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 811-06495
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
(Exact name of registrant as specified in charter)
301 E. Colorado Boulevard, Suite 720
Pasadena, CA 91101
(Address of principal executive offices) (Zip code)
Donald F. Crumrine
Flaherty & Crumrine Incorporated
301 E. Colorado Boulevard, Suite 720
Pasadena, CA 91101
(Name and address of agent for service)
registrant's telephone number, including area code: 626-795-7300
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.
FLAHERTY & CRUMRINE PREFERRED INCOME OPPORTUNITY FUND
To the Shareholders of Flaherty & Crumrine Preferred Income Opportunity Fund:
There can be no mincing words. The preferred market had an awful year. As
the table demonstrates, the environment has been extremely difficult for PFO,
which must invest most of its assets in preferred securities and which utilizes
leverage to achieve its goal of producing a high level of current income. The
most positive thing we can say about these numbers stems from our fervent belief
that, at present, preferred securities prices have simply fallen too much, and,
over time, will recover.
TOTAL RETURN ON NET ASSET VALUE(1)
FOR PERIODS ENDED NOVEMBER 30, 2008
ACTUAL RETURNS AVERAGE ANNUALIZED RETURNS
------------------------- ----------------------------------
THREE SIX ONE THREE FIVE TEN LIFE OF
MONTHS MONTHS YEAR YEARS YEARS YEARS FUND(2)
------ ------ ----- ----- ----- ----- -------
Flaherty & Crumrine Preferred
Income Opportunity Fund ........ -33.9% -43.2% -48.5% -21.1% -11.3% -1.8% 3.6%
Lipper Domestic Investment
Grade Funds(3) ................. -15.2% -17.1% -17.6% -2.8% 0.2% 3.4% 5.2%
----------
(1) Based on monthly data provided by Lipper Inc. in each calendar month
during the relevant period. Distributions are assumed to be reinvested at
NAV in accordance with Lipper's practice, which differs from the
methodology used elsewhere in this report.
(2) Since inception on February 13, 1992.
(3) Reflects the equally-weighted average performance returns of all
closed-end funds in Lipper's Domestic Investment-Grade funds category in
each month during the period. The category currently includes closed-end
funds in the U.S. Mortgage and Corporate Debt BBB Rated sub-categories and
has included other sub-categories in prior periods. Although the
investment strategies used by the Fund differ significantly from the
strategies used by these other fixed-income funds, the Fund seeks to
accomplish a similar objective.
We encourage you to read the "Discussion Topics" that follow for a more
thorough analysis of the Fund's investment performance. We've also included the
performance of several preferred market indices for further comparison.
Once more we struggle to find appropriate words to describe events in the
financial markets. Although evidence of market troubles first appeared in
mid-2007, there can be little doubt that in recent months we have witnessed the
worst fallout from the financial crisis. Over a ten day period in September, the
government placed Fannie Mae and Freddie Mac into conservatorship, Lehman
Brothers filed for bankruptcy and AIG required the first of two massive doses of
government assistance. Like a financial earthquake, these events sent tremors
throughout the financial system, with the preferred market situated near the
epicenter.
In response, the Federal Reserve has flooded the system with liquidity,
and numerous new government programs designed to stabilize the financial system
have been created. The critical objective of each program is to restore
confidence in the system, and to that end no amount of effort (or money) has
been spared. Many of these efforts appear to be taking hold, and while we are
clearly in the midst of a severe economic slowdown, the foundation for recovery
is being established.
Of these government programs, the Capital Purchase Program ("CPP")
launched in mid-October had the greatest significance for the Fund. Through this
program, the government injected almost $350 billion of capital into qualifying
banks and finance companies by purchasing newly issued preferred securities. The
preferred market got a boost when it was disclosed that EXISTING preferred
securities of companies that participate in the program will typically RANK
EQUAL OR SENIOR to those held by the government.
Most of the new government programs are aimed at shoring up the financial
industry (commercial banks, investment banks and insurance companies). Despite
having disproportionately less exposure to financials when compared to the
overall preferred universe(1), the Fund's performance has been hurt badly by the
industry downturn. At their lowest levels, prices on some financial issues had
fallen by over 75%. Once the lifeline of government aid reaches a particular
company, prices on its securities tend to rebound, but they remain well below
earlier levels. Of the 21 bank and finance companies owned in the Fund, 15 have
received government assistance or have been acquired by stronger institutions.
Much of the price decline can be attributed to concerns about credit
quality, but as we've discussed in the past, technical factors like the ongoing
massive, economy-wide deleveraging and a dramatic decline in market liquidity
have hurt valuations as well. Issues of utility and energy companies, which
comprise most of the non-financial portion of the portfolio, also experienced
substantial price declines during the period. While concerns about credit
quality may have contributed to these price declines, technical factors have
played a major role.
Market conditions have made it necessary to reduce the amount of leverage
employed by the Fund. As the value of the Fund's investment portfolio declined,
the ratio of assets to liabilities fell below required levels. The only remedy
has been to redeem a portion of the leverage. To date the Fund has retired
29.1%, or $20.4 million, of the leverage in place at the beginning of the year.
Leverage is critical for enabling the Fund to achieve its goal of providing high
current income - we encourage you to carefully read the discussion topics that
follow.
An unavoidable consequence of deleveraging has been a reduction in the
amount of income available to shareholders in the form of monthly dividends.
Simply put, the Fund sold assets in order to redeem leverage, and fewer assets
mean less income generated. Since the beginning of fiscal 2008, market
conditions have required us to reduce the monthly dividend several times, for a
total reduction of 26.5%. Again, this important topic is addressed more fully in
the discussion topics.
Under normal circumstances, PFO must have LESS THAN 25% of its portfolio
invested in the banking sector. Recently, the bank portion has risen above this
level, reaching 35.9% as of January 9, 2009. The increase is primarily the
result of prices of the Fund's bank investments increasing relative to the rest
of the portfolio, banks acquiring finance companies and broker-dealers and the
conversion of finance companies into bank holding companies.
----------
(1) According to the Flaherty & Crumrine website, www.preferredstockguide.com,
preferred securities issued by financial companies comprise 85% of the
face value of the overall preferred market. As of November 30, 2008, 48%
of the market value of PFO's portfolio was in financials.
2
The unprecedented turbulence in financial markets also prompted the Fund
to modify its interest-rate hedging strategy this year. As the credit crisis
intensified in 2008, the normal relationship between the prices of preferred
securities and the Fund's interest rate hedge positions (primarily options on
Treasury bond futures and interest rate swaps) weakened or even reversed, so
that the hedge could not be used effectively to help stabilize the Fund's NAV.
At the same time, the yield curve steepened and option prices rose, increasing
the cost of hedging. As these conditions developed, the Fund scaled back its
interest rate hedge positions, removing them entirely by the end of 2008. We
continue to review the effectiveness of the Fund's hedging strategies, and we
anticipate using some hedging instruments when we believe it can accomplish its
goals. For the most part, that means markets returning to more normal
relationships. We don't know when that day will come, but we remain confident
that it will.
Where do we go from here? Just about any fixed-income investment that
doesn't have "US Treasury" in its name has likely declined substantially in
price over recent months, but the market for preferred securities has been
particularly hard hit. Price declines of 50-75% on investment grade preferreds
have not been unusual. We believe the preferred market is significantly
undervalued at this time and that long-term investors will be rewarded
handsomely for their patience. This conclusion is based upon our analysis
described in the discussion topics and on the Fund's website.
Finally, we know this has been an extremely difficult year for
shareholders, and while we might like to say we have been here before, we can't
because we haven't. We believe that our fundamental approach to portfolio
management has helped us avoid most of the credit casualties (the biggest
exception being our exposure to Lehman Brothers Holdings). We also believe the
current portfolio is comprised of survivors. The steps taken by the Fed and
Treasury are starting to gain traction and will help. Economic downturns are
always followed by recoveries and the incoming administration has indicated that
stabilizing the economy is its highest priority. Although we cannot say exactly
when the preferred market will recover, we look forward to a much happier 2009!
Sincerely,
/s/ Donald F. Crumrine /s/ Robert M. Ettinger
Donald F. Crumrine Robert M. Ettinger
Chairman of the Board President
January 13, 2009
3
DISCUSSION TOPICS
THE FUND'S PREFERRED SECURITIES PORTFOLIO AND COMPONENTS OF TOTAL RETURN ON NAV
It's pretty safe to say the preferred securities market suffered its worst
year in history in 2008. While no index comprehensively reflects the preferred
market, Merrill Lynch publishes four different indices which attempt to measure
performance of some sectors of the investment-grade preferred securities market:
the Merrill Lynch 8% Capped DRD Preferred Stock Index (which includes
traditional tax-advantaged preferred stocks); the Merrill Lynch 8% Capped Hybrid
Preferred Securities Index (which includes fully-taxable, exchange-traded
preferred securities); the Merrill Lynch 8% Capped Corporate U.S. Capital
Securities Index (which includes fully taxable capital securities); and the
Merrill Lynch Adjustable Preferred Stock, 7% Constrained Index (which includes
both tax-advantaged and taxable preferred securities with adjustable dividends).
Set forth below are the six month and twelve month total returns of these
indices:
TOTAL RETURNS OF MERRILL LYNCH PREFERRED SECURITIES INDICES*
FOR PERIODS ENDED NOVEMBER 30, 2008
Six Months One Year
---------- --------
Merrill Lynch 8% Capped DRD Preferred Stock Index(SM) ................. -41.5% -41.9%
Merrill Lynch 8% Capped Hybrid Preferred Securities Index(SM) ......... -25.7% -21.9%
Merrill Lynch 8% Capped Corporate U.S. Capital Securities Index(SM) ... -32.2% -35.9%
Merrill Lynch Adjustable Preferred Stock, 7% Constrained Index(SM) .... -51.4% -54.4%
* The Merrill Lynch 8% Capped DRD Preferred Index(SM) includes investment
grade preferred securities issued by both corporations and government
agencies that qualify for the corporate dividends received deduction with
issuer concentration capped at a maximum of 8%. The Merrill Lynch 8%
Capped Hybrid Preferred Index(SM) includes taxable, fixed-rate, U.S.
dollar-denominated investment-grade, preferred securities listed on a U.S.
exchange with issuer concentration capped at 8%. The Merrill Lynch 8%
Capped Corporate U.S. Capital Securities Index(SM) includes investment
grade fixed rate or fixed-to-floating rate $1,000 par securities that
receive some degree of equity credit from the rating agencies or their
regulators with issuer concentration capped at a maximum of 8%. The
Merrill Lynch 7% Capped Adjustable Rate Preferred Securities Index(SM)
includes adjustable rate preferred securities issued by US corporations
and government agencies with issuer concentration capped at a maximum of
7%. All index returns include interest and dividend income and, unlike the
Fund's returns, are unmanaged and do not reflect any expenses.
While we realize it's only small consolation, as set forth in the table
below, the Fund's total return on its securities portfolio before leverage
exceeded most of these indices. Unfortunately, the Fund's strategy of using
leverage to increase current income amplified its negative returns, and coupled
with its expenses and hedging strategy, caused the NAV of the Fund to
underperform most of the unleveraged indices.
The table below reflects performance of each investment tool used by the
Fund to achieve its objective, namely: (a) investing in a portfolio of
securities; (b) hedging that portfolio of securities against significant
increases in long-term interest rates; and (c) issuing an auction-rate preferred
stock to leverage and enhance returns to Common Stock shareholders. The table
then adjusts for the impact of the Fund's operating expenses to arrive at a
total return on NAV (which factors in all of these items).
4
COMPONENTS OF PFO'S TOTAL RETURN ON NAV
FOR PERIODS ENDED NOVEMBER 30, 2008
Six Months One Year
---------- --------
Total Return on Unleveraged Securities Portfolio
(including principal and income) ................... -25.3% -28.4%
Return from Interest Rate Hedging Strategy ......... -0.4% -0.4%
Impact of Leverage ................................. -16.5% -17.6%
Expenses ........................................... -1.0% -2.1%
----- -----
Total Return on NAV -43.2% -48.5%
TOTAL RETURN ON MARKET PRICE OF FUND SHARES
While our focus is primarily on managing the Fund's portfolio, an
investor's actual return is comprised of monthly dividend payments plus changes
in the Fund's market price. The loss-of-confidence factors that hurt prices of
securities in the Fund's portfolio also caused selling of shares of the Fund
itself that widened the Fund's market-price discount to NAV. This double
negative resulted in a total return on market value for the year ended November
30, 2008 of -57.4%. During the fourth fiscal quarter alone, total return on
MARKET VALUE was -43.5%.
Of course, the factors impacting prices of securities in the Fund's
portfolio also drove down the price of the Fund. The market price hit a low of
$2.56 on October 10th and $2.54 on November 20th. As of December 31st,
subsequent to the Fund's fiscal year end the price had recovered some, closing
the calendar year at $4.60.
As can be seen from the chart below, the gap between the price of the Fund
and the intrinsic value of the Fund (NAV) reached its widest level ever during
October. No surprise, the record discount coincided with share price closing
lows.
