Assets ................................................ 80,456,307
-------------
LIABILITIES:
Payables:
Outstanding loan ............................................ 11,450,000
Distributions to Common Shareholders ........................ 3,557,833
Investment securities purchased ............................. 908,428
Interest and fees due on loan ............................... 152,349
Investment advisory fees .................................... 66,080
Audit and tax fees .......................................... 49,200
Printing fees ............................................... 26,264
Legal fees .................................................. 15,030
Administrative fees ......................................... 8,333
Trustees' fees and expenses ................................. 7,488
Custodian fees .............................................. 3,582
Transfer agent fees ......................................... 2,523
Accrued expenses and other liabilities ......................... 1,501
-------------
Total Liabilities ........................................... 16,248,611
-------------
NET ASSETS ..................................................... $ 64,207,696
=============
NET ASSETS CONSIST OF:
Paid-in capital ................................................ $ 268,630,608
Par value ...................................................... 142,313
Accumulated net investment income (loss) ....................... (3,557,834)
Accumulated net realized gain (loss) on investments ............ (87,672,546)
Net unrealized appreciation (depreciation) on investments ...... (113,334,845)
-------------
NET ASSETS ..................................................... $ 64,207,696
=============
NET ASSET VALUE, per Common Share (par value $0.01 per
Common Share) ............................................... $ 4.51
=============
Number of Common Shares outstanding (unlimited number of Common
Shares has been authorized) ................................. 14,231,333
=============
See Notes to Financial Statements.
Page 8
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED NOVEMBER 30, 2008
INVESTMENT INCOME:
Dividends (net of foreign withholding tax of $269,041) ......... $ 18,586,823
-------------
Total investment income ..................................... 18,586,823
-------------
EXPENSES:
Investment advisory fees ....................................... 1,886,212
Interest and fees on loan ...................................... 1,497,712
Administrative fees ............................................ 184,343
Excise tax expense ............................................. 142,159
Legal fees ..................................................... 101,673
Printing fees .................................................. 79,058
Audit and tax fees ............................................. 63,855
Transfer agent fees ............................................ 36,765
Trustees' fees and expenses .................................... 36,152
Custodian fees ................................................. 22,153
Other .......................................................... 74,652
-------------
Total expenses .............................................. 4,124,734
-------------
NET INVESTMENT INCOME .......................................... 14,462,089
-------------
NET REALIZED AND UNREALIZED GAIN (LOSS):
Net realized gain (loss) on:
Investments ................................................. (80,922,280)
Foreign currency transactions ............................... (13)
-------------
Net realized gain (loss) ....................................... (80,922,293)
-------------
Net change in unrealized appreciation (depreciation)
on investments .............................................. (45,371,825)
-------------
NET REALIZED AND UNREALIZED GAIN (LOSS) ........................ (126,294,118)
-------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM
OPERATIONS .................................................. $(111,832,029)
=============
See Notes to Financial Statements.
Page 9
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENTS OF CHANGES IN NET ASSETS
YEAR ENDED PERIOD ENDED
11/30/2008 11/30/2007 (a)
------------- --------------
OPERATIONS:
Net investment income (loss) ....................................... $ 14,462,089 $ 9,806,749
Net realized gain (loss) ........................................... (80,922,293) (6,750,282)
Net change in unrealized appreciation (depreciation) ............... (45,371,825) (67,963,020)
------------- -------------
Net increase (decrease) in net assets resulting from operations .... (111,832,029) (64,906,553)
------------- -------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income .............................................. (17,995,120) (9,973,682)
Return of capital .................................................. (1,293,149) --
------------- -------------
Total distributions to shareholders ................................ (19,288,269) (9,973,682)
------------- -------------
CAPITAL TRANSACTIONS:
Proceeds from sale of Common Shares ................................ -- 267,977,508
Proceeds from Common Shares reinvested ............................. 2,172,230 534,400
Offering costs ..................................................... 85,301 (561,210)
------------- -------------
Net increase (decrease) in net assets resulting from capital
transactions .................................................... 2,257,531 267,950,698
------------- -------------
Total increase (decrease) in net assets ............................ (128,862,767) 193,070,463
NET ASSETS:
Beginning of period ................................................ 193,070,463 --
------------- -------------
End of period ...................................................... $ 64,207,696 $ 193,070,463
============= =============
Accumulated net investment income (loss) at end of period .......... $ (3,557,834) $ (166,949)
============= =============
CAPITAL TRANSACTIONS WERE AS FOLLOW:
Common Shares at beginning of period ............................... 14,064,166 --
Common Shares sold ................................................. -- 14,030,236
Common Shares issued as reinvestment under the Dividend Reinvestment
Plan ............................................................ 167,167 33,930
------------- -------------
Common Shares at end of period ..................................... 14,231,333 14,064,166
============= =============
----------
(a) Initial seed date of April 23, 2007. The Fund commenced operations on May
25, 2007.
See Notes to Financial Statements.
Page 10
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED NOVEMBER 30, 2008
CASH FLOWS FROM OPERATING ACTIVITIES:
Net decrease in net assets resulting from operations ........... $(111,832,029)
Adjustments to reconcile net increase (decrease) in net assets
resulting from operations to net cash provided by operating
activities:
Purchases of investments .................................... (26,702,670)
Sales of investments ........................................ 61,486,152
Net realized gain/loss on investments ....................... 80,922,280
Net change in unrealized appreciation/depreciation on
investments .............................................. 45,371,825
CHANGES IN ASSETS AND LIABILITIES:
Increase in receivable for investment securities sold ....... (2,218,018)
Decrease in dividends receivable ............................ 702,261
Increase in prepaid expenses ................................ (3,830)
Increase in payable for investment securities purchased ..... 908,428
Decrease in interest and fees on loan ....................... (29,790)
Decrease in offering costs payable .......................... (115,591)
Decrease in investment advisory fees payable ................ (126,066)
Decrease in administrative fees payable ..................... (10,325)
Increase in audit and tax fees payable ...................... 15,355
Decrease in printing fees payable ........................... (11,075)
Increase in legal fees payable .............................. 12,526
Increase in custodian fees payable .......................... 250
Decrease in Trustees' fees and expenses payable ............. (3,042)
Decrease in transfer agent fees payable ..................... (1,609)
Decrease in accrued expenses and other liabilities .......... (6,889)
-------------
CASH PROVIDED BY OPERATING ACTIVITIES .......................... $ 48,358,143
-------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Common shares reinvested ......................... 2,172,230
Offering costs ................................................. 85,301
Distributions to Common Shareholders from net investment
income ...................................................... (19,500,387)
Return of capital distributions ................................ (1,293,149)
Issuances of loan .............................................. 9,100,000
Repayments of loan ............................................. (33,650,000)
-------------
CASH USED IN FINANCING ACTIVITIES .............................. (43,086,005)
-------------
Increase in cash ............................................... 5,272,138
Cash at beginning of period .................................... 316,065
-------------
Cash at end of period .......................................... $ 5,588,203
=============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest and fees .............. $ 1,527,502
=============
Cash paid during the period for taxes .......................... $ 142,159
=============
See Notes to Financial Statements.
Page 11
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
FINANCIAL HIGHLIGHTS
FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD
YEAR PERIOD
ENDED ENDED
11/30/2008 (h) 11/30/2007 (a)
-------------- --------------
Net asset value, beginning of period ........................... $ 13.73 $ 19.10(b)
------- --------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income (loss) ................................... 1.02 0.70
Net realized and unrealized gain (loss) ........................ (8.88) (5.32)
------- --------
Total from investment operations ............................... (7.86) (4.62)
------- --------
DISTRIBUTIONS PAID TO SHAREHOLDERS FROM:
Net investment income .......................................... (1.27) (0.71)
Return of capital .............................................. (0.09) --
------- --------
Total from distributions ....................................... (1.36) (0.71)
------- --------
Common Shares offering costs charged to paid-in capital ........ -- (0.04)
------- --------
Net asset value, end of period ................................. $ 4.51 $ 13.73
======= ========
Market value, end of period .................................... $ 3.29 $ 14.23
======= ========
TOTAL RETURN BASED ON NET ASSET VALUE (c) (e) .................. (61.38)% (24.53)%
======= ========
TOTAL RETURN BASED ON MARKET VALUE (d) (e) ..................... (72.80)% (25.36)%
======= ========
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) ........................... $64,208 $193,070
Ratio of total expenses to average net assets .................. 2.72% 1.99%(f)
Ratio of total expenses to average net assets excluding interest
expense and fees ............................................ 1.73% 1.41%(f)
Ratio of net investment income to average net assets ........... 9.53% 8.64%(f)
Portfolio turnover rate ........................................ 15% 3%
INDEBTEDNESS:
Loan outstanding (in 000's) .................................... $11,450 $ 36,000
Asset Coverage per $1,000 of indebtedness (g) .................. $ 6,608 $ 6,363
----------
(a) Initial seed date of April 23, 2007. The Fund commenced operations on May
25, 2007.
(b) Net of sales load of $0.90 per share on initial offering.
(c) Total return based on net asset value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in net
asset value per share and does not reflect sales load.
(d) Total return based on market value is the combination of reinvested
dividend distributions and reinvested capital gains distributions, if any,
at prices obtained by the Dividend Reinvestment Plan and changes in Common
Share price.
(e) Total return is not annualized for periods less than one year.
