[Federal Register Volume 74, Number 92 (Thursday, May 14, 2009)]
[Notices]
[Pages 22766-22769]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-11234]


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SECURITIES AND EXCHANGE COMMISSION

[Investment Company Act Release No. 28722; File No. 812-13598]


Flaherty & Crumrine Preferred Income Fund Incorporated, et al.; 
Notice of Application

May 8, 2009.
AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Notice of application for an order under section 6(c) of the 
Investment Company Act of 1940 (``Act'') for an exemption from sections 
18(a)(1)(A) and (B) of the Act.

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Applicants: Flaherty & Crumrine Preferred Income Fund Incorporated 
(``PFD''), Flaherty & Crumrine Preferred Income Opportunity Fund 
Incorporated (``PFO''), Flaherty & Crumrine/Claymore Preferred 
Securities Income Fund Incorporated (``FFC''), and Flaherty & Crumrine/
Claymore Total Return Fund Incorporated (``FLC'') (each, a ``Fund'' and 
collectively, ``Funds'').

Summary of Application: Applicants request an order (``Order'') 
granting an exemption from sections 18(a)(1)(A) and (B) of the Act for 
a period from the date of the Order until October 31, 2010. The Order 
would permit each Fund to issue or incur debt that would be used to 
redeem the Fund's auction preferred shares (``APS Shares'') issued 
prior to February 1, 2008 that are outstanding at the time of such 
issuance or incurrence (``post-Order debt''), and to refinance such 
post-Order debt, subject to the 200% asset coverage requirement 
ordinarily applicable to a senior security that is stock. The Order 
also would permit each Fund to declare dividends or any other 
distributions on, or purchase, capital stock during the term of the 
Order, provided that any such post-Order debt has asset coverage of at 
least 200% after deducting the amount of such transaction.

Filing Dates: The application was filed on November 4, 2008, and 
amended on March 23, 2009 and April 23, 2009.

Hearing or Notification of Hearing: An order granting the application 
will be issued unless the Commission orders a hearing. Interested 
persons may request a hearing by writing to the Commission's Secretary 
and serving applicants with a copy of the request, personally or by 
mail. Hearing requests should be received by the Commission by 5:30 
p.m. on May 29, 2009, and should be accompanied by proof of service on 
applicants, in the form of an affidavit or, for lawyers, a certificate 
of service. Hearing requests should state the nature of the writer's 
interest, the reason for the request, and the issues contested. Persons 
who wish to be notified of a hearing may request notification by 
writing to the Commission's Secretary.

ADDRESSES: Secretary, Securities and Exchange Commission, 100 F Street, 
NE., Washington, DC 20549-1090. Applicants: Donald F. Crumrine, 
Flaherty & Crumrine Incorporated, 301 E. Colorado Boulevard, Suite 720, 
Pasadena, CA 91101.

FOR FURTHER INFORMATION CONTACT: Steven I. Amchan, Attorney Adviser, at 
(202) 551-6826, or Jennifer L. Sawin, Branch Chief, at (202) 551-6821 
(Division of Investment Management, Office of Investment Company 
Regulation).

SUPPLEMENTARY INFORMATION: The following is a summary of the 
application. The complete application may be obtained via the 
Commission's Web site by searching for the file number, or an applicant 
using the Company name box, at http://www.sec.gov/search/search.htm or 
by calling (202) 551-8090.

[[Page 22767]]