FLAHERTY & CRUMRINE PREFERRED INCOME OPPORTUNITY FUND (PFO)
PREMIUM/DISCOUNT OF MARKET PRICE TO NAV 12/1/1999 TO 1/9/2009
(PERFORMANCE GRAPH)
12/3/99 -0.097
12/10/99 -0.0807
12/17/99 -0.1118
12/24/99 -0.1212
12/31/99 -0.0354
1/7/00 -0.0028
1/14/00 -0.0385
1/21/00 -0.0996
1/28/00 -0.1047
2/4/00 -0.0923
2/11/00 -0.0845
2/18/00 -0.1038
2/25/00 -0.0962
3/3/00 -0.1021
3/10/00 -0.0858
3/17/00 -0.1055
3/24/00 -0.1272
3/31/00 -0.1361
4/7/00 -0.1047
4/14/00 -0.0894
4/21/00 -0.0781
4/28/00 -0.064
5/5/00 -0.0385
5/12/00 -0.0566
5/19/00 -0.0734
5/26/00 -0.0759
6/2/00 -0.0905
6/9/00 -0.1037
6/16/00 -0.0943
6/23/00 -0.0775
6/30/00 -0.0841
7/7/00 -0.0909
7/14/00 -0.0893
7/21/00 -0.097
7/28/00 -0.0927
8/4/00 -0.0912
8/11/00 -0.0879
8/18/00 -0.1046
8/25/00 -0.1046
9/1/00 -0.1105
9/8/00 -0.1113
9/15/00 -0.0836
9/22/00 -0.1189
9/29/00 -0.1155
10/6/00 -0.0896
10/13/00 -0.0921
10/20/00 -0.0895
10/27/00 -0.0725
11/3/00 -0.0739
11/10/00 -0.0747
11/17/00 -0.0962
11/24/00 -0.0937
12/1/00 -0.0928
12/8/00 -0.0903
12/15/00 -0.0913
12/22/00 -0.0672
12/29/00 -0.0276
1/5/01 -0.0411
1/12/01 -0.02
1/19/01 -0.0077
1/26/01 0.0192
2/2/01 -0.0528
2/9/01 -0.0346
2/16/01 -0.0184
2/23/01 -0.0257
3/2/01 -0.0109
3/9/01 -0.036
3/16/01 -0.0393
3/23/01 -0.036
3/30/01 -0.0109
4/6/01 0.02
4/13/01 0.0046
4/20/01 0.0243
4/27/01 -0.0278
5/4/01 -0.0218
5/11/01 0.0037
5/18/01 -0.0228
5/25/01 -0.0111
6/1/01 -0.0345
6/8/01 -0.0325
6/15/01 -0.0654
6/22/01 -0.0623
6/29/01 -0.0379
7/6/01 -0.0307
7/13/01 -0.0098
7/20/01 -0.0264
7/27/01 0.0237
8/3/01 0.0035
8/10/01 -0.0567
8/17/01 -0.0439
8/24/01 -0.0365
8/31/01 -0.0603
9/7/01 -0.0353
9/14/01 -0.0353
9/21/01 0
9/28/01 -0.0414
10/5/01 -0.0433
10/12/01 -0.0114
10/19/01 -0.0191
10/26/01 -0.0138
11/2/01 0.0017
11/9/01 -0.0068
11/16/01 0.026
11/23/01 0.0304
11/30/01 -0.0284
12/7/01 -0.0009
12/14/01 -0.0201
12/21/01 0.021
12/28/01 0.0289
1/4/02 0.0297
1/11/02 0.0276
1/18/02 0.0268
1/25/02 0.0677
2/1/02 0.0444
2/8/02 0.0607
2/15/02 0.0457
2/22/02 0.0582
3/1/02 0.0595
3/8/02 0.0124
3/15/02 0.0302
3/22/02 0.0383
3/29/02 0.04
4/5/02 0.0248
4/12/02 0.0409
4/19/02 0.0394
4/26/02 0.0526
5/3/02 0.0839
5/10/02 0.0595
5/17/02 0.0858
5/24/02 0.0757
5/31/02 0.0766
6/7/02 0.0832
6/14/02 0.067
6/21/02 0.0743
6/28/02 0.0933
7/5/02 0.1238
7/12/02 0.0692
7/19/02 0.0972
7/26/02 0.1421
8/2/02 0.1372
8/9/02 0.1002
8/16/02 0.1195
8/23/02 0.1206
8/30/02 0.1077
9/6/02 0.1002
9/13/02 0.0965
9/20/02 0.0993
9/27/02 0.1042
10/4/02 0.1141
10/11/02 0.1429
10/18/02 0.0519
10/25/02 0.0741
11/1/02 0.0733
11/8/02 0.0721
11/15/02 0.0664
11/22/02 0.061
11/29/02 0.0872
12/6/02 0.0972
12/13/02 0.1086
12/20/02 0.1278
12/27/02 0.1558
1/3/03 0.1518
1/10/03 0.093
1/17/03 0.1092
1/24/03 0.0865
1/31/03 0.1038
2/7/03 0.0983
2/14/03 0.096
2/21/03 0.1148
2/28/03 0.0969
3/7/03 0.1258
3/14/03 0.1585
3/21/03 0.0897
3/28/03 0.1033
4/4/03 0.1225
4/11/03 0.1477
4/18/03 0.1463
4/25/03 0.1211
5/2/03 0.0989
5/9/03 0.0553
5/16/03 0.033
5/23/03 0.0145
5/30/03 0.0486
6/6/03 -0.0024
6/13/03 -0.0086
6/20/03 0.0032
6/27/03 0.0144
7/4/03 0.0296
7/11/03 -0.0249
7/18/03 -0.0105
7/25/03 -0.0049
8/1/03 -0.0353
8/8/03 -0.0217
8/15/03 -0.0297
8/22/03 0.0008
8/29/03 -0.0032
9/5/03 0.0008
9/12/03 -0.0112
9/19/03 -0.023
9/26/03 -0.0346
10/3/03 -0.0214
10/10/03 -0.0207
10/17/03 -0.0254
10/24/03 0.0095
10/31/03 0.0284
11/7/03 0.0422
11/14/03 0.0386
11/21/03 0.074
11/28/03 0.0731
12/5/03 0.0875
12/12/03 0.0816
12/19/03 0.1044
12/26/03 0.1084
1/2/04 0.129
1/9/04 0.1265
1/16/04 0.1176
1/23/04 0.1305
1/30/04 0.1482
2/6/04 0.1425
2/13/04 0.1404
2/20/04 0.1598
2/27/04 0.1199
3/5/04 0.125
3/12/04 0.1358
3/19/04 0.1518
3/26/04 0.1631
4/2/04 0.1128
4/9/04 0.0576
4/16/04 0.0812
4/23/04 0.0174
4/30/04 0.0229
5/7/04 0.0056
5/14/04 0.0535
5/21/04 0.0802
5/28/04 0.0808
6/4/04 0.0662
6/11/04 0.0541
6/18/04 0.0466
6/25/04 0.0503
7/2/04 0.0502
7/9/04 0.0535
7/16/04 0.0572
7/23/04 0.0604
7/30/04 0.0471
8/6/04 0.0884
8/13/04 0.0798
8/20/04 0.0958
8/27/04 0.1202
9/3/04 0.1234
9/10/04 0.1265
9/17/04 0.1212
9/24/04 0.0843
10/1/04 0.0966
10/8/04 0.0858
10/15/04 0.0957
10/22/04 0.0944
10/29/04 0.0865
11/5/04 0.1136
11/12/04 0.1112
11/19/04 0.113
11/26/04 0.1065
12/3/04 0.057
12/10/04 0.0445
12/17/04 0.0643
12/24/04 0.0955
12/31/04 0.0731
1/7/05 0.0837
1/14/05 0.0708
1/21/05 0.0705
1/28/05 0.0682
2/4/05 0.0635
2/11/05 0.0689
2/18/05 0.0876
2/25/05 0.0751
3/4/05 0.0467
3/11/05 0
3/18/05 -0.0252
3/25/05 -0.0463
4/1/05 -0.0268
4/8/05 -0.0182
4/15/05 -0.0361
4/22/05 -0.0471
4/29/05 -0.0196
5/6/05 0.0016
5/13/05 -0.0047
5/20/05 0.0213
5/27/05 0.0205
6/3/05 0.0242
6/10/05 0.0259
6/17/05 -0.0316
6/24/05 0.0024
7/1/05 0.0207
7/8/05 0.0345
7/15/05 0.0619
7/22/05 0.0492
7/29/05 0.0668
8/5/05 0.0743
8/12/05 0.0343
8/19/05 0.0621
8/26/05 0.0686
9/2/05 0.0745
9/9/05 0.0994
9/16/05 0.0914
9/23/05 0.0543
9/30/05 0.0546
10/7/05 0.0204
10/14/05 -0.0057
10/21/05 -0.0164
10/28/05 -0.0372
11/4/05 -0.0431
11/11/05 -0.0361
11/18/05 -0.0221
11/25/05 -0.0305
12/2/05 -0.0231
12/9/05 -0.0561
12/16/05 -0.0796
12/23/05 -0.0735
12/30/05 -0.094
1/6/06 -0.0457
1/13/06 0.0178
1/20/06 0.0334
1/27/06 0.027
2/3/06 0.03
2/10/06 0.0137
2/17/06 0.0146
2/24/06 0.0146
3/3/06 0.0195
3/10/06 -0.0624
3/17/06 -0.0453
3/24/06 -0.0593
3/31/06 -0.0645
4/7/06 -0.0606
4/14/06 -0.0842
4/21/06 -0.0798
4/28/06 -0.0735
5/5/06 -0.0842
5/12/06 -0.096
5/19/06 -0.1087
5/26/06 -0.0865
6/2/06 -0.0796
6/9/06 -0.0954
6/16/06 -0.0938
6/23/06 -0.0785
6/30/06 -0.0641
7/7/06 -0.0782
7/14/06 -0.0584
7/21/06 -0.0477
7/28/06 -0.0444
8/4/06 -0.0025
8/11/06 0.0252
8/18/06 -0.0248
8/25/06 -0.0249
9/1/06 -0.0099
9/8/06 -0.0206
9/15/06 -0.0173
9/22/06 -0.0252
9/29/06 -0.0358
10/6/06 -0.009
10/13/06 -0.0164
10/20/06 -0.0254
10/27/06 -0.0307
11/3/06 -0.0243
11/10/06 -0.0401
11/17/06 -0.004
11/24/06 -0.0064
12/1/06 -0.0166
12/8/06 0.0008
12/15/06 0.004
12/22/06 -0.0202
12/29/06 -0.0024
1/5/07 -0.0024
1/12/07 0.0045
1/19/07 0.0088
1/26/07 0.0081
2/2/07 -0.0032
2/9/07 0.0081
2/16/07 -0.0048
2/23/07 -0.0056
3/2/07 -0.0063
3/9/07 0.0064
3/16/07 -0.0048
3/23/07 0.0089
3/30/07 0.0276
4/5/07 0.0366
4/13/07 0.0147
4/20/07 0.0024
4/27/07 0.0368
5/4/07 0.0235
5/11/07 0.0089
5/18/07 0.0164
5/25/07 0.0157
6/1/07 0.0075
6/8/07 -0.02
6/15/07 -0.0242
6/22/07 -0.025
6/29/07 0.0025
7/6/07 -0.0302
7/13/07 -0.0436
7/20/07 -0.0093
7/27/07 -0.0139
8/3/07 -0.0131
8/10/07 -0.0203
8/17/07 -0.1041
8/24/07 -0.0385
8/31/07 -0.0214
9/7/07 -0.0416
9/14/07 -0.0335
9/21/07 -0.0009
9/28/07 0.0115
10/5/07 0.0098
10/12/07 -0.0168
10/19/07 -0.0605
10/26/07 -0.008
11/2/07 -0.0398
11/9/07 -0.0483
11/16/07 -0.0145
11/23/07 0.017
11/30/07 0.0158
12/7/07 -0.011
12/14/07 -0.0435
12/21/07 -0.0356
12/28/07 -0.0031
1/4/08 0.0161
1/11/08 0.0098
1/18/08 0.0542
1/25/08 0.0797
2/1/08 0.0601
2/8/08 0.0797
2/15/08 0.0191
2/22/08 0.0519
2/29/08 0.0121
3/7/08 0.0215
3/14/08 -0.0022
3/20/08 0.0481
3/28/08 0.0348
4/4/08 0.0327
4/11/08 -0.0045
4/18/08 0.0089
4/25/08 0.0608
5/2/08 0.0686
5/9/08 0.0766
5/16/08 0.0837
5/23/08 0.1357
5/30/08 0.125
6/6/08 0.1172
6/13/08 0.115
6/20/08 0.1076
6/27/08 0.162
6/30/08 0.1481
7/3/08 0.1314
7/11/08 0.156
7/18/08 0.1586
7/25/08 0.0288
8/1/08 0.0648
8/8/08 0.0618
8/15/08 0.0334
8/22/08 0.0249
8/29/08 -0.0149
9/5/08 -0.0392
9/12/08 -0.0373
9/19/08 -0.03
9/26/08 -0.0378
10/3/08 -0.2004
10/10/08 -0.4599
10/17/08 -0.1616
10/24/08 -0.1902
10/31/08 -0.0623
11/7/08 -0.1202
11/14/08 -0.2292
11/21/08 -0.4009
11/28/08 -0.1656
12/5/08 -0.2561
12/12/08 -0.2839
12/19/08 -0.1375
12/26/08 -0.1446
12/31/08 -0.1051
1/2/09 -0.0367
1/9/09 -0.0391
5
We have often observed year-end selling pressure in the Fund as investors
attempt to realize gains or losses for tax purposes. Given the sharp decline in
the Fund's price, this year appeared to be no different. We were heartened to
see some price recovery in December, which probably means the Fund's high
current yield on market price, 13.0% as of December 31st, has attracted new
investors.
MONTHLY DISTRIBUTIONS TO FUND SHAREHOLDERS
The monthly distribution paid to shareholders is intended to reflect
current market conditions, but we also must make assumptions about the future.
We begin with an estimate of the sustainable income generated from the
investment portfolio, and end with a forecast of expenses. While it sounds
simple, in periods of rapid change, forecasting income and expenses becomes more
art than science. As a result, the monthly dividend rate changed several times
this year. A portion of the distributions in calendar year 2008 were classified
as a tax return of capital rather than ordinary income.
Since the beginning of fiscal 2008, the monthly dividend has been reduced
from $0.068 to $0.050. Most of the dividend reduction in 2008 can be attributed
to deleveraging. The reasons for deleveraging are discussed in detail below, but
the impact on the Fund's monthly dividend is fairly obvious - in order to redeem
or purchase a portion of its outstanding leverage, the Fund had to sell assets.
As a result, the smaller portfolio generated less income; and while a smaller
leverage balance helped reduce expenses, the net result was less income
available to common shareholders.
THE FUND'S LEVERAGE
Let's start with, "Why does the Fund use leverage?" The answer is that the
cost of leverage typically is lower than the yield on the Fund's portfolio and
provides a valuable net addition to income for common shareholders. Since the
Fund's inception, Auction Preferred Stock ("APS") has been the most effective
form of leverage for a fund such as PFO, and an integral component of the Fund's
income objective. However, earlier this year the auction process became a
casualty of the liquidity crisis, and by February auctions were "failing". (This
unfortunate terminology is used when there are not enough new investors to
absorb the shares available for sale at or below the issue's maximum dividend
rate. It should not be confused with a default by the issuer.)
Each issue of APS specifies how the rate will be determined when an
auction fails. In the case of PFO, if an auction fails, the rate is set at the
higher of the 60 day non-financial commercial paper index plus 2.5%, or that
same index times 1.75. Since February, the rates paid by the Fund have been
determined in this manner.
Fortunately, as Federal Reserve efforts to lower short-term interest rates
(including the benchmark commercial paper index) have finally started to work,
rates being paid by the Fund have dropped as well, and are now well below where
they were a year ago.
Until recently, changes to the AMOUNT of leverage have been rare. However,
during the last fiscal quarter the Fund redeemed $20.4 million of its APS. As of
November 30, 2008, PFO had $49.6 million in auction preferred stock outstanding.
The overall percent leverage represented by auction preferred stock to the
Fund's total net assets available to common and preferred as of the same date
was approximately 47.1%, reflecting the redemptions during the quarter (footnote
6 of the financial statements shows the details of these redemptions).
6
When the Fund was created, certain requirements designed to protect the
interest of APS investors were established. Among these, the Fund must meet
certain asset coverage requirements. Essentially, this calculation compares the
Fund's asset values (discounted according to a specific set of rules) to the
liquidation value of the APS plus the Fund's other liabilities. If this
discounted asset value does not meet or exceed this amount, the Fund may not set
aside, declare or pay dividends to common stock shareholders, and it must take
steps to "cure" this coverage test. To do so, the Fund may adjust holdings
(certain assets receive better asset coverage treatment than others) and sell
assets to raise cash. Proceeds from asset sales may be invested in higher
quality, lower yielding securities or held in cash, or in some cases used to
reduce leverage, to restore the required level of asset coverage. If market
values continue to decline, additional sales may be needed. If asset values move
higher, the asset coverage will improve and additional asset sales will not be
required.
If the Fund fails to meet this asset coverage test for ten business days,
it is required to declare its intention to redeem at least enough shares of APS
to once again pass the test (if you can't raise the bridge, you must lower the
water). In addition, the Fund has the OPTION of redeeming APS on any given
auction date (which recur every 49 days) or purchasing shares directly from APS
holders in private transactions.
In order to pay common stock dividends, the Fund must also meet certain
requirements under the Investment Company Act of 1940. Among other things, the
Act requires the Fund to have at least 200% asset coverage for its APS before it
may declare a dividend to be paid to common stock shareholders. In other words,
before declaring its dividend, a Fund has to have at least $2 of assets for
every $1 of APS outstanding.
While we were able to make significant progress in meeting the asset
coverage tests by changing the composition of the portfolio, the Fund was forced
to conduct mandatory redemptions in November. In addition, the Board of
Directors of the Fund determined to further de-leverage through optional
redemptions and share repurchases.
We continue to explore alternatives to the APS, including debt financing.
We want to be certain that any new type of leverage is consistent with the
Fund's long term objectives. In the meantime, and importantly, the rates being
paid on remaining APS have declined, along with other short-term interest rates,
and still provide meaningful benefits to the dividend paid to common
shareholders.