(f) Annualized.
(g) Calculated by taking the Fund's total assets less the Fund's total
liabilities (not including the loan outstanding) and dividing by the
outstanding loan balance in 000's.
(h) On July 29, 2008, the Fund's Board of Trustees approved a sub-advisory
agreement with Confluence Investment Management LLC. See Note 3 "Investment
Advisory Fee and Other Affiliated Transactions" in Notes to Financial
Statements.
See Notes to Financial Statements.
Page 12
NOTES TO FINANCIAL STATEMENTS
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008
1. FUND DESCRIPTION
First Trust Specialty Finance and Financial Opportunities Fund (formerly First
Trust/Gallatin Specialty Finance and Financial Opportunities Fund) (the "Fund")
is a non-diversified, closed-end management investment company organized as a
Massachusetts business trust on March 20, 2007, 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 FGB
on the New York Stock Exchange ("NYSE").
The Fund's primary investment objective is to seek a high level of current
income. The Fund seeks attractive total return as a secondary objective. Under
normal market conditions, the Fund will invest at least 80% of its Managed
Assets in a portfolio of securities of specialty finance and other financial
companies that Confluence Investment Management LLC ("Confluence" or the
"Sub-Advisor") believes offer attractive opportunities for income and capital
appreciation. Under normal market conditions, the Fund will concentrate its
investments in securities of companies within industries in the financial
sector. "Managed Assets" means the average daily gross asset value of the Fund
(including assets attributable to the principal amount of borrowings) minus the
sum of the Fund's accrued and unpaid dividends and accrued liabilities (other
than the principal amount of any borrowings incurred by 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 net asset value ("NAV") of the Common Shares of the Fund is determined daily
as of the close of regular trading on the NYSE, normally 4:00 p.m. Eastern time,
on each day the NYSE is open for trading. Domestic debt securities and foreign
securities are priced using data reflecting the earlier closing of the principal
markets for those securities. The NAV per Common Share is calculated by dividing
the value of all assets of the Fund (including accrued interest and dividends),
less all liabilities (including accrued expenses, dividends declared but unpaid
and any borrowings of the Fund) by the total number of Common Shares
outstanding.
The Fund's investments are valued daily at market value or, in the absence of
market value with respect to any portfolio securities, at fair value according
to procedures adopted by the Fund's Board of Trustees. A majority of the Fund's
assets are valued using market information supplied by third parties. In the
event that market quotations are not readily available, the pricing service does
not provide a valuation for a particular asset, or the valuations are deemed
unreliable, the Fund's Board of Trustees has designated First Trust Advisors
L.P. ("First Trust") to use a fair value method to value the Fund's securities
and investments. Additionally, if events occur after the close of the principal
markets for particular securities (e.g., domestic debt and foreign securities),
but before the Fund values its assets, that could materially affect NAV, First
Trust may use a fair value method to value the Fund's securities and
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.
Portfolio securities listed on any exchange other than the NASDAQ National
Market ("NASDAQ") are valued at the last sale price on the business day as of
which such value is being determined. If there has been no sale on such day, the
securities are valued at the mean of the most recent bid and asked prices on
such day. Securities traded on the NASDAQ are valued at the NASDAQ Official
Closing Price as determined by NASDAQ. Portfolio securities traded on more than
one securities exchange are valued at the last sale price on the business day as
of which such value is being determined at the close of the exchange
representing the principal market for such securities. Portfolio securities
traded in the over-the-counter market, but excluding securities traded on the
NASDAQ, are valued at the closing bid prices. Short-term investments that mature
in less than 60 days when purchased are valued at amortized cost.
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 157, Fair Value Measurements
("FAS 157"), effective for fiscal years beginning after November 15, 2007. This
standard clarifies the definition of fair value for financial reporting,
establishes a framework for measuring fair value and requires additional
disclosures about the use of fair value measurements. FAS 157 became effective
for the Fund as of December 1, 2007, the beginning of its current fiscal year.
The three levels of the fair value hierarchy under FAS 157 are described as
follows:
Page 13
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008
- Level 1 - quoted prices in active markets for identical securities
- Level 2 - other significant observable inputs (including quoted prices
for similar securities, interest rates, prepayment speeds, credit
risk, etc.)
- Level 3 - significant unobservable inputs (including the Fund's own
assumptions in determining the fair value of investments)
The inputs or methodology used for valuing securities are not necessarily an
indication of the risk associated with investing in those securities. A summary
of the inputs used to value the Fund's investments as of November 30, 2008 is
included in the Fund's Portfolio of Investments.
B. SECURITIES TRANSACTIONS AND INVESTMENT INCOME:
Securities transactions are recorded as of the trade date. Realized gains and
losses from securities transactions are recorded on the identified cost basis.
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on the accrual basis.
C. RESTRICTED SECURITIES:
The Fund invests in restricted securities, which are securities that 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. As of November 30, 2008, the
Fund held restricted securities as shown in the following table. The Fund does
not have the right to demand that such securities be registered. These
securities are valued according to the valuation procedures as stated in the
Portfolio Valuation footnote (Note 2A) and are not expressed as a discount to
the carrying value of comparable unrestricted securities.
CARRYING
ACQUISITION VALUE PER CARRYING % OF
SECURITY DATE SHARES SHARE COST VALUE NET ASSETS
-------- ----------- ------- --------- ---------- ---------- ----------
Cypress Sharpridge Investments, Inc. 5/19/08 192,307 $12.85 $2,999,989 $2,419,222 3.77%
Cypress Sharpridge Investments, Inc.
Warrants 5/19/08 576,923 -- -- -- --
------- ---------- ---------- ----
769,230 $2,999,989 $2,419,222 3.77%
======= ========== ========== ====
D. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS:
Dividends from net investment income, if any, of the Fund are declared and paid
quarterly or as the Board of Trustees may determine from time to time.
Distributions of any net capital gains earned by the Fund are distributed at
least annually. 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 year ended November
30, 2008, resulting in book and tax accounting differences, have been
reclassified at year end to reflect an increase to accumulated net investment
income (loss) by $142,146 and a increase in accumulated net realized gain (loss)
by $13 and decrease to paid-in capital of $142,159. Net assets were not affected
by these reclassifications.
The tax character of distributions paid during the fiscal years ended November
30, 2008 and November 30, 2007 was as follows:
Distributions paid from:
2008 2007
------------- ----------
Ordinary Income ............................... $17,995,120 $9,973,682
Return of Capital ............................. 1,293,149 --
As of November 30, 2008, the components of distributable earnings on a tax basis
were as follows:
Undistributed Ordinary Income ................. $ --
Net Unrealized Appreciation (Depreciation) .... (113,930,149)
Accumulated Capital and Other Losses .......... (87,077,243)
Page 14
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008
E. INCOME TAXES:
The Fund intends to continue to qualify as a regulated investment company by
complying with the requirements under Subchapter M of the Internal Revenue Code
of 1986, as amended, which includes distributing substantially all of its net
investment income and net realized gains to shareholders. Accordingly, no
provision has been made for federal or state income taxes.
The Fund intends to utilize provisions of the federal income tax laws, which
allows it to carry a realized capital loss forward for eight years following the
year of loss and offset such loss against any future realized capital gains. At
November 30, 2008, the Fund had available realized capital losses of $5,166,354
and $62,586,895 to offset future net capital gains through the fiscal years
ending 2015 and 2016, respectively.
Certain capital losses realized after October 31 may be deferred and treated as
occurring on the first day of the following fiscal year. For the fiscal year
ended November 30, 2008, the Fund intends to elect to defer net realized capital
losses of $19,323,993 and foreign currency losses of $1 incurred between
November 1, 2008 through November 30, 2008.
In June 2006, FASB issued Interpretation No. 48 ("FIN 48"), "Accounting for
Uncertainty in Income Taxes". FIN 48 establishes the minimum threshold for
recognizing, and a system for measuring, the benefits of a tax position taken or
expected to be taken in a tax return and is effective for the Fund's current
fiscal year. As of November 30, 2008, management has evaluated the application
of FIN 48 to the Fund, and has determined that no provision for income tax is
required in the Fund's financial statements.
F. EXPENSES:
The Fund pays all expenses directly related to its operations.
G. 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
Gallatin Asset Management, Inc. ("Gallatin"), the Fund's prior sub-advisor, paid
all organization costs 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, $561,210, was recorded as a reduction of the proceeds from the
sale of Common Shares during the fiscal period ended November 30, 2007. During
the fiscal year ended November 30, 2008, it was determined that actual offering
costs were less than the estimated offering costs by $85,301. Therefore,
paid-in-capital was increased by that amount in the current year, as reflected
in the Statements of Changes in Net Assets.
H. ACCOUNTING PRONOUNCEMENT:
In March 2008, FASB released Statement of Financial Accounting Standards No.
161, "Disclosures about Derivative Instruments and Hedging Activities" ("FAS
161"). FAS 161 requires qualitative disclosures about objectives and strategies
for using derivatives, quantitative disclosures about fair value amounts of and
gains and losses on derivative instruments, and disclosures about credit
risk-related contingent features in derivative agreements. The application of
FAS 161 is required for fiscal years beginning after November 15, 2008 and
interim periods within those fiscal years. Management is currently evaluating
the impact the adoption of FAS 161 will have on the Fund's financial statement
disclosures, if any.
3. INVESTMENT ADVISORY FEE AND OTHER AFFILIATED TRANSACTIONS
First Trust is a limited partnership with one limited partner, Grace Partners of
DuPage L.P., and one general partner, The Charger Corporation. First Trust
serves as investment advisor to the Fund pursuant to an Investment Management
Agreement. First Trust is responsible for the ongoing monitoring of the Fund's
investment portfolio, managing the Fund's business affairs and providing certain
administrative services necessary for the management of the Fund. For these
investment management services, First Trust is entitled to a monthly fee
calculated at an annual rate of 1.00% of the Fund's Managed Assets.
Prior to July 29, 2008, Gallatin served as the Fund's sub-advisor and managed
the Fund's portfolio subject to First Trust's supervision. Effective July 29,
2008, Confluence began serving as the Fund's Sub-Advisor. The Sub-Advisor
receives a monthly portfolio management fee calculated at an annual rate of
0.50% of Managed Assets that is paid by First Trust from its investment advisory
fee.
PNC Global Investment Servicing (U.S.) Inc., formerly known as PFPC, Inc., an
indirect majority-owned subsidiary of the PNC Financial Services Group, serves
as the Fund's Administrator, Fund Accountant, Transfer Agent and Board
Administrator in accordance with certain fee arrangements. PFPC Trust Company,
also an indirect, majority-owned subsidiary of The PNC Financial Services Group,
Inc., serves as the Fund's Custodian in accordance with certain fee
arrangements.
Page 15
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008
Each Trustee who is not an officer or employee of First Trust, any sub-advisor
or any of their affiliates ("Independent Trustees") is paid an annual retainer
of $10,000 per trust for the first 14 trusts of the First Trust Fund Complex and
an annual retainer of $7,500 per trust for each additional trust in the First
Trust Fund Complex. The annual retainer is allocated equally among each of the
trusts. No additional meeting fees are paid in connection with board or
committee meetings.
Additionally, the Lead Independent Trustee is paid $10,000 annually and the
Chairman of the Audit Committee is paid $5,000 annually, with such compensation
paid by the trusts in the First Trust Fund Complex and divided among those
trusts. Trustees are also reimbursed by the trusts in the First Trust Fund
Complex for travel and out-of-pocket expenses in connection with all meetings.
Effective January 1, 2008, each of the chairmen of the Nominating and Governance
Committee and the Valuation Committee are paid $2,500 annually to serve in such
capacities, with such compensation paid by the trusts in the First Trust Fund
Complex and divided among those trusts. Also, effective January 1, 2008, the
Lead Independent Trustee and each Committee chairman will serve two-year terms.
The officers and interested trustee receive no compensation from the Fund for
serving in such capacities.
For the fiscal year ended November 30, 2008, the Fund paid brokerage commissions
to A.G. Edwards & Sons, Inc., an affiliate of Gallatin, the Fund's prior
sub-advisor, totaling $305.
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 year ended November 30,
2008, were $26,702,670 and $61,486,152, respectively.
5. LEVERAGE
On September 12, 2008, the Fund entered into a Customer Agreement and a Credit
Annex thereto with Credit Suisse Securities (USA) LLC, which currently provides
for an uncommitted credit facility to be used as leverage for the Fund (the
"Credit Suisse Facility"). The proceeds of the first borrowing under the Credit
Suisse Facility were used to repay all amounts outstanding under the Loan and
Pledge Agreement dated as of July 11, 2007 between the Fund and Custodial Trust
Company (the "CTC Facility"). The Credit Suisse Facility provides for a secured,
uncommitted line of credit for the Fund, where Fund assets are pledged against
advances made to the Fund. Under the requirements of the 1940 Act, the Fund,
immediately after any such borrowings, must have an "asset coverage" of at least
300% (33 1/3% of the Fund's total assets after borrowings). The total amount of
loans that may be outstanding at any one time under the Credit Suisse Facility
is $70,000,000. For the year ended November 30, 2008, the daily average amount
outstanding under the CTC Facility and the Credit Suisse Facility was
$36,689,617. The high and low annual interest rates during the year ended
November 30, 2008 were 5.87% and 3.40%, respectively, and the weighted average
interest rate was 4.00%. The interest rate at November 30, 2008 was 3.47%.
6. INDEMNIFICATION
The Fund has a variety of indemnification obligations under contracts with its
service providers. The Fund's maximum exposure under these arrangements is
unknown. However, the Fund has not had prior claims or losses pursuant to these
contracts and expects the risk of loss to be remote.
7. RISK CONSIDERATIONS
Risks are inherent in all investing. The following summarizes some of the risks
that should be considered for the Fund. For additional information about the
risks associated with investing in the Fund, please see the Fund's prospectus
and statement of additional information, as well as other Fund regulatory
filings.
INVESTMENT AND MARKET RISK: An investment in the Fund's Common Shares is subject
to investment risk, including the possible loss of the entire principal
invested. An investment in Common Shares represents an indirect investment in
the securities owned by the Fund. The value of these securities, like other
market investments, may move up or down, sometimes rapidly and unpredictably.
Common Shares at any point in time may be worth less than the original
investment, even after taking into account the reinvestment of Fund dividends
and distributions. Security prices can fluctuate for several reasons including
the general condition of the equity market, or when political or economic events
affecting the issuers occur. When the Advisor or Sub-Advisor determines that it
is temporarily unable to follow the Fund's investment strategy or that it is
impractical to do so (such as when a market disruption event has occurred and
trading in the securities is extremely limited or absent) the Fund may take
temporary defensive positions.
In 2008, securities markets have been significantly negatively affected by the
financial crisis that initially resulted from the downturn in the subprime
mortgage market in the United States. The potential impact of the financial
crisis on securities markets may prove to be significant and long-lasting and
may have a substantial impact on the value of the Fund.
Page 16
NOTES TO FINANCIAL STATEMENTS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008
FINANCIAL SECTOR CONCENTRATION RISK: Under normal market conditions, the Fund
will invest at least 25% of its total assets in securities of companies within
industries in the financial sector. A fund concentrated in a single industry or
sector is likely to present more risks than a fund that is broadly diversified
over several industries or groups of industries. Compared to the broad market,
an individual sector may be more strongly affected by changes in the economic
climate, broad market shifts, moves in a particular dominant stock, or
regulatory changes. Specialty finance and other financial companies in general
are subject to extensive government regulation, which may change frequently. The
profitability of specialty finance and other financial companies is largely
dependent upon the availability and cost of capital funds, and may fluctuate
significantly in response to changes in interest rates, as well as changes in
general economic conditions. From time to time, severe competition may also
affect the profitability of specialty finance and other financial companies.
Financial companies can be highly dependent upon access to capital markets and
any impediments to such access, such as general economic conditions or a
negative perception in the capital markets of a company's financial condition or
prospects, could adversely affect its business. Leasing companies can be
negatively impacted by changes in tax laws which affect the types of
transactions in which such companies engage.
BUSINESS DEVELOPMENT COMPANY ("BDC") RISK: Investments in closed-end funds that
elect to be treated as BDCs may be subject to a high degree of risk. BDCs
typically invest in small and medium-sized private and certain public companies
that may not have access to public equity markets or capital raising. As a
result, a BDC's portfolio typically will include a substantial amount of
securities purchased in private placements, and its portfolio may carry risks
similar to those of a private equity or venture capital fund. Securities that
are not publicly registered may be difficult to value and may be difficult to
sell at a price representative of their intrinsic value. Investments in BDCs are
subject to various risks, including management's ability to meet the BDC's
investment objective, and to manage the BDC's portfolio when the underlying
securities are redeemed or sold, during periods of market turmoil and as
investors' perceptions regarding a BDC or its underlying investments change. BDC
shares are not redeemable at the option of the BDC shareholder and, as with
shares of other closed-end funds, they may trade in the secondary market at a
discount to their NAV.
REIT, MORTGAGE-RELATED AND ASSET-BACKED SECURITIES RISKS: Investing in REITs
involves certain unique risks in addition to investing in the real estate
industry in general. REITs are subject to interest rate risks (especially
mortgage REITs) and the risk of default by lessees or borrowers. An equity REIT
may be affected by changes in the value of the underlying properties owned by
the REIT. A mortgage REIT may be affected by the ability of the issuers of its
portfolio mortgages to repay their obligations. REITs whose underlying assets
are concentrated in properties used by a particular industry are also subject to
risks associated with such industry. REITs may have limited financial resources,
their securities may trade less frequently and in a limited volume, and their
securities may be subject to more abrupt or erratic price movements than larger
company securities.
In addition to REITs, the Fund may invest in a variety of other mortgage-related
securities, including commercial mortgage securities and other mortgage-backed
instruments. Rising interest rates tend to extend the duration of
mortgage-related securities, making them more sensitive to changes in interest
rates, and may reduce the market value of the securities. In addition,
mortgage-related securities are subject to prepayment risk, the risk that
borrowers may pay off their mortgages sooner than expected, particularly when
interest rates decline. This can reduce the Fund's returns because the Fund may
have to reinvest that money at lower prevailing interest rates.
The Fund's investments in other asset-backed securities are subject to risks
similar to those associated with mortgage-backed securities, as well as
additional risks associated with the nature of the assets and the servicing of
those assets.