PREFERRED MARKET CONDITIONS
As we've mentioned, prices on almost all preferred securities are down in
recent months, and in some instances the declines are hard to fathom.
Traditional valuation techniques have not been very useful in this environment,
but one tool that helps frame the discussion is called DEFAULT TOLERANCE.
We've posted a thorough discussion of our analysis on the Fund's website
under the heading PREFERRED VALUATION AFTER THE TARP, and we encourage
shareholders to check it out. For our purposes here, a summary will suffice.
The objective of the analysis is to answer the question "GIVEN CURRENT
VALUATIONS, WHAT PERCENTAGE OF THE PORTFOLIO WOULD HAVE TO DEFAULT TO LEAVE YOU
WORSE OFF THAN BUYING A TEN-YEAR US TREASURY NOTE?" As with any model, there are
assumptions made, but even with conservative assumptions, over the ten years
beginning December 31, 2008, 48% of the Fund's current portfolio would have to
default in order for the Treasury note to produce a better return. This is an
extraordinarily high default rate.
Looking rationally at preferred securities valuation leads us to the firm
conclusion that preferreds are cheap. They are at historically wide spreads to
benchmark fixed-income asset classes. They can tolerate
7
very high default rates and still generate positive returns, and the
government's actions to limit the severity of the recession should substantially
reduce the risk that defaults get that severe. At more-reasonable default rates,
preferreds can provide common equity-like returns with lower risk. We believe
that preferred securities remain extremely attractive for long-term investors.
However, we recognize that markets today are far from completely rational.
Stung by losses, some leveraged preferred investors have been forced to exit the
market, and many will not come back. Others see short-term risk that they feel
outweighs preferreds' long-term potential, or they fear that new issue supply
will prevent preferreds from recovering. Still others genuinely fear that the
U.S. economy is headed for another Great Depression, despite all efforts to
prevent it.
We do not know precisely how this recession will play itself out. We can
only assess the factors that we think will affect preferred valuation and act
accordingly. All investing entails taking risks. Intelligent long-term investing
entails taking risks when the potential payoffs are high and the probability of
poor outcomes is low. We believe that in the preferred market, now is such a
time.
Although all companies have felt some strain from the recession and credit
crunch, banks, finance companies, broker-dealers and, more recently, insurance
companies have been most affected, given their direct and indirect exposure
initially to the problems in housing and subsequently to financial markets. The
pressure on preferred security valuations, especially those of financial
issuers, intensified in early September with the federal government taking
conservatorship of Fannie Mae and Freddie Mac (the GSEs), investing at a
position senior to existing preferred holders and suspending the payment of
preferred dividends. This proved a major catalyst for the collapse of preferred
valuations (most dramatically for DRD eligible issues) beginning in September.
These developments were closely followed by the bankruptcy of Lehman Brothers
Holdings and the rescue of AIG. The surviving major broker-dealers reacted
accordingly, with Merrill Lynch arranging a quick marriage with Bank of America
and Goldman Sachs and Morgan Stanley converting to bank holding company
registration, mandating a more conservative capital structure.
Beginning in mid-September, the federal government response to these
developments has been significant. After some resistance, Congress approved the
Treasury's Troubled Assets Relief Program (TARP). Although the funding was
initially envisioned to support asset valuations, on October 14th the Treasury
announced the Capital Purchase Program for banks and thrifts under the TARP,
with clarification that the government's equity investment will rank equal with
(and not rank senior to) existing DRD eligible preferred shareholders and junior
to taxable preferred securities. This restored confidence in a preferred market
that had been weakened significantly by the events beginning with the GSE
conservatorship, and should facilitate the eventual restoration of private
equity into these companies.
More recently, the Treasury announced a second round of preferred equity
financing for Citigroup under the TARP, in addition to joining various other
government agencies guaranteeing $306 billion of this systemically important
institution's troubled assets. In doing so, the Treasury returned to the
original focus of the TARP - stabilizing asset valuations. Having committed the
entire first tranche of TARP funding, the Treasury is now requesting the
additional funds included in the initial legislation from Congress.
In consultation with Treasury, over the same period the Federal Reserve
and the FDIC have established or announced a variety of funding facilities or
guarantee programs to help stabilize financial markets, the magnitude of which
dwarf the size of TARP. These include liquidity facilities for banks, primary
dealers, money market funds (using banks as intermediaries), commercial paper
issuers and, most recently, asset-backed commercial paper issuers. Recent
guarantee programs support intermediate bank debt issuers and
8
money market funds. Announced for February 2009 are the Term Asset-backed
Securities Loan Facility and the Government Sponsored Entities Purchase Program,
to provide liquidity for consumer lending and to holders of GSE debt.
The speed and magnitude of the federal government's response to
developments which climaxed in September have been unprecedented. While all
issuers of preferred securities face a difficult operating environment over the
next several years, this will be especially true for banks and other financial
companies. However, the federal government's prompt recent actions provide some
assurance that the financial system will continue to function.
TAX ADVANTAGES OF 2008 CALENDAR YEAR DISTRIBUTIONS
In 2008, the Fund passed on a portion of its income to individuals in the
form of qualified dividend income or QDI. QDI is taxed at a maximum 15% rate
instead of an individual's ordinary income tax rate. In calendar year 2008,
approximately 57.0% of distributions made by the Fund was eligible for QDI
treatment. For an individual in the 28% tax bracket, this means that the Fund's
total distributions will only be taxed at a blended 20.6% rate versus the 28%
rate which would apply to distributions by a fund containing traditional
corporate bonds. This tax advantage means that, all other things being equal, an
individual in the 28% tax bracket who held 100 shares of Common Stock of the
Fund for the calendar year would have had to receive approximately $84 in
distributions from a traditional corporate bond fund to net the same after-tax
amount as the $77 in distributions paid by the Fund.
For detailed information about the tax treatment of the particular
distributions received from the Fund, please see the Form 1099 you receive from
either the Fund or your broker.
Corporate shareholders also receive a federal tax benefit from the 52.0%
of distributions that were eligible for the inter-corporate dividends received
deduction or DRD.
It is important to remember that the composition of the portfolio and the
income distributions can change from one year to the next, and that the QDI or
DRD portions of next year's distributions may not be the same (or even similar)
to this year's.
Pursuant to Rule 23c-1 under the Investment Company Act of 1940, the Fund
is authorized to repurchase APS on the open market or through negotiated private
transactions. Purchases of APS, if any, will be executed as market and business
conditions warrant on the open market or in negotiated or block trades. The Fund
is not obligated to repurchase any dollar amount or number of APS, and the
timing and amount of any APS repurchased will depend on market conditions, share
price, corporate and regulatory requirements, capital availability and other
factors. Authorization to repurchase APS is at the discretion of the Fund's
Board of Directors and may be limited or terminated at any time without prior
notice.
9
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OVERVIEW
NOVEMBER 30, 2008 (UNAUDITED)
FUND STATISTICS ON 11/30/08
---------------------------
Net Asset Value $ 4.71
Market Price $ 3.93
Discount 16.56%
Yield on Market Price 16.79%
Common Stock Shares Outstanding 11,833,198
MOODY'S RATINGS % OF PORTFOLIO
----------------------- --------------
AA 3.0%
A 10.1%
BBB 49.9%
BB 19.8%
Below "BB" 0.1%
Not Rated 4.6%
----
Below Investment Grade* 16.2%
* BELOW INVESTMENT GRADE BY BOTH MOODY'S AND S&P.
(PIE CHART)
INDUSTRY CATEGORIES % OF PORTFOLIO
------------------- --------------
Utilities 28%
Banking 26%
Insurance 15%
Financial Services 7%
Energy 7%
Other 17%
TOP 10 HOLDINGS BY ISSUER % OF PORTFOLIO
-------------------------- --------------
Southern California Edison 5.1%
Merrill Lynch 4.9%
Liberty Mutual Group 4.9%
Sovereign Bancorp 4.4%
Interstate Power & Light 3.7%
Banco Santander 3.0%
Ocean Spray 2.8%
Puget Energy 2.8%
Kinder Morgan 2.7%
Enbridge Energy Partners 2.5%
% OF PORTFOLIO**
----------------
Holdings Generating Qualified Dividend Income (QDI) for Individuals 51%
Holdings Generating Income Eligible for the Corporate Dividends Received Deduction (DRD) 46%
** THIS DOES NOT REFLECT YEAR-END RESULTS OR ACTUAL TAX CATEGORIZATION OF
FUND DISTRIBUTIONS. THESE PERCENTAGES CAN, AND DO, CHANGE, PERHAPS
SIGNIFICANTLY, DEPENDING ON MARKET CONDITIONS. INVESTORS SHOULD CONSULT
THEIR TAX ADVISOR REGARDING THEIR PERSONAL SITUATION. SEE ACCOMPANYING
NOTES TO THE FINANCIAL STATEMENTS FOR THE TAX CHARACTERIZATION OF 2008
DISTRIBUTIONS.
10
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS
NOVEMBER 30, 2008
SHARES/$ PAR VALUE
----------- ------------
PREFERRED SECURITIES -- 84.8%
BANKING -- 25.4%
$ 3,000,000 Astoria Capital Trust I, 9.75% 11/01/29, Series B ................. $ 2,524,146
Banco Santander:
184,750 6.50% Pfd. ..................................................... 2,782,797**(1)
22,750 6.80% Pfd. ..................................................... 359,734**(1)
$ 3,900,000 Capital One Capital III, 7.686% 08/15/36 .......................... 1,804,062
$ 4,500,000 CBG Florida REIT Corporation, 7.114%, 144A**** .................... 900,000
39,000 Citigroup, Inc., 8.125% Pfd., Series AA ........................... 548,438*
45,000 Cobank, ACB, 7.00% Pfd., 144A**** ................................. 1,201,950*
$ 3,500,000 Comerica Capital Trust II, 6.576% 02/20/37 ........................ 1,337,021
4,500 FBOP Corporation, Adj. Rate Pfd., 144A**** ........................ 2,362,500*
$ 2,250,000 First Hawaiian Capital I, 8.343% 07/01/27, Series B ............... 1,872,488(1)
2,250 First Tennessee Bank, Adj. Rate Pfd., 144A**** .................... 1,153,125*
$ 450,000 HBOS PLC, 6.657%, 144A**** ........................................ 209,730**(1)
4,400 HSBC Series II, Variable Inverse Pfd., Pvt. ....................... 44*+
2,500 HSBC USA, Inc., $2.8575 Pfd. ...................................... 90,860*
3,600 JPMorgan Chase & Co., 6.15% Pfd., Series E ........................ 136,125*
35,000 Keycorp Capital IX, 6.75% Pfd. 12/15/66 ........................... 479,063
99,000 National City Corporation, 9.875% Pfd. ............................ 2,078,010*
28,000 PFGI Capital Corporation, 7.75% Pfd. .............................. 476,000
$ 2,500,000 Regions Financing Trust II, 6.625% 05/15/47 ....................... 1,106,253
3,200 Regions Financing Trust III, 8.875% Pfd. 06/15/78 ................. 64,480
212,700 Sovereign Bancorp, 7.30% Pfd., Series C ........................... 2,871,450*
9,875 Sovereign Capital Trust V, 7.75% Pfd. 05/22/36 .................... 149,051
1,850 Sovereign REIT, 12.00% Pfd., Series A, 144A**** ................... 1,658,211
U.S. Bancorp, Auction Pass-Through Trust, Cl. B:
9 Series 2006-5, Variable Rate Pfd., 144A**** .................... 225*+
9 Series 2006-6, Variable Rate Pfd., 144A**** .................... 225*+
$ 900,000 Washington Mutual Preferred Funding IV, 9.75%, 144A**** ........... 630++
$ 1,400,000 Webster Capital Trust IV, 7.65% 06/15/37 .......................... 589,802
------------
26,756,420
------------
FINANCIAL SERVICES -- 7.4%
CIT Group, Inc.:
10,000 5.189% Pfd., Series B .......................................... 249,500*
261,200 6.35% Pfd., Series A ........................................... 2,114,101*
890 First Republic Preferred Capital Corporation, 10.50% Pfd.,
144A**** ....................................................... 822,769
The accompanying notes are an integral part of the financial statements.
11
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2008
SHARES/$ PAR VALUE
------------ ------------
PREFERRED SECURITIES -- (CONTINUED)
FINANCIAL SERVICES -- (CONTINUED)
22,500 First Republic Preferred Capital Corporation II, 8.75% Pfd.,
Series B, 144A**** ................................................ $ 420,750
Goldman Sachs:
24,680 Cabco Trust Capital I, Adj. Rate Pfd. 02/15/34 ................. 220,578
11 Pass-Through Certificates, Class B, 144A**** ................... 0*+
3,500 STRIPES Custodial Receipts, Pvt. ............................... 35*+
Lehman Brothers Holdings, Inc.:
45,800 5.67% Pfd., Series D ........................................... 11,794*++
9,500 5.94% Pfd., Series C ........................................... 2,484*++
25,000 6.50% Pfd., Series F ........................................... 1,638*++
13,400 7.95% Pfd. ..................................................... 29*++
Merrill Lynch:
112,000 Adj. Rate Pfd., Series 5 ....................................... 882,000*
3,000 Series II STRIPES Custodial Receipts, Pvt. ..................... 7,530*+
200,000 6.25% Pfd. ..................................................... 2,537,500*
30,000 8.625% Pfd., Series 8 .......................................... 538,125*
------------
7,808,833
------------
INSURANCE -- 12.7%
$ 3,250,000 AON Capital Trust A, 8.205% 01/01/27 .............................. 1,655,108
Arch Capital Group Ltd.:
10,000 7.875% Pfd., Series B .......................................... 161,250**(1)
24,400 8.00% Pfd., Series A ........................................... 417,089**(1)
29,700 Axis Capital Holdings, 7.50% Pfd., Series B ....................... 1,582,455(1)
90,000 Delphi Financial Group, 7.376% Pfd. 05/15/37 ...................... 863,442
$ 3,250,000 Everest Re Holdings, 6.60% 05/15/37 ............................... 1,355,689
Liberty Mutual Group:
$ 4,500,000 7.80% 03/15/37, 144A**** ....................................... 2,305,278
$ 250,000 10.75% 06/15/58, 144A**** ...................................... 132,238
$ 1,500,000 MetLife Capital Trust X, 9.25% 04/08/38, 144A**** ................. 999,593
125,000 MetLife, Inc., 6.50% Pfd., Series B ............................... 1,558,600*
$ 200,000 PartnerRe Finance II, 6.44% 12/01/66 .............................. 101,726(1)
Renaissancere Holdings Ltd.:
42,050 6.08% Pfd., Series C ........................................... 520,579**(1)
56,700 6.60% Pfd., Series D ........................................... 793,800**(1)
115,500 Scottish Re Group Ltd., 7.25% Pfd. ................................ 66,124**(1)+
$ 1,060,000 USF&G Capital, 8.312% 07/01/46, 144A**** .......................... 896,300
------------
13,409,271
------------
The accompanying notes are an integral part of the financial statements.
12
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2008
SHARES/$ PAR VALUE
------------ ------------
PREFERRED SECURITIES -- (CONTINUED)
UTILITIES -- 28.1%
Alabama Power Company:
4,980 4.60% Pfd. ..................................................... $ 360,751*
6,485 4.72% Pfd. ..................................................... 482,030*
868 4.92% Pfd. ..................................................... 67,253*
21,500 6.45% Pfd. ..................................................... 505,465*
1,579 Baltimore Gas & Electric Company, 6.70% Pfd., Series 1993 ......... 149,058*
5,560 Central Vermont Public Service Corporation, 8.30% Sinking
Fund Pfd., Pvt. ................................................... 557,390*
2,050 Connecticut Light & Power Company, 4.50% Pfd., Series 1956 ........ 69,618*
2,000 Consolidated Edison Company of New York, 4.65% Pfd., Series C ..... 154,320*
$ 1,750,000 Dominion Resources, Inc., 7.50% ................................... 893,540
15,030 Duquesne Light Company, 3.75% Pfd. ................................ 398,445*
4,400 Florida Power Company, 4.75% Pfd. ................................. 339,460*
Georgia Power Company:
5,655 6.125% Pfd. .................................................... 139,078*
6,500 6.50% Pfd., Series 07-A ........................................ 565,500*
2,000 Great Plains Energy, Inc., 4.35% Pfd. ............................. 135,950*
Hawaiian Electric Company, Inc.:
2,471 5.00% Pfd., Series D ........................................... 51,196*
7,438 5.00% Pfd., Series E ........................................... 154,106*
1,383 5.00% Pfd., Series I ........................................... 28,654*
30,500 Indianapolis Power & Light Company, 5.65% Pfd. .................... 2,448,540*
154,900 Interstate Power & Light Company, 8.375% Pfd., Series B ........... 3,949,950*
Pacific Enterprises:
15,935 $4.50 Pfd. ..................................................... 1,165,805*
8,935 $4.75 Pfd., Series 53 .......................................... 689,961*
$ 1,500,000 PECO Energy Capital Trust III, 7.38% 04/06/28, Series D ........... 1,331,531
14,020 Public Service Electric & Gas Company, 5.28% Pfd., Series E ....... 1,167,305*
$ 5,750,000 Puget Sound Energy, Inc., 6.974% 06/01/67 ......................... 2,911,225
South Carolina Electric & Gas Company:
13,711 5.125% Purchase Fund Pfd., Pvt. ................................ 762,247*
7,774 6.00% Purchase Fund Pfd., Pvt. ................................. 396,863*
Southern California Edison:
25,000 6.00% Pfd., Series C ........................................... 2,186,250*
35,000 6.125% Pfd. .................................................... 3,140,900*
$ 1,780,000 Southern Union Company, 7.20% 11/01/66 ............................ 994,399
$ 750,000 TXU Electric Capital V, 8.175% 01/30/37 ........................... 511,725
The accompanying notes are an integral part of the financial statements.
13
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2008
SHARES/$ PAR VALUE
------------ ------------
PREFERRED SECURITIES -- (CONTINUED)
UTILITIES -- (CONTINUED)
Union Electric Company:
5,700 4.56% Pfd. .................................................... $ 400,710*
10,156 $7.64 Pfd. .................................................... 1,042,260*
$ 1,700,000 Wisconsin Energy Corporation, 6.25% 05/15/67 ..................... 851,136
6,000 Wisconsin Power & Light Company, 6.20% Pfd. ...................... 536,632*
------------
29,539,253
------------
ENERGY -- 7.4%
$ 4,000,000 Enbridge Energy Partners LP, 8.05% 10/01/37 ...................... 2,656,596
$ 2,500,000 Enterprise Products Partners, 7.034% 01/15/68 .................... 1,301,753
3,000 Kinder Morgan GP, Inc., 8.33% Pfd., 144A**** ..................... 2,897,010*
10,000 Lasmo America Limited, 8.15% Pfd., 144A**** ...................... 943,200*(1)
------------
7,798,559
------------
MISCELLANEOUS INDUSTRIES -- 3.8%
13,600 E.I. Du Pont de Nemours and Company, $4.50 Pfd., Series B ........ 1,025,526*
35,000 Ocean Spray Cranberries, Inc., 6.25% Pfd., 144A**** .............. 3,000,900*
------------
4,026,426
------------
TOTAL PREFERRED SECURITIES
(Cost $149,755,280) ........................................... 89,338,762
------------
CORPORATE DEBT SECURITIES -- 2.6%
INSURANCE -- 2.6%
$ 4,417,000 Liberty Mutual Insurance, 7.697% 10/15/97, 144A**** .............. 2,768,721
------------
2,768,721
------------
TOTAL CORPORATE DEBT SECURITIES
(Cost $4,328,822) ............................................. 2,768,721
------------
MONEY MARKET FUND -- 12.1%
12,735,271 BlackRock Provident Institutional, T-Fund ........................ 12,735,271
------------
TOTAL MONEY MARKET FUND
(Cost $12,735,271) ............................................ 12,735,271
------------
The accompanying notes are an integral part of the financial statements.
14
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
PORTFOLIO OF INVESTMENTS (CONTINUED)
NOVEMBER 30, 2008
TOTAL INVESTMENTS (Cost $166,819,373***) ........................ 99.5% $ 104,842,754
OTHER ASSETS AND LIABILITIES (Net) .............................. 0.5% 504,629
--------------
TOTAL NET ASSETS AVAILABLE TO COMMON AND PREFERRED STOCK ........ 100.0%@ $ 105,347,383
--------------
AUCTION PREFERRED STOCK (APS) REDEMPTION VALUE .................. (49,600,000)
--------------
TOTAL NET ASSETS AVAILABLE TO COMMON STOCK ...................... $ 55,747,383
==============
----------
* Securities eligible for the Dividends Received Deduction and distributing
Qualified Dividend Income.
** Securities distributing Qualified Dividend Income only.
*** Aggregate cost of securities held.
**** Securities exempt from registration under Rule 144A of the Securities Act
of 1933. These securities may be resold in transactions exempt from
registration to qualified institutional buyers. These securities have been
determined to be liquid under the guidelines established by the Board of
Directors.
(1) Foreign Issuer.
+ Non-income producing.
++ The issuer has filed for bankruptcy protection. As a result, the Fund may
not be able to recover the principal invested and also does not expect to
receive income on this security going forward.
@ The percentage shown for each investment category is the total value of
that category as a percentage of net assets available to Common and
Preferred Stock.
ABBREVIATIONS:
CABCO -- Corporate Asset Backed Corporation
PFD. -- Preferred Securities
PVT. -- Private Placement Securities
STRIPES -- Structured Residual Interest Preferred Enhanced Securities
The accompanying notes are an integral part of the financial statements.
15
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
STATEMENT OF ASSETS AND LIABILITIES
NOVEMBER 30, 2008
ASSETS:
Investments, at value (Cost $166,819,373) ...................................... $ 104,842,754
Dividends and interest receivable .............................................. 1,499,203
Prepaid expenses ............................................................... 67,853
--------------
Total Assets. .............................................................. 106,409,810
LIABILITIES:
Dividends payable to Common Stock Shareholders ................................. $ 65,947
Investment advisory fee payable ................................................ 55,465
Administration, Transfer Agent and Custodian fees payable ...................... 19,654
Audit fees payable ............................................................. 56,200
Legal fees payable ............................................................. 18,926
Directors' fees payable ........................................................ 895
Accrued expenses and other payables ............................................ 47,611
Accumulated undeclared distributions to Auction Preferred Stock Shareholders ... 797,729
------------
Total Liabilities .......................................................... 1,062,427
--------------
AUCTION PREFERRED STOCK (496 SHARES OUTSTANDING)
REDEMPTION VALUE .............................................................. 49,600,000
--------------
NET ASSETS AVAILABLE TO COMMON STOCK .............................................. $ 55,747,383
==============
NET ASSETS AVAILABLE TO COMMON STOCK consist of:
Distributions in excess of net investment income ............................... $ (990,701)
Accumulated net realized loss on investments sold .............................. (19,323,684)
Unrealized depreciation of investments ......................................... (61,976,619)
Par value of Common Stock ...................................................... 118,332
Paid-in capital in excess of par value of Common Stock ......................... 137,920,055
--------------
Total Net Assets Available to Common Stock ................................. $ 55,747,383
==============
NET ASSET VALUE PER SHARE OF COMMON STOCK:
Common Stock (11,833,198 shares outstanding) .................................. $ 4.71
==============
The accompanying notes are an integral part of the financial statements.
16
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
STATEMENT OF OPERATIONS
FOR THE YEAR ENDED NOVEMBER 30, 2008
INVESTMENT INCOME:
Dividends+ .................................................................... $ 9,358,713
Interest ...................................................................... 4,341,667
--------------
Total Investment Income .................................................. 13,700,380
EXPENSES:
Investment advisory fee ....................................................... $ 940,741
Administrator's fee ........................................................... 170,008
Auction Preferred Stock broker commissions and auction agent fees ............. 177,900
Audit fees .................................................................... 68,700
Legal fees .................................................................... 133,530
Insurance expense ............................................................. 123,207
Transfer Agent fees ........................................................... 72,664
Directors' fees ............................................................... 75,190
Custodian fees ................................................................ 22,471
Compliance fees ............................................................... 37,719
Other ......................................................................... 115,906
------------
Total Expenses ........................................................... 1,938,036
--------------
NET INVESTMENT INCOME ............................................................ 11,762,344
--------------
REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS
Net realized loss on investments sold during the year ......................... (15,071,115)
Net realized loss from written options during the year ........................ (57,579)
Change in net unrealized appreciation/depreciation of investments ............. (49,297,762)
--------------
NET REALIZED AND UNREALIZED LOSS ON INVESTMENTS .................................. (64,426,456)
--------------
DISTRIBUTIONS TO AUCTION PREFERRED STOCK SHAREHOLDERS:
From net investment income (including changes in accumulated
undeclared distributions) .................................................. (3,854,239)
--------------
NET DECREASE IN NET ASSETS TO COMMON STOCK RESULTING FROM OPERATIONS ............. $ (56,518,351)
==============
----------
+ For Federal income tax purposes, a significant portion of this amount may
not qualify for the inter-corporate dividends received deduction ("DRD")
or as qualified dividend income ("QDI") for individuals.
The accompanying notes are an integral part of the financial statements.
17
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
STATEMENTS OF CHANGES IN NET ASSETS AVAILABLE TO COMMON STOCK
YEAR ENDED YEAR ENDED
NOVEMBER 30, 2008 NOVEMBER 30, 2007
----------------- -----------------
OPERATIONS:
Net investment income .......................................................... $ 11,762,344 $ 12,431,906
Net realized loss on investments sold during the year .......................... (15,128,694) (1,720,220)
Change in net unrealized depreciation of investments ........................... (49,297,762) (26,931,948)
Distributions to APS* Shareholders from net investment income, including
changes in accumulated undeclared distributions ............................... (3,854,239) (3,357,998)
----------------- -----------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS ........................... (56,518,351) (19,578,260)
DISTRIBUTIONS:
Dividends paid from net investment income to Common Stock Shareholders(1) ...... (8,888,100) (9,284,238)
Tax return of capital to Common Stock Shareholders ............................. (352,939) --
----------------- -----------------
TOTAL DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS ............................... (9,241,039) (9,284,238)
FUND SHARE TRANSACTIONS:
Increase from shares issued under the Dividend Reinvestment and Cash Purchase
Plan .......................................................................... 820,340 591,605
Gain on repurchase of Auction Preferred Stock(2) ............................... 1,600,000 --
----------------- -----------------
NET INCREASE IN NET ASSETS AVAILABLE TO COMMON STOCK RESULTING FROM FUND
SHARE TRANSACTIONS ............................................................ 2,420,340 591,605
NET DECREASE IN NET ASSETS AVAILABLE TO COMMON STOCK FOR THE YEAR ................. $ (63,339,050) $ (28,270,893)
================= =================
NET ASSETS AVAILABLE TO COMMON STOCK:
Beginning of year .............................................................. $ 119,086,433 $ 147,357,326
Net decrease in net assets during the year ..................................... (63,339,050) (28,270,893)
----------------- -----------------
End of year (including distributions in excess of net investment income
$(990,701) and $(339,917), respectively) ...................................... $ 55,747,383 $ 119,086,433
================= =================
----------
* Auction Preferred Stock (formerly known as Money Market Cumulative
Preferred(TM) Stock).
(1) May include income earned, but not paid out, in prior fiscal year.
(2) See Note 6.
The accompanying notes are an integral part of the financial statements.
18
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
FINANCIAL HIGHLIGHTS
FOR A COMMON STOCK SHARE OUTSTANDING THROUGHOUT EACH YEAR.
Contained below is per share operating performance data, total investment
returns, ratios to average net assets and other supplemental data. This
information has been derived from information provided in the financial
statements and market price data for the Fund's shares.
YEAR ENDED NOVEMBER 30,
---------------------------------------------------------
2008 2007 2006 2005 2004
--------- --------- --------- --------- ---------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year .................................. $ 10.14 $ 12.60 $ 12.14 $ 12.27 $ 12.59
--------- --------- --------- --------- ---------
INVESTMENT OPERATIONS:
Net investment income ............................................... 1.00 1.06 1.02 0.96 0.98
Net realized and unrealized gain/(loss) on investments .............. (5.46) (2.44) 0.49 (0.01) (0.27)
DISTRIBUTIONS TO APS* SHAREHOLDERS:
From net investment income .......................................... (0.33) (0.29) (0.25) (0.17) (0.09)
--------- --------- --------- --------- ---------
Total from investment operations .................................... (4.79) (1.67) 1.26 0.78 0.62
--------- --------- --------- --------- ---------
DISTRIBUTIONS TO COMMON STOCK SHAREHOLDERS:
From net investment income .......................................... (0.75) (0.79) (0.80) (0.91) (0.94)
From return of capital .............................................. (0.03) -- -- -- --
--------- --------- --------- --------- ---------
Total distributions to Common Stock Shareholders .................... (0.78) (0.79) (0.80) (0.91) (0.94)
--------- --------- --------- --------- ---------
Gain on repurchase of Auction Preferred Stock ....................... 0.14 -- -- -- --
--------- --------- --------- --------- ---------
Net asset value, end of year ........................................ $ 4.71 $ 10.14 $ 12.60 $ 12.14 $ 12.27
========= ========= ========= ========= =========
Market value, end of year ........................................... $ 3.93 $ 10.30 $ 12.42 $ 11.53 $ 13.53
Total investment return based on net asset value** .................. (48.12%) (13.90%) 11.02% 6.36% 4.68%
Total investment return based on market value** ..................... (57.38%) (11.28%) 15.22% (8.40%) 7.57%
RATIOS TO AVERAGE NET ASSETS AVAILABLE
TO COMMON STOCK SHAREHOLDERS:
Total net assets, end of year (in 000's) ......................... $ 55,747 $ 119,086 $ 147,357 $ 141,717 $ 142,145
Operating expenses. .............................................. 2.05% 1.56% 1.52% 1.53% 1.52%
Net investment income + .......................................... 8.36% 6.53% 6.34% 6.30% 7.11%
SUPPLEMENTAL DATA:++
Portfolio turnover rate .......................................... 60% 60% 68% 57% 28%
Total net assets available to Common and Preferred Stock,
end of period (in 000's) ........................................ $ 105,347 $ 189,086 $ 217,357 $ 211,717 $ 212,145
Ratio of operating expenses to total average net assets
available to Common and Preferred Stock ......................... 1.19% 1.04% 1.02% 1.03% 1.03%
* Auction Preferred Stock (formerly known as Money Market Cumulative
Preferred(TM) Stock).
** Assumes reinvestment of distributions at the price obtained by the Fund's
Dividend Reinvestment and Cash Purchase Plan.
+ The net investment income ratios reflect income net of operating expenses
and payments to APS Shareholders.
++ Information presented under heading Supplemental Data includes APS.
The accompanying notes are an integral part of the financial statements.