LEVERAGE RISK: The use of leverage results in additional risks and can magnify
the effect of any losses. The funds borrowed pursuant to a leverage borrowing
program constitute a substantial lien and burden by reason of their prior claim
against the income of the Fund and against the net assets of the Fund in
liquidation. The rights of lenders to receive payments of interest on and
repayments of principal on any borrowings made by the Fund under a leverage
borrowing program are senior to the rights of holders of Common Shares with
respect to the payment of dividends or upon liquidation. If the Fund is not in
compliance with certain credit facility provisions, the Fund may not be
permitted to declare dividends or other distributions or purchase Common Shares.
NON-DIVERSIFICATION RISK: Because the Fund is non-diversified, it is only
limited as to the percentage of its assets which may be invested in the
securities of any one issuer by the diversification requirements imposed by the
Internal Revenue Code of 1986, as amended. Because the Fund may invest a
relatively high percentage of its assets in a limited number of issuers, the
Fund may be more susceptible to any single economic, political or regulatory
occurrence and to the financial conditions of the issuers in which it invests.
Page 17
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF FIRST TRUST SPECIALTY FINANCE AND
FINANCIAL OPPORTUNITIES FUND:
We have audited the accompanying statement of assets and liabilities of First
Trust Specialty Finance and Financial Opportunities Fund (the "Fund") (formerly
known as First Trust/Gallatin Specialty Finance and Financial Opportunity Fund),
including the portfolio of investments, as of November 30, 2008, the related
statements of operations and cash flows for the year then ended and the
statement of changes in net assets and financial highlights for the year then
ended and for the period May 25, 2007 (commencement of operations) through
November 30, 2007. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material misstatement.
The Fund is not required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audits included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Fund's internal control over
financial reporting. Accordingly, we express no such opinion. An audit also
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. Our procedures included confirmation
of securities owned as of November 30, 2008, by correspondence with the Fund's
custodian and brokers; where replies were not received from brokers, we
performed other auditing procedures. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of First
Trust Specialty Finance and Financial Opportunities Fund as of November 30,
2008, the results of its operations and cash flows for the year then ended and
changes in its net assets and financial highlights for the year ended and for
the period May 25, 2007 (commencement of operations) through November 30, 2007,
in conformity with accounting principles generally accepted in the United States
of America.
(Deloitte & Touche LLP)
Chicago, Illinois
January 23, 2009
Page 18
ADDITIONAL INFORMATION
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
DIVIDEND REINVESTMENT PLAN
If your Common Shares are registered directly with the Fund or if you hold your
Common Shares with a brokerage firm that participates in the Fund's Dividend
Reinvestment Plan (the "Plan"), unless you elect, by written notice to the Fund,
to receive cash distributions, all dividends, including any capital gain
distributions, on your Common Shares will be automatically reinvested by PNC
Global Investment Servicing (U.S.) Inc. (the "Plan Agent"), in additional Common
Shares under the Plan. If you elect to receive cash distributions, you will
receive all distributions in cash paid by check mailed directly to you by the
Plan Agent, as dividend paying agent.
If you decide to participate in the Plan, the number of Common Shares you will
receive will be determined as follows:
(1) If Common Shares are trading at or above NAV at the time of valuation,
the Fund will issue new shares at a price equal to the greater of (i)
NAV per Common Share on that date or (ii) 95% of the market price on
that date.
(2) If Common Shares are trading below NAV at the time of valuation, the
Plan Agent will receive the dividend or distribution in cash and will
purchase Common Shares in the open market, on the NYSE or elsewhere,
for the participants' accounts. It is possible that the market price
for the Common Shares may increase before the Plan Agent has completed
its purchases. Therefore, the average purchase price per share paid by
the Plan Agent may exceed the market price at the time of valuation,
resulting in the purchase of fewer shares than if the dividend or
distribution had been paid in Common Shares issued by the Fund. The
Plan Agent will use all dividends and distributions received in cash
to purchase Common Shares in the open market within 30 days of the
valuation date except where temporary curtailment or suspension of
purchases is necessary to comply with federal securities laws.
Interest will not be paid on any uninvested cash payments.
You may elect to opt-out of or withdraw from the Plan at any time by giving
written notice to the Plan Agent, or by telephone at (800) 331-1710, in
accordance with such reasonable requirements as the Plan Agent and the Fund may
agree upon. If you withdraw or the Plan is terminated, you will receive a
certificate for each whole share in your account under the Plan and you will
receive a cash payment for any fraction of a share in your account. If you wish,
the Plan Agent will sell your shares and send you the proceeds, minus brokerage
commissions.
The Plan Agent maintains all Common Shareholders' accounts in the Plan and gives
written confirmation of all transactions in the accounts, including information
you may need for tax records. Common Shares in your account will be held by the
Plan Agent in non-certificated form. The Plan Agent will forward to each
participant any proxy solicitation material and will vote any shares so held
only in accordance with proxies returned to the Fund. Any proxy you receive will
include all Common Shares you have received under the Plan.
There is no brokerage charge for reinvestment of your dividends or distributions
in Common Shares. However, all participants will pay a pro rata share of
brokerage commissions incurred by the Plan Agent when it makes open market
purchases.
Automatically reinvesting dividends and distributions does not mean that you do
not have to pay income taxes due upon receiving dividends and distributions.
Capital gains and income are realized, although cash is not received by you.
Consult your financial advisor for more information.
If you hold your Common Shares with a brokerage firm that does not participate
in the Plan, you will not be able to participate in the Plan and any dividend
reinvestment may be effected on different terms than those described above.
The Fund reserves the right to amend or terminate the Plan if in the judgment of
the Board of Trustees the change is warranted. There is no direct service charge
to participants in the Plan; however, the Fund reserves the right to amend the
Plan to include a service charge payable by the participants. Additional
information about the Plan may be obtained by writing PNC Global Investment
Servicing (U.S.) Inc., 301 Bellevue Parkway, Wilmington, Delaware 19809.
PROXY VOTING POLICIES AND PROCEDURES
A description of the policies and procedures that the Fund uses to determine how
to vote proxies and information on how the Fund voted proxies relating to
portfolio securities during the most recent 12-month period ended June 30 is
available (1) without charge, upon request, by calling (800) 988-5891; (2) on
the Fund's website located at http://www.ftportfolios.com; and (3) on the
Securities and Exchange Commission's website at http://www.sec.gov.
Page 19
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
PORTFOLIO HOLDINGS
The Fund files its complete schedule of portfolio holdings with the Securities
and Exchange Commission ("SEC") for the first and third quarters of each fiscal
year on Form N-Q. The Fund's Forms N-Q are available (1) by calling (800)
988-5891; (2) on the Fund's website located at http://www.ftportfolios.com; (3)
on the SEC's website at http://www.sec.gov; and (4) for review and copying at
the SEC's Public Reference Room ("PRR") in Washington, DC. Information regarding
the operation of the PRR may be obtained by calling (800) SEC-0330.
TAX INFORMATION
Of the ordinary income (including short-term capital gains) distributions made
by the Fund during the fiscal year ended November 30, 2008, 0.40% qualified for
the corporate dividend received deduction available to corporate shareholders.
The Fund hereby designates as qualified dividend income distributions 10.99% of
ordinary income distributions (including short-term capital gains), for the
fiscal year ended November 30, 2008.
NYSE CERTIFICATION INFORMATION
In accordance with Section 303A-12 of the New York Stock Exchange ("NYSE")
Listed Company Manual, the Fund's President has certified to the NYSE that, as
of May 14, 2008, he was not aware of any violation by the Fund of NYSE corporate
governance listing standards. In addition, the Fund's reports to the SEC on
Forms N-CSR, N-CSRS and N-Q will contain certifications by the Fund's principal
executive officer and principal financial officer that relate to the Fund's
public disclosure in such reports and are required by Rule 30a-2 under the 1940
Act.
SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
At a Special Shareholder meeting of the Fund held on February 20, 2008,
Shareholders voted to approve a new investment sub-advisory agreement with
Gallatin. Gallatin was previously a wholly-owned subsidiary of A.G. Edwards,
Inc. On May 31, 2007, Wachovia Corp. announced that it had reached an agreement
in principle with A.G. Edwards, Inc. under which Wachovia Corp. would acquire
A.G. Edwards, Inc. (the "Acquisition"). The Acquisition was completed on October
1, 2007. The consummation of the Acquisition resulted in a change of control of
Gallatin, which constituted an "assignment" under federal securities laws of the
original investment sub-advisory agreement among the Fund, Gallatin and First
Trust. Accordingly, the Fund's Board of Trustees approved an interim
sub-advisory agreement with Gallatin effective October 1, 2007, whereby Gallatin
would continue to serve as the Fund's sub-advisor for a maximum period of 150
days. The new sub-advisory agreement, approved by Shareholders on February 20,
2008, was substantially similar to the Fund's original sub-advisory agreement
with Gallatin. The number of votes cast in favor of the new sub-advisory
agreement was 6,739,848, the number of votes against was 256,656, and the number
of abstentions was 7,376,629.