19
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
PER SHARE OF COMMON STOCK
TOTAL DIVIDEND
DIVIDENDS NET ASSET NYSE REINVESTMENT
PAID+ VALUE CLOSING PRICE PRICE (1)
--------- --------- ------------- -------------
December 31, 2007 ................................. $ 0.0680 $ 9.64 $ 9.46 $ 9.64
January 31, 2008 .................................. 0.0680 10.23 10.25 10.23
February 29, 2008 ................................. 0.0680 9.94 10.06 9.94
March 31, 2008 .................................... 0.0680 8.65 9.09 8.65
April 30, 2008 .................................... 0.0680 8.93 9.47 9.00
May 30, 2008 ...................................... 0.0680 8.80 9.90 9.41
June 30, 2008 ..................................... 0.0680 8.10 9.30 8.83
July 31, 2008 ..................................... 0.0680 7.39 7.77 7.39
August 29, 2008 ................................... 0.0680 7.36 7.25 7.35
October 27, 2008(2). .............................. 0.0610 5.31(3) 4.15 4.60
November 12, 2008 ................................. 0.0550 5.16(4) 3.81 3.97
November 28, 2008 ................................. 0.0550 4.71 3.93 3.73
----------
+ May include distributions classified as a tax return of capital.
(1) Whenever the net asset value per share of the Fund's Common Stock is less
than or equal to the market price per share on the reinvestment date, new
shares issued will be valued at the higher of net asset value or 95% of
the then current market price. Otherwise, the reinvestment shares of
Common Stock will be purchased in the open market.
(2) September 30, 2008 distribution delayed; paid on October 27, 2008.
(3) NAV as of October 24, 2008.
(4) NAV as of November 7, 2008.
The accompanying notes are an integral part of the financial statements.
20
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
FINANCIAL HIGHLIGHTS (CONTINUED)
PER SHARE OF COMMON STOCK
The table below sets out information with respect to Auction Preferred
Stock currently outstanding.
INVOLUNTARY
ASSET LIQUIDATION
TOTAL SHARES COVERAGE PREFERENCE
DATE OUTSTANDING (1) PER SHARE (2) PER SHARE (3)
-------- --------------- ------------- -------------
11/30/08 496 $ 214,002 $ 100,000
11/30/07 700 270,894 100,000
11/30/06 700 310,819 100,000
11/30/05 700 302,788 100,000
11/30/04 700 303,137 100,000
11/30/03 700 306,301 100,000
----------
(1) See note 6.
(2) Calculated by subtracting the Fund's total liabilities (excluding the APS
and accumulated undeclared distributions to APS) from the Fund's total
assets and dividing that amount by the number of APS shares outstanding.
(3) Excludes accumulated undeclared dividends.
The accompanying notes are an integral part of the financial statements.
21
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated (the
"Fund") was incorporated as a Maryland corporation on December 10, 1991, and
commenced operations on February 13, 1992 as a diversified, closed-end
management investment company under the Investment Company Act of 1940, as
amended (the "1940 Act"). The Fund's investment objective is to provide its
common shareholders with high current income consistent with the preservation of
capital.
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 the financial statements is in conformity with U.S. generally
accepted accounting principles ("US GAAP") and requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities in the financial statements and the reported amounts of increases
and decreases in net assets from operations during the reporting period. Actual
results could differ from those estimates.
Portfolio valuation: The net asset value of the Fund's Common Stock is
determined by the Fund's Administrator no less frequently than on the last
business day of each week and month. It is determined in accordance with the
policies and procedures approved by the Board of Directors of the Fund by
dividing the value of the Fund's net assets available to Common Stock by the
number of shares of Common Stock outstanding. The value of the Fund's net assets
available to Common Stock is deemed to equal the value of the Fund's total
assets less (i) the Fund's liabilities and (ii) the aggregate liquidation value
of the outstanding Auction Preferred Stock ("APS").
The Fund's preferred and debt securities are valued on the basis of
current market quotations provided by independent pricing services or dealers
approved by the Board of Directors of the Fund. Each quotation is based on the
mean of the bid and asked prices of a security. In determining the value of a
particular preferred or debt security, a pricing service or dealer may use
information with respect to transactions in such investments, quotations, market
transactions in comparable investments, various relationships observed in the
market between investments, and/or calculated yield measures based on valuation
technology commonly employed in the market for such investments. Common stocks
that are traded on stock exchanges are valued at the last sale price or official
close price on the exchange, as of the close of business on the day the
securities are being valued or, lacking any sales, at the last available mean
price. Futures contracts and option contracts on futures contracts are valued on
the basis of the settlement price for such contracts on the primary exchange on
which they trade. Investments in over-the-counter derivative instruments, such
as interest rate swaps and options thereon ("swaptions"), are valued using
prices supplied by a pricing service, or if such prices are unavailable, prices
provided by a single broker or dealer that is not the counterparty or, if no
such prices are available, at a price at which the counterparty to the contract
would repurchase the instrument or terminate the contract. Investments for which
market quotations are not readily available or for which management determines
that the prices are not reflective of current market conditions are valued at
fair value as determined in good faith by or under the direction of the Board of
Directors of the Fund, including reference to valuations of other securities
which are comparable in quality, maturity and type.
22
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Investments in money market instruments and all debt and preferred
securities which mature in 60 days or less are valued at amortized cost.
Investments in money market funds are valued at the net asset value of such
funds.
In September 2006, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 157 "Fair Value
Measurements" ("SFAS 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. The Fund has
adopted SFAS 157 as of December 1, 2007. The three levels of the fair value
hierarchy under SFAS 157 are described below:
- 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 net assets as of November 30,
2008 is as follows:
OTHER FINANCIAL
INSTRUMENTS
INVESTMENTS (UNREALIZED
IN SECURITIES APPRECIATION/
VALUATION INPUTS (MARKET VALUE) DEPRECIATION)*
------------------------------------------------- -------------- ----------------
Level 1 - Quoted Prices ......................... $ 24,199,088 $ --
Level 2 - Other Significant Observable Inputs ... 80,643,666 --
Level 3 - Significant Unobservable Inputs ....... -- --
------------- ----
Total $ 104,842,754 $ --
* Other financial instruments are derivative instruments not reflected in
the Portfolio of Investments, such as futures, forwards and swaps which
are valued at the unrealized appreciation/depreciation on the investment.
As of November 30, 2008 the Fund does not have any other financial
instruments.
Securities transactions and investment income: Securities transactions are
recorded as of the trade date. Realized gains and losses from securities sold
are recorded on the specific identified cost basis. Dividend income is recorded
on ex-dividend dates. Interest income is recorded on the accrual basis. The Fund
also amortizes premiums and accretes discounts on fixed income securities using
the effective yield method.
Options: Purchases of options are recorded as an investment, the value of
which is marked-to-market at each valuation date. When the Fund enters into a
closing sale transaction, the Fund will record a gain or loss depending on the
difference between the purchase and sale price. The risks associated with
purchasing options and the maximum loss the Fund would incur are limited to the
purchase price originally paid.
23
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
When the Fund writes an option, an amount equal to the premium received by
the Fund is recorded as a liability, the value of which is marked-to-market at
each valuation date. When a written option expires, the Fund realizes a gain
equal to the amount of the premium originally received. When the Fund enters
into a closing purchase transaction, the Fund realizes a gain (or loss if the
cost of the closing purchase transaction exceeds the premium received when the
option was written) without regard to any unrealized gain or loss on the
underlying security, and the liability related to such option is eliminated.
When a call option is exercised, the Fund realizes a gain or loss from the sale
of the underlying security and the proceeds from such sale are increased by the
amount of the premium originally received. When a put option is exercised, the
amount of the premium originally received will reduce the cost of the security
which the Fund purchased upon exercise.
The risk in writing a call option is that the Fund may forego the
opportunity for profit if the market price of the underlying security increases
and the option is exercised. The risk in writing a put option is that the Fund
may incur a loss if the market price of the underlying security decreases and
the option is exercised.
Repurchase agreements: The Fund may engage in repurchase agreement
transactions. The Fund's investment adviser reviews and approves the eligibility
of the banks and dealers with which the Fund may enter into repurchase agreement
transactions. The value of the collateral underlying such transactions is at
least equal at all times to the total amount of the repurchase obligations,
including interest. The Fund maintains possession of the collateral through its
custodian and, in the event of counterparty default, the Fund has the right to
use the collateral to offset losses incurred. There is the possibility of loss
to the Fund in the event the Fund is delayed or prevented from exercising its
rights to dispose of the collateral securities.
Federal 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, applicable to regulated
investment companies and intends to distribute substantially all of its taxable
net investment income to its shareholders. Therefore, no federal income tax
provision is required.
In June 2006, the FASB issued FASB Interpretation 48 ("FIN 48"),
"Accounting for Uncertainty in Income Taxes." This standard defines the
threshold for recognizing the benefits of tax-return positions in the financial
statements as "more-likely-than-not" to be sustained upon challenge by the
taxing authority and requires measurement of a tax position meeting the
more-likely-than-not criterion, based on the largest benefit that is more than
50 percent likely to be realized. FIN 48 became effective as of the beginning of
the first fiscal year beginning after December 15, 2006, with early application
permitted if no interim financial statements have been issued. At adoption,
companies must adjust their financial statements to reflect only those tax
positions that are more likely-than-not to be sustained as of the adoption date.
The tax periods open to examination by the Internal Revenue Service include the
fiscal years ended November 30, 2008, 2007, 2006 and 2005. The Fund's major tax
jurisdictions are federal and California. As of November 30, 2008, the Fund has
evaluated the adoption of FIN 48 and determined that there is no material impact
on the financial statements.
Dividends and distributions to shareholders: The Fund expects to declare
dividends on a monthly basis to shareholders of Common Stock ("Shareholders").
Distributions to Shareholders are recorded on
24
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
the ex-dividend date. Any net realized short-term capital gains will be
distributed to Shareholders at least annually. Any net realized long-term
capital gains may be distributed to Shareholders at least annually or may be
retained by the Fund as determined by the Fund's Board of Directors. Capital
gains retained by the Fund are subject to tax at the capital gains corporate tax
rate. Subject to the Fund qualifying as a regulated investment company, any
taxes paid by the Fund on such net realized long-term capital gains may be used
by the Fund's Shareholders as a credit against their own tax liabilities. The
Fund may pay distributions in excess of the Fund's net investment company
taxable income and this excess would be a tax-free return of capital distributed
from the Fund's assets.
Income and capital gain distributions are determined and characterized in
accordance with income tax regulations which may differ from US GAAP. These
differences are primarily due to (1) differing treatments of income and gains on
various investment securities held by the Fund, including timing differences,
(2) the attribution of expenses against certain components of taxable investment
income, and (3) federal regulations requiring proportionate allocation of income
and gains to all classes of shareholders.
Distributions from net realized gains for book purposes may include
short-term capital gains, which are included as ordinary income for tax
purposes, and may exclude amortization of premium on certain fixed income
securities, which are not reflected in ordinary income for tax purposes. The tax
character of distributions paid, including changes in accumulated undeclared
distributions to APS Shareholders, during 2008 and 2007 was as follows:
DISTRIBUTIONS PAID IN FISCAL YEAR 2008 DISTRIBUTIONS PAID IN FISCAL YEAR 2007
-------------------------------------- --------------------------------------
ORDINARY LONG-TERM RETURN OF ORDINARY LONG-TERM
INCOME CAPITAL GAINS CAPITAL INCOME CAPITAL GAINS
----------- ------------- ---------- ----------- -------------
Common $ 8,888,100 $ 0 $ 352,939 $ 9,284,238 $ 0
Preferred $ 3,854,239 $ 0 $ 0 $ 3,357,998 $ 0
As of November 30, 2008, the components of distributable earnings (i.e.,
ordinary income and capital gain/loss) available to Common and Preferred Stock
Shareholders, on a tax basis, were as follows:
UNDISTRIBUTED UNDISTRIBUTED NET UNREALIZED
CAPITAL (LOSS) CARRYFORWARD ORDINARY INCOME LONG-TERM GAIN APPRECIATION/(DEPRECIATION)
--------------------------- --------------- -------------- ---------------------------
$ (19,138,376) $ 0 $ 0 $ (62,161,927)
At November 30, 2008, the composition of the Fund's $19,138,376
accumulated realized capital losses was $1,223,987, $694,286, $2,051,511 and
$15,168,592 incurred in 2002, 2004, 2007 and 2008, respectively. These losses
may be carried forward and offset against any future capital gains through 2010,
2012, 2015 and 2016, respectively.
Reclassification of accounts: During the year ended November 30, 2008,
reclassifications were made in the Fund's capital accounts to report these
balances on a tax basis, excluding temporary differences, as of November 30,
2008. Additional adjustments may be required in subsequent reporting periods.
These reclassifications have no impact on the net asset value of the Fund.
25
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The calculation of net investment income per share in the financial
highlights excludes these adjustments. Below are the reclassifications:
PAID-IN UNDISTRIBUTED ACCUMULATED NET REALIZED
CAPITAL NET INVESTMENT INCOME GAIN ON INVESTMENTS
------- --------------------- ------------------------
$ 8,684 $ 329,211 $ (337,895)
Excise tax: The Internal Revenue Code of 1986, as amended, imposes a 4%
nondeductible excise tax on the Fund to the extent the Fund does not distribute
by the end of any calendar year at least (1) 98% of the sum of its net
investment income for that year and its capital gains (both long-term and short-
term) for its fiscal year and (2) certain undistributed amounts from previous
years. The Fund paid $17,142 of Federal excise taxes attributable to calendar
year 2007 in March 2008.
Additional Accounting Standards: In March 2008, the FASB issued Statement
of Financial Accounting Standards No. 161, "Disclosures about Derivative
Instruments and Hedging Activities" ("SFAS 161"). SFAS 161 is effective for
fiscal years and interim periods beginning after November 15, 2008. SFAS 161
requires enhanced disclosures about the Fund's derivative and hedging
activities. Management is currently evaluating the impact the adoption of SFAS
161 will have on the Fund's financial statement disclosures.
3. INVESTMENT ADVISORY FEE, ADMINISTRATION FEE, TRANSFER AGENT FEE, CUSTODIAN
FEE, DIRECTORS' FEES AND CHIEF COMPLIANCE OFFICER FEE
Flaherty & Crumrine Incorporated (the "Adviser") serves as the Fund's
investment adviser. Prior to May 22, 2008, the Fund paid the Adviser a monthly
fee at an annual rate of 0.625% of the value of the Fund's average monthly total
net assets available to Common and Preferred Stock up to $100 million and 0.50%
of the value of the Fund's average monthly total net assets available to Common
and Preferred Stock in excess of $100 million.
For purposes of calculating the fees payable to the Adviser, Administrator
and Custodian, the Fund's average weekly total managed assets means the total
assets of the Fund minus the sum of accrued liabilities. For purposes of
determining total managed assets, the liquidation preference of any preferred
shares issued by the Fund is not treated as a liability.
Effective as of May 22, 2008, the Fund pays the Adviser a monthly fee at
an annual rate of 0.625% of the value of the Fund's average monthly total
managed assets up to $100 million and 0.50% of the Fund's average monthly total
managed assets of $100 million or more. For purposes of calculating the fees
payable to the Adviser, Administrator and Custodian, the Fund's total managed
assets means the total assets of the Fund (including any assets attributable to
the Fund's auction preferred stock that may be outstanding or otherwise
attributable to the use of leverage) minus the sum of accrued liabilities (other
than debt, if any, representing financial leverage). For purposes of determining
total managed assets, the liquidation preference of any preferred shares issued
by the Fund is not treated as a liability.
26
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
PNC Global Investment Servicing (U.S.) Inc. ("PNC"), formerly known as
PFPC Inc., serves as the Fund's Administrator. As Administrator, PNC calculates
the net asset value of the Fund's shares attributable to Common Stock and
generally assists in all aspects of the Fund's administration and operation. As
compensation for PNC's services as Administrator, the Fund pays PNC a monthly
fee at an annual rate of 0.10% of the first $200 million of the Fund's average
weekly total managed assets, 0.04% of the next $300 million of the Fund's
average weekly total managed assets, 0.03% of the next $500 million of the
Fund's average weekly total managed assets and 0.02% on the Fund's average
weekly total managed assets above $1 billion.
PNC also serves as the Fund's Common Stock dividend-paying agent and
registrar (Transfer Agent). As compensation for PNC's services, the Fund pays
PNC a fee at an annual rate of 0.02% of the first $150 million of the Fund's
average weekly net assets attributable to Common Stock, 0.0075% of the next $350
million of the Fund's average weekly net assets attributable to Common Stock,
and 0.0025% of the Fund's average weekly net assets attributable to Common Stock
above $500 million, plus certain out of pocket expenses. For the purpose of
calculating such fee, the Fund's average weekly net assets attributable to
Common Stock are deemed to be the average weekly value of the Fund's total
assets minus the sum of the Fund's liabilities. For this calculation, the Fund's
liabilities are deemed to include the aggregate liquidation preference of any
outstanding Fund preferred shares.
PFPC Trust Company ("PFPC Trust") serves as the Fund's custodian. PFPC
Trust is an indirect subsidiary of PNC Financial Services. As compensation for
PFPC Trust's services as custodian, the Fund pays PFPC Trust a monthly fee at
the annual rate of 0.010% of the first $200 million of the Fund's average weekly
total managed assets, 0.008% of the next $300 million of the Fund's average
weekly total managed assets, 0.006% of the next $500 million of the Fund's
average weekly total managed assets and 0.005% of the Fund's average weekly
total managed assets above $1 billion.
The Fund currently pays each Director who is not a director, officer or
employee of the Adviser a fee of $9,000 per annum, plus $500 for each in-person
meeting of the Board of Directors or any committee and $150 for each telephone
meeting. The Audit Committee Chairman receives an additional annual fee of
$2,500. The Fund also reimburses all Directors for travel and out-of-pocket
expenses incurred in connection with such meetings.
The Fund currently pays the Adviser a fee of $37,500 per annum for Chief
Compliance Officer services and reimburses out-of-pocket expenses incurred in
connection with providing services in this role.
4. PURCHASES AND SALES OF SECURITIES
For the year ended November 30, 2008, the cost of purchases and proceeds
from sales of securities excluding short-term investments, aggregated
$93,431,463 and $125,085,425, respectively.
At November 30, 2008, the aggregate cost of securities for federal income
tax purposes was $167,004,681, the aggregate gross unrealized appreciation for
all securities in which there is an excess of value over tax cost was $1,868,989
and the aggregate gross unrealized depreciation for all securities in which
there is an excess of tax cost over value was $64,030,916.
27
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Written option transactions during the year ended November 30, 2008, are
summarized as follows:
CONTRACT PREMIUMS
AMOUNTS RECEIVED
-------- ----------
Written options outstanding at beginning of year ....... 0 $ 0
---- ----------
Options Opened ......................................... 255 444,102
Options Exercised ...................................... 0 0
Options Expired ........................................ 0 0
Options Closed ......................................... (255) (444,102)
---- ----------
Written options outstanding at end of period ........... 0 $ 0
5. COMMON STOCK
At November 30, 2008, 240,000,000 shares of $0.01 par value Common Stock
were authorized. Common Stock transactions were as follows:
YEAR ENDED YEAR ENDED
11/30/08 11/30/07
----------------- -----------------
SHARES AMOUNT SHARES AMOUNT
------ --------- ------ ---------
Shares issued under the Dividend Reinvestment
and Cash Purchase Plan ......................... 88,991 $ 820,340 48,835 $ 591,605
------ --------- ------ ---------
6. AUCTION PREFERRED STOCK (APS) (FORMERLY KNOWN AS MONEY MARKET CUMULATIVE
PREFERRED(TM) STOCK)
The Fund's Articles of Incorporation authorize the issuance of up to
10,000,000 shares of $0.01 par value preferred stock. The APS is senior to the
Common Stock and results in the financial leveraging of the Common Stock. Such
leveraging tends to magnify both the risks and opportunities to Common Stock
Shareholders. Dividends on shares of APS are cumulative.
The Fund is required to meet certain asset coverage tests with respect to
the APS. If the Fund fails to meet these requirements and does not correct such
failure, the Fund may be required to redeem, in part or in full, APS at a
redemption price of $100,000 per share plus an amount equal to the accumulated
and unpaid dividends on such shares in order to meet these requirements.
Additionally, failure to meet the foregoing asset requirements could restrict
the Fund's ability to pay dividends to Common Stock Shareholders and could lead
to sales of portfolio securities at inopportune times.
If the Fund allocates any net gains or income ineligible for the dividends
received deduction to shares of the APS, the Fund is required to make additional
distributions to APS Shareholders or to pay a higher dividend rate in amounts
needed to provide a return, net of tax, equal to the return had such originally
paid distributions been eligible for the dividends received deduction.
An auction of the APS is generally held every 49 days. Existing APS
Shareholders may submit an order to hold, bid or sell such shares at par value
on each auction date. APS Shareholders may also trade shares in the secondary
market, if any, between auction dates. Since mid-February 2008, the normal
28
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
functioning of the market for auction preferred stock of U.S. closed-end funds,
including the Fund, has been disrupted, and the Fund's APS holders have not been
able to sell their shares through the auction process.
The Fund announced the redemption of APS shares as noted in the table
below. Mandatory redemptions are required under certain circumstances, as
discussed above. Shares were redeemed at a redemption price equal to the
liquidation preference of $100,000 per share, plus the amount of accumulated but
unpaid dividends for each redemption date, respectively.
DESCRIPTION $ AMOUNT OF APS ANNOUNCE DATE PAYMENT DATE
-------------------- --------------- ---------------- -----------------
Optional Redemption $ 10,000,000 October 1, 2008 October 14, 2008
Mandatory Redemption $ 2,400,000 October 21, 2008 November 20, 2008*
* Shares were redeemed on the date reflected; however, from the Fund's
perspective, the November 20 mandatory redemption was effective as of
October 24, 2008. The earlier effective date was due to the unconditional
deposit of funds with the paying agent.
The Fund repurchased APS shares in negotiated private transactions as
noted in the table below. The purchases were made at a price of $80,000 per
share. The difference between the purchase price and the liquidation preference
of $100,000 per share is included on the Statement of Changes to Net Assets
Available to Common Stock in this report as "Gain on repurchase of Auction
Preferred Stock". The gain resulting from both purchases was $1.6 million.
DESCRIPTION $ AMOUNT OF APS TRADE DATE SETTLEMENT DATE
---------------- --------------- ----------------- -----------------
Share Repurchase $ 4,500,000 November 10, 2008 November 14, 2008
Share Repurchase $ 3,500,000 November 10, 2008 November 18, 2008
At November 30, 2008, 496 shares of APS were outstanding at the annualized
rate of 4.32%. The dividend rate, as set by the auction process, is generally
expected to vary with short-term interest rates. As a result of ongoing
disruptions in the auction market, the Fund is paying a dividend rate equal to
the maximum rate, as defined in the Fund's Articles Supplementary. The maximum
rate is equal to the greater of (i) 175% of the reference rate and (ii) 2.50%
plus the reference rate. "Reference Rate" means the applicable "AA"
Non-Financial Composite Commercial Paper Rate. These rates may vary in a manner
unrelated to the income received on the Fund's assets, which could have either a
beneficial or detrimental impact on net investment income and gains available to
Common Stock Shareholders. While the Fund expects to structure its portfolio
holdings and hedging transactions to lessen such risks to Common Stock
Shareholders, there can be no assurance that such results will be attained.
7. PORTFOLIO INVESTMENTS, CONCENTRATION AND INVESTMENT QUALITY
The Fund invests primarily in a diversified portfolio of preferred
securities. This includes traditional preferred stocks eligible for the
inter-corporate dividends received deduction ("DRD") and fully taxable preferred
securities. Under normal market conditions, at least 80% of the value of the
Fund's net assets will be invested in preferred securities. Also, under normal
market conditions, the Fund invests at
29
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
least 25% of its total assets in securities issued by companies in the utilities
industry and a significant percentage, but no more than 25% of its total assets,
in securities issued by companies in the banking industry. The Fund's portfolio
may therefore be subject to greater risk and market fluctuation than a portfolio
of securities representing a broader range of investment alternatives.
The Fund may invest up to 25% of its assets at the time of purchase in
securities rated below investment grade. These securities must be rated at least
either "Ba3" by Moody's Investors Service, Inc. or "BB-" by Standard & Poor's
or, if unrated, judged to be comparable in quality by the Adviser, in any case,
at the time of purchase. However, these securities must be issued by an issuer
having a class of senior debt rated investment grade outstanding.
The Fund may invest up to 15% of its assets in common stocks and, under
normal market conditions, up to 20% of its assets in debt securities. Certain of
its investments in hybrid, i.e., fully taxable, preferred securities will be
subject to the foregoing 20% limitation to the extent that, in the opinion of
the Adviser, such investments are deemed to be debt-like in key characteristics.
Typically, a security will not be considered debt-like (a) if an issuer can
defer payment of income for eighteen months or more without triggering an event
of default and (b) if such issue is a junior and fully subordinated liability of
an issuer or its ultimate guarantor.
In addition to foreign money market securities, the Fund may invest up to
30% of its total assets in the securities of companies organized or having their
principal place of business outside the United States. All foreign securities
held by the Fund will be denominated in U.S. dollars.
8. SPECIAL INVESTMENT TECHNIQUES
The Fund may employ certain investment techniques in accordance with its
fundamental investment policies. These may include the use of when-issued and
delayed delivery transactions. Securities purchased or sold on a when-issued or
delayed delivery basis may be settled within 45 days after the date of the
transaction. Such transactions may expose the Fund to credit and market
valuation risk greater than that associated with regular trade settlement
procedures. The Fund may also enter into transactions, in accordance with its
investment policies, involving any or all of the following: short sales of
securities, purchases of securities on margin, futures contracts, interest rate
swaps, swap futures, options on futures contracts, options on securities,
swaptions and certain credit derivative transactions, including, but not limited
to, the purchase and sale of credit protection. As in the case of when-issued
securities, the use of over-the-counter derivatives, such as interest rate
swaps, swaptions, and credit default swaps may expose the Fund to greater
credit, operations, liquidity, and valuation risk than is the case with
regulated, exchange traded futures and options. These transactions are used for
hedging or other appropriate risk-management purposes, or, under certain other
circumstances, to increase return. No assurance can be given that such
transactions will achieve their desired purposes or will result in an overall
reduction of risk to the Fund.
30
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
9. SECURITIES LENDING
The Fund may lend up to 15% of its total assets (including the value of
the loan collateral) to certain qualified brokers in order to earn additional
income. The Fund receives compensation in the form of fees or interest earned on
the investment of any cash collateral received. The Fund also continues to
receive interest and dividends on the securities loaned. The Fund receives
collateral in the form of cash or securities with a market value at least equal
to the market value of the securities on loan, including accrued interest. In
the event of default or bankruptcy by the borrower, the Fund could experience
delays and costs in recovering the loaned securities or in gaining access to the
collateral. The Fund has the right under the lending agreement to recover the
securities from the borrower on demand. As of November 30, 2008, there were no
securities on loan by the Fund. Income from securities lending for the year
ended November 30, 2008 was $31,152 and is included in interest income on the
Statement of Operations.
31
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated:
We have audited the accompanying statement of assets and liabilities of
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated, including
the portfolio of investments, as of November 30, 2008, and the related statement
of operations for the year then ended, the statements of changes in net assets
for each of the years in the two-year period then ended, and the financial
highlights for each of the years in the five-year period then ended. These
financial statements and financial highlights are the responsibility of
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 audit to obtain reasonable assurance about whether the
financial statements and financial highlights are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. Our procedures included
confirmation of securities owned as of November 30, 2008 by correspondence with
the custodian. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. 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
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated as of
November 30, 2008, and the results of its operations for the year then ended,
the changes in its net assets for each of the years in the two-year period then
ended, and the financial highlights for each of the years in the five-year
period then ended, in conformity with U.S. generally accepted accounting
principles.
(KPMG LLP)
Boston, Massachusetts
January 23, 2009
32
Flaherty & Crumrine Preferred Income Opportunity Fund
SUPPLEMENTARY TAX INFORMATION (UNAUDITED)
Distributions to Common Stock and Auction Preferred Stock (APS)
Shareholders are characterized as follows for purposes of Federal income taxes
(as a percentage of total distributions, including any tax return of capital):
FISCAL YEAR 2008
INDIVIDUAL SHAREHOLDER CORPORATE SHAREHOLDER
---------------------------- -----------------------------
ORDINARY TAX RETURN ORDINARY TAX RETURN
QDI INCOME OF CAPITAL DRD INCOME OF CAPITAL
------ -------- ---------- ------ -------- ----------
APS 60.85% 39.15% 0.00% 54.57% 45.43% 0.00%
Common Stock 58.31% 37.53% 4.16% 52.30% 43.54% 4.16%
CALENDAR YEAR 2008
INDIVIDUAL SHAREHOLDER CORPORATE SHAREHOLDER
---------------------------- -----------------------------
ORDINARY TAX RETURN ORDINARY TAX RETURN
QDI INCOME OF CAPITAL DRD INCOME OF CAPITAL
------ -------- ---------- ------ -------- ----------
APS 58.87% 41.13% 0.00% 53.62% 46.38% 0.00%
Common Stock 57.00% 39.09% 3.91% 51.99% 44.10% 3.91%
Qualified Dividend Income ("QDI") distributions are taxable at a maximum
15% personal tax rate.
SECTION 19 NOTICES
Section 19 of the 1940 Act requires registered investment companies to
include a notice with the payment of a dividend if a portion of that dividend
may come from sources other than undistributed net income (other sources could
include realized gains from the sale of securities and non-taxable return of
capital). Copies of the Section 19 notices for the Fund are available on the
website at www.preferredincome.com.
Form 1099-DIV will be sent to shareholders in January 2009 reporting the
amount and tax characterization of distributions for the 2008 calendar year.
33
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED)
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
Under the Fund's Dividend Reinvestment and Cash Purchase Plan (the
"Plan"), a shareholder whose Common Stock is registered in his or her own name
will have all distributions reinvested automatically by PNC as agent under the
Plan, unless the shareholder elects to receive cash. Distributions with respect
to shares registered in the name of a broker-dealer or other nominee (that is,
in "street name") may be reinvested by the broker or nominee in additional
shares under the Plan, but only if the service is provided by the broker or
nominee, unless the shareholder elects to receive distributions in cash. A
shareholder who holds Common Stock registered in the name of a broker or other
nominee may not be able to transfer the Common Stock to another broker or
nominee and continue to participate in the Plan. Investors who own Common Stock
registered in street name should consult their broker or nominee for details
regarding reinvestment.
The number of shares of Common Stock distributed to participants in the
Plan in lieu of a cash dividend is determined in the following manner. Whenever
the market price per share of the Fund's Common Stock is equal to or exceeds the
net asset value per share on the valuation date, participants in the Plan will
be issued new shares valued at the higher of net asset value or 95% of the then
current market value. Otherwise, PNC will buy shares of the Fund's Common Stock
in the open market, on the New York Stock Exchange ("NYSE") or elsewhere, on or
shortly after the payment date of the dividend or distribution and continuing
until the ex-dividend date of the Fund's next distribution to holders of the
Common Stock or until it has expended for such purchases all of the cash that
would otherwise be payable to the participants. The number of purchased shares
that will then be credited to the participants' accounts will be based on the
average per share purchase price of the shares so purchased, including brokerage
commissions. If PNC commences purchases in the open market and the then current
market price of the shares (plus any estimated brokerage commissions)
subsequently exceeds their net asset value most recently determined before the
completion of the purchases, PNC will attempt to terminate purchases in the open
market and cause the Fund to issue the remaining dividend or distribution in
shares. In this case, the number of shares received by the participant will be
based on the weighted average of prices paid for shares purchased in the open
market and the price at which the Fund issues the remaining shares. These
remaining shares will be issued by the Fund at the higher of net asset value or
95% of the then current market value.