The Joint Annual meeting of Shareholders of the Common Shares of Macquarie/First
Trust Global Infrastructure/Utilities Dividend & Income Fund, Energy Income and
Growth Fund, First Trust Enhanced Equity Income Fund, First Trust/Aberdeen
Global Opportunity Income Fund, First Trust/FIDAC Mortgage Income Fund, First
Trust Strategic High Income Fund, First Trust Strategic High Income Fund II,
First Trust/Aberdeen Emerging Opportunity Fund, First Trust Specialty Finance
and Financial Opportunities Fund (formerly First Trust/Gallatin Specialty
Finance and Financial Opportunities Fund) and First Trust Active Dividend Income
Fund and Shareholders of the Preferred Shares of First Trust Tax-Advantaged
Preferred Income Fund, was held on April 14, 2008. At the Annual Meeting,
Independent Trustee Robert F. Keith was elected for a three-year term. The
number of votes cast in favor of Mr. Keith was 13,764,464, the number of votes
against was 173,146 and the number of abstentions was 0. James A. Bowen, Richard
E. Erickson, Thomas R. Kadlec and Neil B. Nielson are the current and continuing
Trustees.
At a Special Shareholder meeting of the Fund held on November 17, 2008,
Shareholders voted to approve a new investment sub-advisory agreement with
Confluence following the resignation of the Fund's prior sub-advisor, Gallatin,
effective July 31, 2008. Accordingly, the Fund's Board of Trustees approved an
interim sub-advisory agreement among the Fund, First Trust and Confluence,
whereby Confluence would serve as the Fund's sub-advisor for a maximum period of
150 days, subject to shareholder approval. The new sub-advisory agreement,
approved by Shareholders on November 17, 2008, is substantially similar to the
Fund's previous sub-advisory agreements with Gallatin. The number of votes cast
in favor of the new sub-advisory agreement was 6,425,404, the number of votes
against was 393,979, and the number of abstentions was 456,771.
Page 20
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
SUB-ADVISORY AGREEMENTS
BOARD CONSIDERATIONS REGARDING APPROVAL OF SUB-ADVISORY AGREEMENTS
The Board of Trustees of the First Trust Specialty Finance and Financial
Opportunities Fund (then known as First Trust/Gallatin Specialty Finance and
Financial Opportunities Fund; the "Fund"), including a majority of the
Independent Trustees, approved the Interim Sub-Advisory Agreement and the New
Sub-Advisory Agreement (collectively, the "Agreements") among the Fund, First
Trust Advisors L.P. (the "Advisor") and Confluence Investment Management LLC
("Confluence") at a meeting held on July 29, 2008. The Board determined that the
terms of the Agreements are fair and reasonable and in the best interests of the
Fund.
On June 2, 2008, Gallatin Asset Management, Inc. ("Gallatin") notified the Fund
and the Advisor of its resignation as sub-advisor to the Fund, effective July
31, 2008 (the "Resignation"). Gallatin indicated that, following personnel
changes within its equity team, it had conducted an internal review of its
capabilities and resources and determined that it was in the best interests of
Fund shareholders and Gallatin to resign. The Advisor immediately notified the
Board and thereafter conducted a review of potential sub-advisors to replace
Gallatin. The Board considered that pursuant to the Investment Company Act of
1940, as amended ("1940 Act"), any sub-advisory agreement with a replacement
sub-advisor would require shareholder approval prior to such sub-advisor
assuming its duties. In light of the short amount of time available to the Fund
and the Advisor to find a suitable replacement for Gallatin and to obtain
shareholder approval of a new sub-advisory agreement, the Advisor worked with
Fund counsel to obtain a "no-action letter" from the staff of the Securities and
Exchange Commission ("SEC"). The "no-action letter" received on July 11, 2008
stated that the staff would not recommend enforcement action to the SEC against
the Fund, the Advisor and any successor sub-advisor if the Fund and the Advisor
were to enter into an interim sub-advisory agreement without first obtaining
shareholder approval to cover the period while shareholder approval of a new
sub-advisory agreement was sought.
Between the time the Fund and the Advisor received notice of the Resignation and
the July 29, 2008 special Board meeting, the Advisor determined that two
potential sub-advisors should be presented to the Board for consideration as the
successor sub-advisor. One of these candidates - Confluence - employed three
former Gallatin employees who had served as the original portfolio managers of
the Fund and managed the Fund until they left Gallatin in May 2008. Prior to the
meeting, each potential sub-advisor provided to the Board written responses to
questions posed by independent legal counsel on behalf of the Independent
Trustees. At the meeting, representatives from Confluence and the other
potential sub-advisor made presentations to the Board and responded to
questions. The Board then discussed the presentations and the materials
provided. The Advisor recommended that Confluence be selected as successor
sub-advisor. The Independent Trustees then met separately with their independent
legal counsel to discuss the information provided by the two potential
sub-advisors and the Advisor. Based on their consideration of all the
information received, the Trustees appointed Confluence as the interim
sub-advisor to the Fund, pursuant to the Interim Sub-Advisory Agreement,
effective August 1, 2008. Also at the special meeting, the Board approved the
New Sub-Advisory Agreement and determined to recommend it to shareholders of the
Fund for their approval. The Board noted that the Advisor and Confluence had
agreed to bear the costs associated with soliciting shareholder approval of the
New Sub-Advisory Agreement.
To reach its determinations as to the Agreements, the Board considered its
duties under the 1940 Act, as well as under the general principles of state law
in reviewing and approving advisory contracts; the requirements of the 1940 Act
in such matters; the fiduciary duty of investment advisors with respect to
advisory agreements and compensation; the standards used by courts in
determining whether investment company boards have fulfilled their duties; and
the factors to be considered by the Board in voting on such agreements. In its
evaluation of the Agreements, the Board considered a report from Confluence
responding to a request for information from counsel to the Independent
Trustees. The report, among other things, outlined the services to be provided
by Confluence (including the relevant personnel responsible for these services
and their experience, including their experience as former portfolio managers
for the Fund); the sub-advisory fee for the Fund as compared to fees charged to
other clients of Confluence; the potential for economies of scale, if any;
financial data on Confluence; any fall out benefits to Confluence; and
information on Confluence's compliance program. The Board applied its business
judgment to determine whether the arrangements between the Fund, the Advisor and
Confluence are reasonable business arrangements from the Fund's perspective as
well as from the perspective of shareholders.
In reviewing the Agreements, the Board considered the nature, quality and extent
of services to be provided by Confluence under the Agreements. The Board noted
Confluence's investment style and the backgrounds of the investment personnel
who would be responsible for the day-to-day management of the Fund. The Board
noted that the proposed portfolio managers had previously managed the Fund as
portfolio managers at Gallatin and considered the benefits of maintaining
continuity in the management of the Fund. The Board considered, in particular,
the performance of the Fund during a very difficult market for financial
services companies when the Fund was managed by the proposed portfolio managers.
The Board considered the support and assistance provided by one of the major
investors in Confluence and its experience as a registered investment advisor.
In light of the information presented and the considerations made, the Board
concluded that the nature, quality and extent of services to be provided to the
Fund by Confluence under the Agreements are expected to be satisfactory.
Page 21
ADDITIONAL INFORMATION - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
The Board considered the sub-advisory fees to be paid under each Agreement,
noting that they would be the same as the fees paid under the current
Sub-Advisory Agreement. The Board considered the proposed sub-advisory fee and
how it would relate to the overall management fee structure of the Fund, noting
that the fees to be paid to Confluence would be paid by the Advisor from its
advisory fee. On the basis of all the information provided, the Board concluded
that the sub-advisory fees to be paid under the Agreements were reasonable and
appropriate in light of the nature, quality and extent of services expected to
be provided by Confluence under the Agreements.
The Board considered that Confluence was unable to estimate the profitability of
the Agreements to Confluence, but the Board noted that the sub-advisory fee rate
was negotiated at arm's length between the Advisor and Confluence, and that
Confluence would be paid by the Advisor. The Board noted that the overall
management fee structure reflects an appropriate level of sharing of any
economies of scale. The Board also considered the fall-out benefits expected to
be realized by Confluence from its relationship with the Fund. The Board noted
that Confluence will not utilize soft dollars in connection with its management
of the Fund's portfolio.
Based on all of the information considered and the conclusions reached, the
Board, including a majority of the Independent Trustees, determined that the
terms of the Agreements are fair and reasonable and that the approval of the
Agreements is in the best interests of the Fund. No single factor was
determinative in the Board's analysis.
Page 22
BOARD OF TRUSTEES AND OFFICERS
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
NUMBER OF
PORTFOLIOS IN OTHER
THE FIRST TRUST TRUSTEESHIPS OR
NAME, ADDRESS, DATE OF BIRTH TERM OF OFFICE AND PRINCIPAL OCCUPATIONS FUND COMPLEX DIRECTORSHIPS
AND POSITION WITH THE FUND LENGTH OF SERVICE(1) DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE
---------------------------- ---------------------- ------------------------- ------------------- -----------------------
INDEPENDENT TRUSTEES
Richard E. Erickson, Trustee - Two Year Term Physician; President, 60 None
c/o First Trust Advisors L.P. - Since Fund Wheaton Orthopedics;
120 E. Liberty Drive, Inception Co-owner and Co-
Suite 400 Director (January 1996 to
Wheaton, IL 60187 May 2007), Sports Med
D.O.B.: 04/51 Center for Fitness;
Limited Partner,
Gundersen Real Estate
Partnership; Limited
Partner, Sportsmed LLC
Thomas R. Kadlec, Trustee - Two Year Term Senior Vice President and 60 Director of ADM
c/o First Trust Advisors L.P. - Since Fund Chief Financial Officer Investor Services, Inc.