Plan participants are not subject to any charge for reinvesting dividends
or capital gains distributions. Each Plan participant will, however, bear a
proportionate share of brokerage commissions incurred with respect to PNC's open
market purchases in connection with the reinvestment of dividends or capital
gains distributions. For the year ended November 30, 2008, $1,848 in brokerage
commissions were incurred.
The automatic reinvestment of dividends and capital gains distributions
will not relieve Plan participants of any income tax that may be payable on the
dividends or capital gains distributions. A participant in the Plan will be
treated for Federal income tax purposes as having received, on the dividend
payment date, a dividend or distribution in an amount equal to the cash that the
participant could have received instead of shares.
34
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
In addition to acquiring shares of Common Stock through the reinvestment
of cash dividends and distributions, a shareholder may invest any further
amounts from $100 to $3,000 semi-annually at the then current market price in
shares purchased through the Plan. Such semi-annual investments are subject to
any brokerage commission charges incurred by PNC under the Plan.
A shareholder whose Common Stock is registered in his or her own name may
terminate participation in the Plan at any time by notifying PNC in writing, by
completing the form on the back of the Plan account statement and forwarding it
to PNC, or by calling PNC directly. A termination will be effective immediately
if notice is received by PNC not less than 10 days before any dividend or
distribution record date. Otherwise, the termination will be effective, and only
with respect to any subsequent dividends or distributions, on the first day
after the dividend or distribution has been credited to the participant's
account in additional shares of the Fund. Upon termination and according to a
participant's instructions, PNC will either (a) issue certificates for the whole
shares credited to the shareholder's Plan account and a check representing any
fractional shares or (b) sell the shares in the market. Shareholders who hold
Common Stock registered in the name of a broker or other nominee should consult
their broker or nominee to terminate participation.
The Plan is described in more detail in the Fund's Plan brochure.
Information concerning the Plan may be obtained from PNC at 1-800-331-1710.
PROXY VOTING POLICIES AND PROXY VOTING RECORD ON FORM N-PX
The Fund files Form N-PX with its complete proxy voting record for the 12
months ended June 30th no later than August 31st of each year. The Fund filed
its latest Form N-PX with the Securities and Exchange Commission ("SEC") on
August 7, 2008. This filing, as well as the Fund's proxy voting policies and
procedures, are available (i) without charge, upon request, by calling the
Fund's transfer agent at 1-800-331-1710 and (ii) on the SEC's website at
www.sec.gov. In addition, the Fund's proxy voting policies and procedures are
available on the Fund's website at www.preferredincome.com.
PORTFOLIO SCHEDULE ON FORM N-Q
The Fund files a complete schedule of portfolio holdings with the SEC for
the first and third fiscal quarters on Form N-Q, the latest of which was filed
for the quarter ended August 31, 2008. The Fund's Form N-Q is available on the
SEC's website at www.sec.gov or may be viewed and obtained from the SEC's Public
Reference Room in Washington D.C. Information on the operation of the Public
Reference Section may be obtained by calling 1-800-SEC-0330.
PORTFOLIO MANAGEMENT TEAM
In managing the day-to-day operations of the Fund, the Adviser relies on
the expertise of its team of money management professionals, consisting of
Messrs. Crumrine, Ettinger, Stone and Chadwick. The professional backgrounds of
each member of the management team are included in the "Information about Fund
Directors and Officers" section of this report.
35
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
CERTIFICATIONS
Included in the Annual Written Affirmation submitted to the NYSE, Donald
F. Crumrine, as the Fund's Chief Executive Officer, has certified that, as of
May 16, 2008, he was not aware of any violation by the Fund of applicable NYSE
corporate governance listing standards. The Fund's reports to the SEC on Forms
N-CSR and N-Q contain certifications by the Fund's principal executive officer
and principal financial officer that relate to the Fund's disclosure in such
reports and that are required by Rule 30a-2(a) under the 1940 Act.
36
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
INFORMATION ABOUT FUND DIRECTORS AND OFFICERS
The business and affairs of the Fund are managed under the direction of
the Fund's Board of Directors. Information pertaining to the Directors and
officers of the Fund is set forth below.
PRINCIPAL NUMBER OF FUNDS
TERM OF OFFICE OCCUPATION(s) IN FUND COMPLEX
NAME, ADDRESS, POSITION(s) AND LENGTH OF DURING PAST OVERSEEN OTHER DIRECTORSHIPS
AND AGE HELD WITH FUND TIME SERVED* FIVE YEARS BY DIRECTOR HELD BY DIRECTOR**
------------------------ -------------- ------------------ -------------------------- --------------- -------------------
NON-INTERESTED DIRECTORS:
DAVID GALE Director Class I Director President of Delta 4
Delta Dividend Group, Inc since Dividend Group, Inc.
220 Montgomery Street January 1997 (investments)
Suite 1920
San Francisco, CA 94104
Age: 59
MORGAN GUST Director Class III Director Owner and operator of 4 CoBiz, Financial, Inc.
301 E. Colorado Boulevard since various entities engaged (financial services)
Suite 720 February 1992 in agriculture and real
Pasadena, CA 91101 estate; Former President
Age: 61 of Giant Industries, Inc.
(petroleum refining and
marketing) from March
2002 through June 2007
KAREN H. HOGAN+ Director Class III Director Active Committee Member 4
301 E. Colorado Boulevard since and Volunteer to several
Suite 720 April 2005 non-profit organizations;
Pasadena, CA 91101 from September 1985 to
Age: 47 January 1997, Senior Vice
President of Preferred
Stock Origination at
Lehman Brothers and
Previously, Vice President
of New Product
Development
----------
* The Fund's Board of Directors is divided into three classes, each class
having a term of three years. Each year the term of office of one class
expires and the successor or successors elected to such class serve for a
three year term. The three year term for each class expires as follows:
CLASS I DIRECTOR - three year term expires at the Fund's 2009 Annual
Meeting of Shareholders; director may continue in office until his
successor is duly elected and qualified.
CLASS II DIRECTORS - three year term expires at the Fund's 2010
Annual Meeting of Shareholders; directors may continue in office
until their successors are duly elected and qualified.
CLASS III DIRECTORS - three year term expires at the Fund's 2011
Annual Meeting of Shareholders; directors may continue in office
until their successors are duly elected and qualified.
** Each Director also serves as a Director for Flaherty & Crumrine
Preferred Income Fund, Flaherty & Crumrine/Claymore Preferred Securities
Income Fund, and Flaherty & Crumrine/Claymore Total Return Fund.
+ As a Director, represents holders of shares of the Fund's Auction
Preferred Stock.
37
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
PRINCIPAL NUMBER OF FUNDS
TERM OF OFFICE OCCUPATION(s) IN FUND COMPLEX
NAME, ADDRESS, POSITION(s) AND LENGTH OF DURING PAST OVERSEEN OTHER DIRECTORSHIPS
AND AGE HELD WITH FUND TIME SERVED* FIVE YEARS BY DIRECTOR HELD BY DIRECTOR**
------------------------ -------------- ------------------ -------------------------- --------------- -------------------
NON-INTERESTED DIRECTORS:
ROBERT F. WULF Director Class II Director Financial Consultant; 4
P.O. Box 753 and Audit since Trustee, University of
Neskowin, OR 97149 Committee February 1992 Oregon Foundation;
Age: 71 Chairman Trustee, San Francisco
Theological Seminary
INTERESTED DIRECTOR:
DONALD F. CRUMRINE+, ++ Director, Class II Director Chairman of the Board 4
301 E. Colorado Boulevard Chairman of since and Director of Flaherty &
Suite 720 the Board and February 1992 Crumrine Incorporated
Pasadena, CA 91101 Chief
Age: 61 Executive
Officer
----------
* The Fund's Board of Directors is divided into three classes, each class
having a term of three years. Each year the term of office of one class
expires and the successor or successors elected to such class serve for a
three year term. The three year term for each class expires as follows:
CLASS I DIRECTOR - three year term expires at the Fund's 2009 Annual
Meeting of Shareholders; director may continue in office until his
successor is duly elected and qualified.
CLASS II DIRECTORS - three year term expires at the Fund's 2010
Annual Meeting of Shareholders; directors may continue in office
until their successors are duly elected and qualified.
CLASS III DIRECTORS - three year term expires at the Fund's 2011
Annual Meeting of Shareholders; directors may continue in office
until their successors are duly elected and qualified.
** Each Director also serves as a Director for Flaherty & Crumrine
Preferred Income Fund, Flaherty & Crumrine/Claymore Preferred Securities
Income Fund, and Flaherty & Crumrine/Claymore Total Return Fund.
+ As a Director, represents holders of shares of the Fund's Auction
Preferred Stock.
++ "Interested person" of the Fund as defined in the 1940 Act. Mr.
Crumrine is considered an "interested person" because of his affiliation
with Flaherty & Crumrine Incorporated, which acts as the Fund's investment
adviser.
38
Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED)
PRINCIPAL
TERM OF OFFICE OCCUPATION(s)
NAME, ADDRESS, POSITION(s) AND LENGTH OF DURING PAST
AND AGE HELD WITH FUND TIME SERVED FIVE YEARS
------------------------ ------------------- -------------- -----------------------------------
OFFICERS:
ROBERT M. ETTINGER President Since President and Director of
301 E. Colorado Boulevard October 2002 Flaherty & Crumrine
Suite 720 Incorporated
Pasadena, CA 91101
Age: 50
R. ERIC CHADWICK Chief Financial Since Director of Flaherty & Crumrine
301 E. Colorado Boulevard Officer, Vice July 2004 Incorporated since June 2006;
Suite 720 President and Vice President of Flaherty &
Pasadena, CA 91101 Treasurer Crumrine Incorporated
Age: 33
CHAD C. CONWELL Chief Compliance Since Chief Compliance Officer of
301 E. Colorado Boulevard Officer, Vice July 2005 Flaherty & Crumrine Incorporated
Suite 720 President and since September 2005; Vice
Pasadena, CA 91101 Secretary President of Flaherty & Crumrine
Age: 36 Incorporated since July 2005;
Attorney with Paul, Hastings,
Janofsky & Walker LLP from
September 1998 to June 2005
BRADFORD S. STONE Vice President Since Director of Flaherty & Crumrine
392 Springfield Avenue and Assistant July 2003 Incorporated since June 2006;
Mezzanine Suite Treasurer Vice President of Flaherty &
Summit, NJ 07901 Crumrine Incorporated
Age: 49
LAURIE C. LODOLO Assistant Since Assistant Compliance Officer of
301 E. Colorado Boulevard Compliance July 2004 Flaherty & Crumrine Incorporated
Suite 720 Officer, Assistant since August 2004; Secretary of
Pasadena, CA 91101 Treasurer and Flaherty & Crumrine Incorporated
Age: 45 Assistant Secretary since February 2004; Account
Administrator of Flaherty & Crumrine
Incorporated
39
DIRECTORS
Donald F. Crumrine, CFA
Chairman of the Board
David Gale
Morgan Gust
Karen H. Hogan
Robert F. Wulf, CFA
OFFICERS
Donald F. Crumrine, CFA
Chief Executive Officer
Robert M. Ettinger, CFA
President
R. Eric Chadwick, CFA
Chief Financial Officer,
Vice President and Treasurer
Chad C. Conwell
Chief Compliance Officer,
Vice President and Secretary
Bradford S. Stone
Vice President and
Assistant Treasurer
Laurie C. Lodolo
Assistant Compliance Officer,
Assistant Treasurer and
Assistant Secretary
INVESTMENT ADVISER
Flaherty & Crumrine Incorporated
e-mail: flaherty@pfdincome.com
QUESTIONS CONCERNING YOUR SHARES OF FLAHERTY & CRUMRINE PREFERRED INCOME
OPPORTUNITY FUND?
- If your shares are held in a Brokerage Account, contact your Broker.
- If you have physical possession of your shares in certificate form,
contact the Fund's Transfer Agent & Shareholder Servicing Agent - -
PNC Global Investment Servicing (U.S.) Inc.
P.O. Box 43027
Providence, RI 02940-3027
1-800-331-1710
THIS REPORT IS SENT TO SHAREHOLDERS OF FLAHERTY & CRUMRINE PREFERRED INCOME
OPPORTUNITY FUND INCORPORATED FOR THEIR INFORMATION. IT IS NOT A PROSPECTUS,
CIRCULAR OR REPRESENTATION INTENDED FOR USE IN THE PURCHASE OR SALE OF SHARES OF
THE FUND OR OF ANY SECURITIES MENTIONED IN THIS REPORT.
(FLAHERTY & CRUMRINE LOGO)
ANNUAL
REPORT
NOVEMBER 30, 2008
www.preferredincome.com
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
directors has determined that David Gale, Karen H. Hogan and Robert F. Wulf are
each qualified to serve as an audit committee financial expert serving on its
audit committee and that they all are "independent," as defined by the
Securities and Exchange Commission.
ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
AUDIT FEES
(a) 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 are
$44,000 for 2008 and $40,600 for 2007.
AUDIT-RELATED FEES
(b) 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 are $0 for 2008 and $0 for 2007.
TAX FEES
(c) 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 are $8,100 for 2008 and
$7,300 for 2007.
ALL OTHER FEES
(d) The aggregate fees billed in each of the last two fiscal years for
products and services provided by the principal accountant, other than
the services reported in paragraphs (a) through (c) of this Item are
$17,200 for 2008 and $15,100 for 2007. These services consist of the
principal accountant providing a "Quarterly Agreed-Upon-Procedures
Report on Articles Supplementary". These Agreed-Upon-Procedures
("AUP") are requirements arising from the Articles Supplementary
creating the Fund's preferred stock. Specifically, the credit rating
agencies require such AUP be undertaken in order to maintain the
preferred stock's rating.
(e)(1) The Fund's Audit Committee Charter states that the Audit Committee
shall have the duty and power to pre-approve all audit and non-audit
services to be provided by the auditors to the Fund, and all non-audit
services to be provided by the auditors to the Fund's investment
adviser and any service providers controlling, controlled by or under
common control with the Fund's investment adviser that provide ongoing
services to the Fund, if the engagement relates directly to the
operations and financial reporting of the Fund.
(e)(2) The percentage of services described in each of paragraphs (b)
through (d) of this Item that were approved by the audit committee
pursuant to paragraph (c)(7)(i)(C) 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 0%.
(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 for each of the last two fiscal years of
the registrant was $0 for 2008 and $0 for 2007.
(h) The registrant's audit committee of the board of directors has
considered whether 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: David Gale, Morgan Gust, Karen H. Hogan, and Robert F. Wulf.
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.
ADVISER PROXY VOTING POLICIES AND PROCEDURES
Flaherty & Crumrine Incorporated ("F&C") acts as discretionary investment
adviser for various clients, including the following six pooled investment
vehicles (the "Funds"):
As adviser to the "U.S. Funds" Flaherty & Crumrine Preferred Income Fund
Flaherty & Crumrine Preferred Income Opportunity Fund
Flaherty & Crumrine/Claymore Preferred Securities Income Fund
Flaherty & Crumrine/Claymore Total Return Fund
As sub-adviser
to the "Canadian Fund" Flaherty & Crumrine Investment Grade Fixed Income Fund
F&C's authority to vote proxies for its clients is established through the
delegation of discretionary authority under its investment advisory contracts
and the U.S. Funds have adopted these policies and procedures for themselves
PURPOSE
These policies and procedures are designed to satisfy F&C's duties of care and
loyalty to its clients with respect to monitoring corporate events and
exercising proxy authority in the best interests of such clients.
In connection with this objective, these policies and procedures are designed to
deal with potential complexities which may arise in cases where F&C's interests
conflict or appear to conflict with the interests of its clients.
These policies and procedures are also designed to communicate with clients the
methods and rationale whereby F&C exercises proxy voting authority.
This document is available to any client or Fund shareholder upon request and
F&C will make available to such clients and Fund shareholders the record of
F&C's votes promptly upon request and to the extent required by Federal law and
regulations.
FUNDAMENTAL STANDARD
F&C will be guided by the principle that, in those cases where it has proxy
voting authority, it will vote proxies, and take such other corporate actions,
consistent with the interest of its clients in a manner free of conflicts of
interest with the objective of client wealth maximization.
GENERAL
F&C has divided its discussion in this document into two major categories:
voting with respect to common stock and voting with respect to senior equity,
e.g., preferred stock and similar securities. In those events where F&C may have
to take action with respect to debt, such as in the case of amendments of
covenants or in the case of default, bankruptcy, reorganization, etc., F&C will
apply the same principles as would apply to common or preferred stock, MUTATIS
MUTANDIS.
These policies and procedures apply only where the client has granted
discretionary authority with respect to proxy voting. Where F&C does not have
authority, it will keep appropriate written records evidencing that such
discretionary authority has not been granted.
F&C may choose not to keep written copies of proxy materials that are subject to
SEC regulation and maintained in the SEC's EDGAR database. In other instances,
F&C will keep appropriate written records in its files or in reasonably
accessible storage.
Similarly, F&C will keep in its files, or reasonably accessible storage, work
papers and other materials that were significant to F&C in making a decision how
to vote.
For purposes of decision making, F&C will assume that each ballot for which it
casts votes is the only security of an issuer held by the client. Thus, when
casting votes where F&C may have discretionary authority with regard to several
different securities of the same issuer, it may vote securities "in favor" for
those securities or classes where F&C has determined the matter in question to
be beneficial while, at the same time, voting "against" for those securities or
classes where F&C has determined the matter to be adverse. Such cases
occasionally arise, for example, in those instances where a vote is required by
both common and preferred shareholders, voting as separate classes, for a change
in the terms regarding preferred stock issuance.
F&C will reach its voting decisions independently, after appropriate
investigation. It does not generally intend to delegate its decision making or
to rely on the recommendations of any third party, although it may take such
recommendations into consideration. F&C may consult with such other experts,
such as CPA's, investment bankers, attorneys, etc., as it regards necessary to
help it reach informed decisions.
Absent good reason to the contrary, F&C will generally give substantial weight
to management recommendations regarding voting. This is based on the view that
management is usually in the best position to know which corporate actions are
in the best interests of common shareholders as a whole.
With regard to those shareholder-originated proposals which are typically
described as "social, environmental, and corporate responsibility" matters, F&C
will typically give weight to management's recommendations and vote against such
shareholder proposals, particularly if the adoption of such proposals would
bring about burdens or costs not borne by those of the issuer's competitors.
In cases where the voting of proxies would not justify the time and costs
involved, F&C may refrain from voting. From the individual client's perspective,
this would most typically come about in the case of small holdings, such as
might arise in connection with spin-offs or other corporate reorganizations.
From the perspective of F&C's institutional clients, this envisions cases (1) as
more fully described below where preferred and common shareholders vote together
as a class or (2) other similar or analogous instances.
Ultimately, all voting decisions are made on a case-by-case basis, taking
relevant considerations into account.
VOTING OF COMMON STOCK PROXIES
F&C categorizes matters as either routine or non-routine, which definition may
or may not precisely conform to the definitions set forth by securities
exchanges or other bodies categorizing such matters. Routine matters would
include such things as the voting for directors and the ratification of auditors
and most shareholder proposals regarding social, environmental, and corporate
responsibility matters. Absent good reason to the contrary, F&C normally will
vote in favor of management's recommendations on these routine matters.
Non-routine matters might include, without limitation, such things as (1)
amendments to management incentive plans, (2) the authorization of additional
common or preferred stock, (3) initiation or termination of barriers to takeover
or acquisition, (4) mergers or acquisitions, (5) changes in the state of
incorporation, (6) corporate reorganizations, and (7) "contested" director
slates. In non-routine matters, F&C, as a matter of policy, will attempt to be
generally familiar with the questions at issue. This will include, without
limitation, studying news in the popular press, regulatory filings, and
competing proxy solicitation materials, if any. Non-routine matters will be
voted on a case-by-case basis, given the complexity of many of these issues.
VOTING OF PREFERRED STOCK PROXIES
Preferred stock, which is defined to include any form of equity senior to common
stock, generally has voting rights only in the event that the issuer has not
made timely payments of income and principal to shareholders or in the event
that a corporation desires to effectuate some change in its articles of
incorporation which might modify the rights of preferred stockholders. These are
non-routine in both form and substance.
In the case of non-routine matters having to do with the modification of the
rights or protections accorded preferred stock shareholders, F&C will attempt,
wherever possible, to assess the costs and benefits of such modifications and
will vote in favor of such modifications only if they are in the bests interests
of preferred shareholders or if the issuer has offered sufficient compensation
to preferred stock shareholders to offset the reasonably foreseeable adverse
consequences of such modifications. A similar
type of analysis would be made in the case where preferred shares, as a class,
are entitled to vote on a merger or other substantial transaction.
In the case of the election of directors when timely payments to preferred
shareholders have not been made ("contingent voting"), F&C will cast its votes
on a case-by-case basis after investigation of the qualifications and
independence of the persons standing for election.
Routine matters regarding preferred stock are the exception, rather than the
rule, and typically arise when the preferred and common shareholders vote
together as a class on such matters as election of directors. F&C will vote on a
case-by-case basis, reflecting the principles set forth elsewhere in this
document. However, in those instances (1) where the common shares of an issuer
are held by a parent company and (2) where, because of that, the election
outcome is not in doubt, F&C does not intend to vote such proxies since the time
and costs would outweigh the benefits.
ACTUAL AND APPARENT CONFLICTS OF INTEREST
Potential conflicts of interest between F&C and F&C's clients may arise when
F&C's relationships with an issuer or with a related third party conflict or
appear to conflict with the best interests of F&C's clients.
F&C will indicate in its voting records available to clients whether or not a
material conflict exists or appears to exist. In addition, F&C will communicate
with the client (which means the independent Directors or Director(s) they may
so designate in the case of the U.S. Funds and the investment adviser in the
case of the Canadian Funds) in instances when a material conflict of interest
may be apparent. F&C must describe the conflict to the client and state F&C's
voting recommendation and the basis therefor. If the client considers there to
be a reasonable basis for the proposed vote notwithstanding the conflict or, in
the case of the Funds, that the recommendation was not affected by the conflict
(without considering the merits of the proposal), F&C will vote in accordance
with the recommendation it had made to the client.
In all such instances, F&C will keep reasonable documentation supporting its
voting decisions and/or recommendations to clients.
AMENDMENT OF THE POLICIES AND PROCEDURES
These policies and procedures may be modified at any time by action of the Board
of Directors of F&C but will not become effective, in the case of the U.S.
Funds, unless they are approved by majority vote of the non-interested directors
of the U.S. Funds. Any such modifications will be sent to F&C's clients by mail
and/or other electronic means in a timely manner. These policies and procedures,
and any amendments hereto, will be posted on the U.S. Funds' websites and will
be disclosed in reports to shareholders as required by law.
ITEM 8. PORTFOLIO MANAGERS OF CLOSED-END MANAGEMENT INVESTMENT COMPANIES.
The following paragraphs provide certain information with respect to the
portfolio managers of the Fund and the material conflicts of interest that may
arise in connection with their management of the investments of the Fund, on the
one hand, and the investments of other client accounts for which they have
responsibility, on the other hand. Certain other potential conflicts of interest
with respect to personal trading and proxy voting are discussed above under
"Item 2 - Codes of Ethics" and "Item 7 - Proxy Voting Policies."
(A)(1) PORTFOLIO MANAGERS
R. Eric Chadwick, Donald F. Crumrine, Robert M. Ettinger and Bradford S. Stone
jointly serve as the Portfolio Managers of the Fund. Additional biographical
information about the portfolio managers is available in the Annual Report
included in Response to Item 1 above.
(A)(2) OTHER ACCOUNTS MANAGED BY PORTFOLIO MANAGERS
The tables below illustrate other accounts where each of the above-mentioned
four portfolio managers has significant day-to-day management responsibilities
as of November 30, 2008:
# of Accounts
Managed for which
Name of Portfolio Total Advisory Fee is
Manager or Team # of Accounts Total Assets Based on
Member Type of Accounts Managed (mm) Performance
--------------------- -------------------------------------- ------------- ------------ -----------------
1. Donald F. Crumrine Other Registered Investment Companies: 3 894,365 0
Other Pooled Investment Vehicles: 2 79 0
Other Accounts: 18 1,105 0
2. Robert M. Ettinger Other Registered Investment Companies: 3 894,365 0
Other Pooled Investment Vehicles: 2 79 0
Other Accounts: 18 1,105 0
3. R. Eric Chadwick Other Registered Investment Companies: 3 894,365 0
Other Pooled Investment Vehicles: 2 79 0
Other Accounts: 18 1,105 0
4. Bradford S. Stone Other Registered Investment Companies: 3 894,365 0
Other Pooled Investment Vehicles: 2 79 0
Other Accounts: 18 1,105 0
POTENTIAL CONFLICTS OF INTEREST
In addition to the Fund, the Portfolio Managers jointly manage accounts for
three other closed-end funds, two Canadian funds and other institutional
clients. As a result, potential conflicts of interest may arise as follows:
- ALLOCATION OF LIMITED TIME AND ATTENTION. The Portfolio Managers may
devote unequal time and attention to the management of all accounts.
As a result, the Portfolio Managers may not be able to formulate as
complete a strategy or identify equally attractive investment
opportunities for each of those accounts as might be the case if they
were to devote substantially more attention to the management of one
account.
- ALLOCATION OF LIMITED INVESTMENT OPPORTUNITIES. If the Portfolio
Managers identify an investment opportunity that may be suitable for
multiple accounts, the Fund may not be able to take full advantage of
that opportunity because the opportunity may need to be allocated
among other accounts.
- PURSUIT OF DIFFERING STRATEGIES. At times, the Portfolio Managers may
determine that an investment opportunity may be appropriate for only
some accounts or may decide that certain of these accounts should take
differing positions (i.e., may buy or sell the particular security at
different times or the same time or in differing amounts) with respect
to a particular security. In these cases, the Portfolio Manager
may place separate transactions for one or more accounts which may
affect the market price of the security or the execution of the
transaction, or both, to the detriment of one or more other accounts.
- VARIATION IN COMPENSATION. A conflict of interest may arise where the
financial or other benefits available to the Portfolio Manager differ
among accounts. While the Adviser only charges fees based on assets
under management and does not receive a performance fee from any of
its accounts, and while it strives to maintain uniform fee schedules,
it does have different fee schedules based on the differing advisory
services required by some accounts. Consequently, though the
differences in such fee rates are slight, the Portfolio Managers may
be motivated to favor certain accounts over others. In addition, the
desire to maintain assets under management or to derive other rewards,
financial or otherwise, could influence the Portfolio Managers in
affording preferential treatment to those accounts that could most
significantly benefit the Adviser.
The Adviser and the Fund have adopted compliance policies and procedures that
are designed to address the various conflicts of interest that may arise for the
Adviser and its staff members. However, there is no guarantee that such policies
and procedures will be able to detect and prevent every situation in which an
actual or potential conflict may arise.
(A)(3) PORTFOLIO MANAGER COMPENSATION
Compensation is paid solely by the Adviser. Each Portfolio Manager receives the
same fixed salary. In addition, each Portfolio Manager receives a bonus based on
peer reviews of his performance and the total net investment advisory fees
received by Flaherty & Crumrine (which are in turn based on the value of its
assets under management). The Portfolio Managers do not receive deferred
compensation, but participate in a profit-sharing plan available to all
employees of the Adviser; amounts are determined as a percentage of the
employee's eligible compensation for a calendar year based on IRS limitations.
Each Portfolio Manager is also a shareholder of Flaherty & Crumrine and receives
quarterly dividends based on his equity interest in the company.
(A)(4) DISCLOSURE OF SECURITIES OWNERSHIP
The following indicates the dollar range of beneficial ownership of shares by
each Portfolio Manager as of November 30, 2008:
Dollar Range of Fund Shares
Name Beneficially Owned*
------------------ ---------------------------
Donald F. Crumrine $50,001 to $100,000
Robert M. Ettinger $100,001 to $500,000
R. Eric Chadwick $50,001 to $100,000
Bradford S. Stone $50,001 to $100,000
* INCLUDES 8,603 SHARES HELD BY FLAHERTY & CRUMRINE INCORPORATED OF WHICH
EACH PORTFOLIO MANAGER HAS BENEFICIAL OWNERSHIP.
ITEM 9. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT
COMPANY AND AFFILIATED PURCHASERS.
Not applicable.
ITEM 10. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
There have been no material changes to the procedures by which the shareholders
may recommend nominees to the registrant's board of directors, where those
changes were implemented after the registrant last provided disclosure in
response to the requirements of Item 407(c)(2)(iv) of Regulation S-K (17 CFR
229.407) (as required by Item 22(b)(15) of Schedule 14A (17 CFR 240.14a-101)),
or this Item.
ITEM 11. CONTROLS AND PROCEDURES.
(a) The registrant's principal executive and principal financial officers,
or persons performing similar functions, have concluded that the
registrant's disclosure controls and procedures (as defined in Rule
30a-3(c) under the Investment Company Act of 1940, as amended (the
"1940 Act") (17 CFR 270.30a-3(c))) are effective, as of a date within
90 days of the filing date of the report that includes the disclosure
required by this paragraph, based on their evaluation of these
controls and procedures required by Rule 30a-3(b) under the 1940 Act
(17 CFR 270.30a-3(b)) and Rules 13a-15(b) or 15d-15(b) under the
Securities Exchange Act of 1934, as amended (17 CFR 240.13a-15(b) or
240.15d-15(b)).
(b) There were no changes in the registrant's internal control over
financial reporting (as defined in Rule 30a-3(d) under the 1940 Act
(17 CFR 270.30a-3(d)) that occurred during the registrant's second
fiscal quarter of the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting.
ITEM 12. EXHIBITS.
(a)(1) Code of ethics, or any amendment thereto, that is the subject of
disclosure required by Item 2 is attached hereto.
(a)(2) Certifications pursuant to Rule 30a-2(a) under the 1940 Act and
Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto.
(a)(3) Written solicitation to purchase securities under Rule 23c-1 under
the Act (the 1940 Act).
(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) Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated
By (Signature and Title)* /s/ Donald F. Crumrine
----------------------------------------
Donald F. Crumrine, Director,
Chairman of the Board and
Chief Executive Officer
(principal executive officer)
Date 1/28/09
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/ Donald F. Crumrine
----------------------------------------
Donald F. Crumrine, Director,
Chairman of the Board and
Chief Executive Officer
(principal executive officer)
Date 1/28/09
By (Signature and Title)* /s/ R. Eric Chadwick
----------------------------------------
R. Eric Chadwick,
Chief Financial Officer, Treasurer, and
Vice President
(principal financial officer)
Date 1/28/09
* Print the name and title of each signing officer under his or her
signature.