120 E. Liberty Drive, Inception (May 2007 to Present), and Director of
Suite 400 Vice President and Chief Archer Financial
Wheaton, IL 60187 Financial Officer (1990 Services, Inc.
D.O.B.: 11/57 to May 2007), ADM
Investor Services, Inc.
(Futures Commission
Merchant); Vice
President (May 2005 to
Present), ADM
Derivatives, Inc.;
Registered Representative
(2000 to Present),
Segerdahl & Company,
Inc., a FINRA member
(Broker-Dealer)
Robert F. Keith, Trustee - Three Year Term President (2003 to 60 None
c/o First Trust Advisors L.P. - Since Fund Present), Hibs
120 E. Liberty Drive, Inception Enterprises (Financial
Suite 400 and Management
Wheaton, IL 60187 Consulting); President
D.O.B.: 11/56 2001 to 2003), Aramark
Management Services
LP; President and Chief
(Operating Officer (1998
to 2003), ServiceMaster
Management Services LP
----------
(1) Currently, Robert F. Keith, as a Class I Trustee, is serving as a trustee
until the Fund's 2011 annual meeting of shareholders. Richard E. Erickson
and Thomas R. Kadlec, as Class II Trustees, are each serving as trustees
until the Fund's 2009 annual meeting of shareholders. James A. Bowen and
Niel B. Nielson, as Class III Trustees, are each serving as trustees until
the Fund's 2010 annual meeting. Officers of the Fund have an indefinite
term.
Page 23
BOARD OF TRUSTEES AND OFFICERS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
NUMBER OF
PORTFOLIOS IN OTHER
THE FIRST TRUST TRUSTEESHIPS OR
NAME, ADDRESS, DATE OF BIRTH TERM OF OFFICE AND PRINCIPAL OCCUPATIONS FUND COMPLEX DIRECTORSHIPS
AND POSITION WITH THE FUND LENGTH OF SERVICE(1) DURING PAST 5 YEARS OVERSEEN BY TRUSTEE HELD BY TRUSTEE
---------------------------- ---------------------- ------------------------- ------------------- -----------------------
INDEPENDENT TRUSTEE - (CONTINUED)
Niel B. Nielson, Trustee - Three Year Term President (June 2002 to 60 Director of Covenant
c/o First Trust Advisors L.P. - Since Fund Present), Covenant Transport Inc.
120 E. Liberty Drive, Inception College
Suite 400
Wheaton, IL 60187
D.O.B.: 03/54
INTERESTED TRUSTEES
James A. Bowen, Trustee(2), - Three Year Trustee President, First Trust 60 Trustee of Wheaton
President, Chairman of the Term and Indefinite Advisors L.P. and First College
Board and CEO Officer Term Trust Portfolios L.P.;
120 E. Liberty Drive, - Since Fund Chairman of the Board of
Suite 400 Inception Directors, BondWave LLC
Wheaton, IL 60187 (Software Development
D.O.B.: 09/55 Company/Broker-
Dealer/Investment
Advisor) and Stonebridge
Advisors LLC (Investment
Advisor)
NAME, ADDRESS POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS
--------------------- ----------------------- ----------------------- -----------------------------
OFFICERS WHO ARE NOT TRUSTEES(3)
Mark R. Bradley Treasurer, Controller, - Indefinite Term Chief Financial Officer,
120 E. Liberty Drive, Chief Financial Officer - Since Fund Inception First Trust Advisors L.P.
Suite 400 and Chief Accounting and First Trust Portfolios
Wheaton, IL 60187 Officer L.P.; Chief Financial
D.O.B.: 11/57 Officer, BondWave LLC
(Software Development
Company/Broker-
Dealer/Investment
Advisor) and Stonebridge
Advisors LLC (Investment
Advisor)
----------
(1) Currently, Robert F. Keith, as a Class I Trustee, is serving as a trustee
until the Fund's 2011 annual meeting of shareholders. Richard E. Erickson
and Thomas R. Kadlec, as Class II Trustees, are each serving as trustees
until the Fund's 2009 annual meeting of shareholders. James A. Bowen and
Niel B. Nielson, as Class III Trustees, are each serving as trustees until
the Fund's 2010 annual meeting. Officers of the Fund have an indefinite
term.
(2) Mr. Bowen is deemed an "interested person" of the Fund due to his position
as President of First Trust Advisors L.P., investment advisor of the Fund.
(3) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 24
BOARD OF TRUSTEES AND OFFICERS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
NAME, ADDRESS POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS
--------------------- ----------------------- ----------------------- -----------------------------
OFFICERS WHO ARE NOT TRUSTEES(3) - (CONTINUED)
James M. Dykas Assistant Treasurer - Indefinite Term Senior Vice President
120 E. Liberty Drive, - Since Fund Inception (April 2007 to Present),
Suite 400 Vice President (January
Wheaton, IL 60187 2005 to April 2007), First
D.O.B.: 01/66 Trust Advisors L.P. and
First Trust Portfolios L.P.;
Executive Director
(December 2002 to
January 2005), Vice
President (December 2000
to December 2002), Van
Kampen Asset
Management and Morgan
Stanley Investment
Management
Christopher R. Fallow Assistant Vice - Indefinite Term Assistant Vice President
120 E. Liberty Drive, President - Since Fund Inception (August 2006 to Present),
Suite 400 Associate (January 2005 to
Wheaton, IL 60187 August 2006), First Trust
D.O.B.: 04/79 Advisors L.P. and First Trust
Portfolios L.P.; Municipal
Bond Trader (July 2001 to
January 2005), BondWave
LLC (Software Development
Company/Broker-Dealer/
Investment Advisor)
W. Scott Jardine Secretary and Chief - Indefinite Term General Counsel, First
120 E. Liberty Drive, Compliance Officer - Since Fund Inception Trust Advisors L.P. and
Suite 400 First Trust Portfolios L.P.;
Wheaton, IL 60187 Secretary, BondWave LLC
D.O.B.: 05/60 (Software Development
Company/Broker-Dealer/
Investment Advisor) and
Stonebridge Advisors LLC
(Investment Advisor)
----------
(3) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 25
BOARD OF TRUSTEES AND OFFICERS - (CONTINUED)
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
NAME, ADDRESS POSITION AND OFFICES TERM OF OFFICE AND PRINCIPAL OCCUPATIONS
AND DATE OF BIRTH WITH FUND LENGTH OF SERVICE DURING PAST 5 YEARS
--------------------- ----------------------- ----------------------- -----------------------------
OFFICERS WHO ARE NOT TRUSTEES(3) - (CONTINUED)
Daniel J. Lindquist Vice President - Indefinite Term Senior Vice President
120 E. Liberty Drive, - Since Fund Inception (September 2005 to
Suite 400 Present), Vice President
Wheaton, IL 60187 (April 2004 to September
D.O.B.: 02/70 2005), First Trust Advisors
L.P. and First Trust
Portfolios L.P.; Chief
Operating Officer (January
2004 to April 2004), Mina
Capital Management, LLC;
Chief Operating Officer
(April 2000 to January
2004), Samaritan Asset
Management Services, Inc.
Coleen D. Lynch Assistant Vice - Indefinite Term Assistant Vice President
120 E. Liberty Drive, President - Since July 2008 (January 2008 to Present),
Suite 400 First Trust Advisors L.P. and
Wheaton, IL 60187 First Trust Portfolios L.P.;
D.O.B.: 07/58 Vice President (May 1998 to
January 2008), Van Kampen
Asset Management and
Morgan Stanley Investment
Management
Kristi A. Maher Assistant Secretary - Indefinite Term Deputy General Counsel
120 E. Liberty Drive, - Since Fund Inception (May 2007 to Present),
Suite 400 Assistant General Counsel
Wheaton, IL 60187 (March 2004 to May
D.O.B.: 12/66 2007), First Trust Advisors
L.P. and First Trust
Portfolios L.P.; Associate
(December 1995 to March
2004), Chapman and
Cutler LLP
----------
(3) The term "officer" means the president, vice president, secretary,
treasurer, controller or any other officer who performs a policy making
function.
Page 26
PRIVACY POLICY
FIRST TRUST SPECIALTY FINANCE AND FINANCIAL OPPORTUNITIES FUND
NOVEMBER 30, 2008 (UNAUDITED)
PRIVACY POLICY
The open-end and closed-end funds advised by First Trust Advisors L.P. (each a
"Fund") consider your privacy an important priority in maintaining our
relationship. We are committed to protecting the security and confidentiality of
your personal information.
SOURCES OF INFORMATION
We may collect nonpublic personal information about you from the following
sources:
- Information we receive from you or your broker-dealer, investment
adviser or financial representative through interviews, applications,
agreements or other forms;
- Information about your transactions with us, our affiliates or others;
- Information we receive from your inquiries by mail, e-mail or
telephone; and
- Information we collect on our website through the use of "cookies."
For example, we may identify the pages on our website that your
browser requests or visits.
INFORMATION COLLECTED
The type of data we collect may include your name, address, social security
number, age, financial status, assets, income, tax information, retirement and
estate plan information, transaction history, account balance, payment history,
investment objectives, marital status, family relationships and other personal
information.
DISCLOSURE OF INFORMATION
We do not disclose any nonpublic personal information about our customers or
former customers to anyone, except as permitted by law. The permitted uses
include the disclosure of such information to unaffiliated companies for the
following reasons:
- In order to provide you with products and services and to effect
transactions that you request or authorize, we may disclose your
personal information as described above to unaffiliated financial
service providers and other companies that perform administrative or
other services on our behalf, such as transfer agents, custodians and
trustees, or that assist us in the distribution of investor materials
such as trustees, banks, financial representatives and printers.
- We may release information we have about you if you direct us to do
so, if we are compelled by law to do so, or in other legally limited
circumstances (for example to protect your account from fraud).
In addition, in order to alert you to our other financial products and services,
we may share your personal information with affiliates of the Fund. Please note,
however, that the California Financial Information Privacy Act contains an "opt
out" mechanism that California consumers may use to prevent us from sharing
nonpublic personal information with affiliates.
CONFIDENTIALITY AND SECURITY
With regard to our internal security procedures, the Fund restricts access to
your nonpublic personal information to those individuals who need to know that
information to provide products or services to you. We maintain physical,
electronic and procedural safeguards to protect your nonpublic personal
information.
POLICY UPDATES AND INQUIRIES
As required by federal law, we will notify you of our privacy policy annually.
We reserve the right to modify this policy at any time; however, if we do change
it, we will tell you promptly.
For questions about our policy, or for additional copies of this notice, please
contact us at (800) 621-1675.
Page 27
This Page Left Blank Intentionally.
(FIRST TRUST LOGO)
INVESTMENT ADVISOR
First Trust Advisors L.P.
120 E. Liberty Drive, Suite 400
Wheaton, IL 60187
INVESTMENT SUB-ADVISOR
Confluence Investment Management LLC
349 Marshall Avenue, Suite 302
Saint Louis, MO 63119
ADMINISTRATOR, CUSTODIAN,
FUND ACCOUNTANT,
TRANSFER AGENT &
BOARD ADMINISTRATOR
PNC Global Investment Servicing (U.S.) Inc.
301 Bellevue Parkway
Wilmington, DE 19809
CUSTODIAN
PFPC Trust Company
8800 Tinicum Boulevard
Philadelphia, PA 19153
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Deloitte & Touche LLP
111 S. Wacker Drive
Chicago, IL 60606
LEGAL COUNSEL
Chapman and Cutler LLP
111 W. Monroe Street
Chicago, IL 60603
ITEM 2. CODE OF ETHICS.
(a) The registrant, as of the end of the period covered by this report,
has adopted a code of ethics that applies to the registrant's
principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar
functions, regardless of whether these individuals are employed by the
registrant or a third party.
(c) There have been no amendments, during the period covered by this
report, to a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are
employed by the registrant or a third party, and that relates to any
element of the code of ethics description.
(d) The registrant has not granted any waivers, including an implicit
waiver, from a provision of the code of ethics that applies to the
registrant's principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing
similar functions, regardless of whether these individuals are
employed by the registrant or a third party, that relates to one or
more of the items set forth in paragraph (b) of this item's
instructions.
ITEM 3. AUDIT COMMITTEE FINANCIAL EXPERT.
As of the end of the period covered by the report, the Registrant's board of
trustees has determined that Thomas R. Kadlec and Robert F. Keith are qualified
to serve as audit committee financial experts serving on its audit committee and
that each of them is "independent," as defined by Item 3 of Form N-CSR.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(a) Audit Fees (Registrant) -- The aggregate fees billed for each of the
last two fiscal years for professional services rendered by the principal
accountant for the audit of the registrant's annual financial statements or
services that are normally provided by the accountant in connection with
statutory and regulatory filings or engagements for those fiscal years were
$55,500 from the inception of the registrant on May 25, 2007 through November
30, 2007 and $0 for the fiscal year ended November 30, 2008.
(b) Audit-Related Fees (Registrant) -- The aggregate fees billed in each of
the last two fiscal years for assurance and related services by the principal
accountant that are reasonably related to the performance of the audit of the
registrant's financial statements and are not reported under paragraph (a)
of this Item were $0 from the inception of the registrant on May 25, 2007
through November 30, 2007 and $0 for the fiscal year ended November 30, 2008.
Audit-Related Fees (Investment Adviser) -- The aggregate fees billed
in each of the last two fiscal years for assurance and related services by the
principal accountant that are reasonably related to the performance of the audit
of the registrant's financial statements and are not reported under paragraph
(a) of this Item were $6,000 from the inception of the registrant on May 25,
2007 through November 30, 2007 and $0 for the fiscal year ended November 30,
2008.
(c) Tax Fees (Registrant) -- The aggregate fees billed in each of the last
two fiscal years for professional services rendered by the principal accountant
for tax compliance, tax advice, and tax planning to the registrant were $0 from
the inception of the registrant on May 25, 2007 through November 30, 2007 and
$5,000 for the fiscal year ended November 30, 2008. These fees were for tax
consultation.
Tax Fees (Investment Adviser) -- The aggregate fees billed in each of
the last two fiscal years for professional services rendered by the principal
accountant for tax compliance, tax advice, and tax planning to the registrant's
adviser were $0 from the inception of the registrant on May 25, 2007 through
November 30, 2007 and $0 for the fiscal year ended November 30, 2008.
(d) All Other Fees (Registrant) -- The aggregate fees billed in each of the
last two fiscal years for products and services provided by the principal
accountant to the registrant, other than the services reported in paragraphs (a)
through (c) of this Item were $0 from the inception of the registrant on May 25,
2007 through November 30, 2007 and $0 for the fiscal year ended November 30,
2008.
All Other Fees (Investment Adviser) -- The aggregate fees billed in
each of the last two fiscal years for products and services provided by the
principal accountant to the registrant's investment adviser, other than the
services reported in paragraphs (a) through (c) of this Item were $0 from the
inception of the registrant on May 25, 2007 through November 30, 2007 and $0 for
the fiscal year ended November 30, 2008.
(e)(1) Disclose the audit committee's pre-approval policies and procedures
described in paragraph (c) (7) of Rule 2-01 of Regulation S-X.
Pursuant to its charter and its Audit and Non-Audit Services Pre-Approval
Policy, the Audit Committee (the "Committee") is responsible for the
pre-approval of all audit services and permitted non-audit services (including
the fees and terms thereof) to be performed for the registrant by its
independent auditors. The Chairman of the Committee is authorized to give such
pre-approvals on behalf of the Committee up to $25,000 and report any such
pre-approval to the full Committee.
The Committee is also responsible for the pre-approval of the independent
auditor's engagements for non-audit services with the registrant's adviser (not
including a sub-adviser whose role is primarily portfolio management and is
sub-contracted or overseen by another investment adviser) and any entity
controlling, controlled by or under common control with the investment adviser
that provides ongoing services to the registrant, if the engagement relates
directly to the operations and financial reporting of the registrant, subject to
the de minimis exceptions for non-audit services described in Rule 2-01 of
Regulation S-X. If the independent auditor has provided non-audit services to
the registrant's adviser (other than any sub-adviser whose role is primarily
portfolio management and is sub-contracted with or overseen by another
investment adviser) and any entity controlling, controlled by or under common
control with the investment adviser that provides ongoing services to the
registrant that were not pre-approved pursuant to its policies, the Committee
will consider whether the provision of such non-audit services is compatible
with the auditor's independence.
(e)(2) The percentage of services described in each of paragraphs (b)
through (d) for the registrant and the registrant's investment adviser of this
Item that were approved by the audit committee pursuant to the pre-approval
exceptions included in paragraph (c)(7)(i)(c) or paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X are as follows:
(b) 0%
(c) 0%
(d) 0%
(f) The percentage of hours expended on the principal accountant's
engagement to audit the registrant's financial statements for the most recent
fiscal year that were attributed to work performed by persons other than the
principal accountant's full-time, permanent employees was less than fifty
percent.
(g) The aggregate non-audit fees billed by the registrant's accountant for
services rendered to the registrant, and rendered to the registrant's investment
adviser (not including any sub-adviser whose role is primarily portfolio
management and is subcontracted with or overseen by another investment adviser),
and any entity controlling, controlled by, or under common control with the
adviser that provides ongoing services to the registrant from the inception of
the registrant on May 25, 2007 through November 30, 2007, were $0 for the
registrant and $7,000 for the registrant's investment adviser, and for the
fiscal year ended November 30, 2008, were $5,000 for the registrant and $12,143
for the registrant's investment adviser.
(h) The registrant's audit committee of its Board of Trustees has
determined that the provision of non-audit services that were rendered to the
registrant's investment adviser (not including any sub-adviser whose role is
primarily portfolio management and is subcontracted with or overseen by another
investment adviser), and any entity controlling, controlled by, or under common
control with the investment adviser that provides ongoing services to the
registrant that were not pre-approved pursuant to paragraph (c)(7)(ii) of Rule
2-01 of Regulation S-X is compatible with maintaining the principal accountant's
independence.
ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS.
(a) The Registrant has a separately designated audit committee consisting
of all the independent directors of the Registrant. The members of the
audit committee are: Thomas R. Kadlec, Niel B. Nielson, Richard E.
Erickson and Robert F. Keith.
ITEM 6. INVESTMENTS.
(a) Schedule of Investments in securities of unaffiliated issuers as of the
close of the reporting period is included as part of the report to shareholders
filed under Item 1 of this form.
(b) Not applicable.
ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END
MANAGEMENT INVESTMENT COMPANIES.
The Proxy Voting Policies are attached herewith.
CONFLUENCE INVESTMENT MANAGEMENT LLC
PROXY VOTING POLICIES AND PROCEDURES
1. INTRODUCTION
As a registered investment adviser, Confluence Investment Management LLC
("Confluence" or the "Adviser") has a fiduciary duty to act solely in the best
interests of its clients. If the client is a registered investment company under
the Investment Company Act of 1940 or the client requests Confluence to do so in
writing, the Adviser will vote proxy materials for its clients. In the event the
Adviser receives any proxies intended for clients who have not delegated proxy
voting responsibilities to the Adviser, the Adviser will promptly forward such
proxies to the client for the client to vote. When requested by the client, the
Adviser may provide advice to the client regarding proposals submitted to the
client for voting. In the event an employee determines that the Adviser has a
conflict of interest due to, for example, a relationship with a company or an
affiliate of a company, or for any other reason which could influence the advice
given, the employee will advise the Chief Compliance Officer who will advise the
Investment Committee, and the Investment Committee will decide whether the
Adviser should either (1) disclose to the client the conflict to enable the
client to evaluate the advice in light of the conflict or (2) disclose to the
client the conflict and decline to provide the advice.
In cases in which the client is a registered investment company under the
Investment Company Act of 1940 or in cases where the client has delegated proxy
voting responsibility and authority to the Adviser, the Adviser has adopted and
implemented the following policies and procedures, which it believes are
reasonably designed to ensure that proxies are voted in the best interests of
its clients. In pursuing this policy, proxies should be voted in a manner that
is intended to maximize value to the client. In situations where Adviser accepts
such delegation and agrees to vote proxies, Adviser will do so in accordance
with these Policies and Procedures. The Adviser may delegate its
responsibilities under these Policies and Procedures to a third party, provided
that no such delegation shall relieve the Adviser of its responsibilities
hereunder and the Adviser shall retain final authority and fiduciary
responsibility for such proxy voting.
2. GENERAL
a. In the event requests for proxies are received with respect to the
voting of equity securities on routine matters, such as election of
directors or approval of auditors, the proxies usually will be voted
with management unless the Adviser determines it has a conflict or the
Adviser determines there are other reasons not to vote with
management. On non-routine matters, such as amendments to governing
instruments, proposals relating to compensation and stock option and
equity compensation plans, corporate governance proposals and
shareholder proposals, the Adviser will vote, or abstain from voting
if deemed appropriate, on a case by case basis in a manner it believes
to be in the best economic interest of the Company's shareholders. In
the event requests for proxies are received with respect to debt
securities, the Adviser will vote on a case by case basis in a manner
it believes to be in the best economic interest of the Company's
shareholders.
b. The Chief Compliance Officer or his/her designate is responsible for
monitoring Adviser's proxy voting actions and ensuring that (i)
proxies are received and forwarded to the appropriate decision makers;
and (ii) proxies are voted in a timely manner upon receipt of voting
instructions. The Adviser is not responsible for voting proxies it
does not receive, but will make reasonable efforts to obtain missing
proxies.
c. The Chief Compliance Officer or his/her designate shall implement
procedures to identify and monitor potential conflicts of interest
that could affect the proxy voting process, including (i) significant
client relationships; (ii) other potential material business
relationships; and (iii) material personal and family relationships.
d. All decisions regarding proxy voting shall be determined by the
Investment Committee of the Adviser and shall be executed by the Chief
Compliance Officer or his/her designate. Every effort shall be made to
consult with the portfolio manager and/or analyst covering the
security.
e. The Adviser may determine not to vote a particular proxy, if the costs
and burdens exceed the benefits of voting (e.g., when securities are
subject to loan or to share blocking restrictions).
3. CONFLICTS OF INTEREST
The Adviser shall use commercially reasonable efforts to determine whether a
potential conflict may exist, and a potential conflict shall be deemed to exist
only if one or more of the managers of the Adviser actually knew or should have
known of the conflict. The Adviser is sensitive to conflicts of interest that
may arise in the proxy decision-making process and has identified the following
potential conflicts of interest:
- A principal of the Adviser or any person involved in the proxy
decision-making process currently serves on the Board of the
portfolio company.
- An immediate family member of a principal of the Adviser or any
person involved in the proxy decision-making process currently
serves as a director or executive officer of the portfolio
company.
- The Adviser, any fund managed by the Adviser, or any affiliate
holds a significant ownership interest in the portfolio company.
This list is not intended to be exclusive. All employees are obligated to
disclose any potential conflict to the Adviser's Chief Compliance Officer.
If a material conflict is identified, Adviser management may (i) disclose the
potential conflict to the client and obtain consent; or (ii) establish an
ethical wall or other informational barriers between the person(s) that are
involved in the conflict and the persons making the voting decisions.
4. RECORDKEEPING The Chief Compliance Officer or his/her designate is
responsible for maintaining the following records:
- proxy voting policies and procedures;
- proxy statements (provided, however, that the Adviser may rely on
the Securities and Exchange Commission's EDGAR system if the
issuer filed its proxy statements via EDGAR or may rely on a
third party as long as the third party has provided the Adviser
with an undertaking to provide a copy of the
proxy statement promptly upon request);
- records of votes cast and abstentions; and
- any records prepared by the Adviser that were material to a proxy
voting decision or that memorialized a decision.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
(A)(1) IDENTIFICATION OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS AND
DESCRIPTION OF ROLE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS
Investment decisions for the registrant are made by the Portfolio Management
Team of Confluence Investment Management LLC ("Confluence"). The members of the
Confluence Portfolio Management Team are responsible for portfolio management,
security selection, leverage management, trading, compliance, position
reconciliation, communication and reporting to the registrant's investment
adviser.
Length of
Name Title Service Business Experience Past 5 Years
----------------- ---------------------- --------- -------------------------------------------------------------------
1. Mark Keller CEO and CIO 8 mos Chief Investment Officer of Gallatin Asset Management Inc. and its
predecessor organization, A.G. Edwards Asset Management, the
investment management arm of A.G. Edwards, Inc.
2. David Miyazaki Senior V.P. and Senior 8 mos Portfolio Manager and Analyst with Gallatin Asset Management Inc. ,
Portfolio Manager the investment management arm of A.G. Edwards, Inc.
3. Daniel Winter Senior V.P. and Senior 8 mos Portfolio Manager and Analyst with Gallatin Asset Management, the
Portfolio Manager investment management arm of A.G. Edwards, Inc.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBER
AND POTENTIAL CONFLICTS OF INTEREST
OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBER
The information in the table below is as of November 30, 2008.
Total No. of Accounts Total Assets in
Name of Portfolio No. of where Advisory Accounts where
Manager or Accounts Fee is Based on Advisory Fee is Based
Team Member Type of Accounts Managed Total Assets Performance on Performance
------------------- --------------------------------- -------- ------------ --------------- ---------------------
1. Mark Keller Registered Investment Companies: 0 $ 0 0 $0
Other Pooled Investment Vehicles: 0 $ 0 0 $0
Other Accounts: 1,240 $220 Mill. 0 $0
2. David Miyazaki Registered Investment Companies: 0 $ 0 0 $0
Other Pooled Investment Vehicles: 0 $ 0 0 $0
Other Accounts: 1,240 $220 Mill. 0 $0
3. Daniel Winter Registered Investment Companies: 0 $ 0 0 $0
Other Pooled Investment Vehicles: 0 $ 0 0 $0
Other Accounts: 1,240 $220 Mill. 0 $0
POTENTIAL CONFLICTS OF INTERESTS
The Confluence Portfolio Management Team may purchase or sell in other accounts
the same securities that are purchased or sold for the registrant. If a
situation arises where the same securities are being purchased or sold in other
accounts and the registrant, the Portfolio Management Team's policy is to follow
a trade rotation to avoid simultaneous and competing buy or sell orders.
(A)(3) COMPENSATION STRUCTURE OF PORTFOLIO MANAGER(S) OR MANAGEMENT TEAM MEMBERS
The members of the Confluence Portfolio Management Team are compensated with an
annual base salary and a discretionary bonus based on Confluence's overall firm
profits rather than individual product line performance or profitability. In
addition Confluence's portfolio managers are equity owners in the Firm, aligning
their long-term interests with the registrant's holders to strive to achieve
superior investment performance over an appropriate time period. This ensures
that the portfolio managers are incentivized to implement a consistent
investment strategy for the registrant without incurring undue risk.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
The information below is as of November 30, 2008:
Dollar Range of Registrant
Name Shares Beneficially Owned
-------------- --------------------------
Mark Keller $10,001 - $50,000
David Miyazaki $10,001 - $50,000
Daniel Winter $ 1 - $10,000
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 trustees, 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 Specialty Finance and Financial Opportunities Fund
(formerly First Trust/Gallatin Specialty Finance and Financial Opportunities
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 January 26, 2009
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
By (Signature and Title)* /s/ James A. Bowen
-------------------------------------------------------
James A. Bowen, Chairman of the Board, President and
Chief Executive Officer
(principal executive officer)
Date January 26, 2009
By (Signature and Title)* /s/ Mark R. Bradley
-------------------------------------------------------
Mark R. Bradley, Treasurer, Controller, Chief
Financial Officer and Chief Accounting Officer
(principal financial officer)
Date January 26, 2009
* Print the name and title of each signing officer under his or her
signature.