Applicants' Representations

    1. Each of the Funds is organized as a Maryland corporation. PFD, 
PFO, and FLC are registered under the Act as diversified, closed-end 
management investment companies. FFC is registered under the Act as a 
non-diversified, closed-end management investment company. Each Fund is 
advised by Flaherty & Crumrine Incorporated (``Flaherty & Crumrine'') 
and has issued and outstanding a class of common shares and a class of 
one or more series of APS Shares.
    2. Applicants state that the Funds issued their APS Shares for 
purposes of investment leverage to augment the amount of investment 
capital available for use in the pursuit of their investment 
objectives. Applicants state that, through the use of leverage, the 
Funds seek to enhance the investment return available to the holders of 
their common shares by earning a rate of portfolio return (which 
includes the return related to investments made with proceeds from 
leverage) that exceeds the leverage costs. Applicants represent that 
owners of APS Shares of FFC and FLC are entitled to receive a stated 
liquidation preference amount of $25,000 per share (plus any 
accumulated but unpaid dividends), and owners of APS Shares of PFD and 
PFO are entitled to receive a stated liquidation preference amount of 
$100,000 per share (plus any accumulated but unpaid dividends), in any 
liquidation, dissolution, or winding up of the relevant Fund before any 
distribution or payment to holders of the Fund's common shares. They 
state that dividends declared and payable on APS Shares have a similar 
priority over dividends declared and payable on the Fund's common 
shares. In addition, applicants state that APS Shares are ``perpetual'' 
securities and are not subject to mandatory redemption by a Fund so 
long as certain asset coverage tests are met. Further, applicants state 
that APS Shares are redeemable at each Fund's option.
    3. Applicants state that prior to February 2008, dividend rates on 
the APS Shares for each dividend period were set at the market clearing 
rate determined through an auction process that brought together 
bidders, who sought to buy APS Shares, and holders of APS Shares, who 
sought to sell their APS Shares. Applicants represent that each Fund's 
Articles Supplementary provide that if an auction fails to clear 
(because of an imbalance of sell orders over bids), the dividend 
payment rate over the next dividend period is set at a specified 
maximum applicable rate (the ``Maximum Rate'') determined by reference 
to a short-term market interest rate (i.e., a commercial paper rate). 
Applicants state that an unsuccessful auction is not a default; the 
relevant Fund continues to pay dividends to all holders of APS Shares, 
but at the specified Maximum Rate rather than a market clearing rate. 
Applicants represent that the Funds experienced no unsuccessful 
auctions prior to February 2008.
    4. Applicants state that if investors did not purchase all of the 
APS Shares tendered for sale at an auction prior to the failure of the 
auction market, dealers historically would enter into the auction and 
purchase any excess shares to prevent the auction from failing. 
Applicants represent that this auction mechanism had generally provided 
readily available liquidity to holders of APS Shares for more than 
twenty years. Applicants state that they understand that many investors 
may have invested short-term cash balances in APS Shares believing they 
were safe short-term investments and, in many cases, the equivalent of 
cash.
    5. Applicants state that in February 2008, the financial 
institutions that historically provided ``back stop'' liquidity to APS 
Shares auctions stopped participating in them and the auctions began to 
fail. Applicants further state that, beginning in February 2008, the 
Funds experienced auction failures due to an imbalance between buy and 
sell orders. Applicants believe that there is no established secondary 
market that would provide holders of the Funds' APS Shares with the 
liquidation preference of $25,000 or $100,000, as the case may be, per 
share. As described more fully in the application, Applicants state 
that they believe they have redeemed as much of the Funds' APS Shares 
as appropriate and feasible. Applicants state, however, that none of 
the Funds would be able to replace its APS Shares entirely with new 
debt without the requested Order providing temporary relief from the 
300% asset coverage test. As a result, applicants state that there is 
currently no reliable mechanism for holders of their APS Shares to 
obtain liquidity, and believe that the current lack of liquidity is 
causing distress and creating severe hardship for holders of their APS 
Shares.
    6. Applicants seek relief for a temporary period from the date on 
which the Order is granted until October 31, 2010 (``Exemption 
Period''). The proposed replacement of the Funds' APS Shares with debt 
would provide liquidity for holders of the Funds' APS Shares, while 
Applicants continue their diligent efforts to obtain a more permanent 
form of financing, such as a new type of senior security that is 
equity.\1\ Applicants submit that the gradual reduction of leverage 
through the use of proceeds of any common share issuances or the 
development of an alternative form of preferred stock might take 
several months, if at all, after the Order has been issued. Applicants 
state that it is uncertain when, or if, the securities and capital 
markets will return to conditions that would enable the Funds to 
achieve compliance with the asset coverage requirements that would 
apply in the absence of the Order. Given the uncertainty and the 
current and continuing unsettled state of the securities and capital 
markets, applicants believe that the Exemption Period is reasonable and 
appropriate. Each Fund's incurrence of debt to redeem its APS Shares 
would be subject to approval by the Fund's board of directors 
(``Board'').
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    \1\ See, e.g., Eaton Vance Management, SEC No-Action Letter 
(June 13, 2008) (permitting the issuance of ``liquidity protected 
preferred shares'' to supplement or replace Eaton Vance funds' 
auction rate preferred stock).
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Applicants' Legal Analysis

    1. Section 18(a)(1)(A) of the Act provides that it is unlawful for 
any registered closed-end investment company to issue any class of 
senior security representing indebtedness, or to sell such security of 
which it is the issuer, unless the class of senior security will have 
an asset coverage of at least 300% immediately after issuance or sale. 
Section 18(a)(2)(A) of the Act provides that it is unlawful for any 
registered closed-end investment company to issue any class of senior 
security that is a stock, or to sell any such security of which it is 
the issuer, unless the class of senior security will have an asset 
coverage of at least 200% immediately after such issuance or sale.\2\
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    \2\ Section 18(h) of the Act defines asset coverage of a senior 
security representing indebtedness of an issuer as the ratio which 
the value of the total assets of the issuer, less all liabilities 
and indebtedness not represented by senior securities, bears to the 
aggregate amount of senior securities representing indebtedness of 
the issuer. The section defines asset coverage of the preferred 
stock of an issuer as the ratio which the value of the total assets 
of the issuer, less all liabilities and indebtedness not represented 
by senior securities, bears to the aggregate amount of senior 
securities representing indebtedness of the issuer plus the 
aggregate amount the class of senior security would be entitled to 
on involuntary liquidation.
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    2. Section 18(a)(1)(B) prohibits a closed-end fund from declaring a 
dividend or other distribution on, or purchasing, its own capital stock 
unless its outstanding indebtedness will have an asset coverage of at 
least 300%

[[Page 22768]]

immediately after deducting the amount of such dividend, distribution 
or purchase price.\3\ Section 18(a)(2)(B) prohibits a closed-end fund 
from declaring a dividend or other distribution on, or purchasing, its 
own common stock unless its outstanding preferred stock will have an 
asset coverage of at least 200% immediately after deducting the amount 
of such dividend, distribution or purchase price.
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    \3\ An exception is made for the declaration of a dividend on a 
class of preferred stock if the senior security representing 
indebtedness has an asset coverage of at least 200% at the time of 
declaration after deduction of the amount of such dividend. See 
section 18(a)(1)(B) of the Act. Further, section 18(g) of the Act 
provides, among other things, that ``senior security,'' for purposes 
of section 18(a)(1)(B), does not include any promissory note or 
other evidence of indebtedness issued in consideration of any loan, 
extension or renewal thereof, made by a bank or other person and 
privately arranged, and not intended to be publicly distributed.
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    3. Section 6(c) of the Act provides, in relevant part, that the 
Commission, by order upon application, may conditionally or 
unconditionally exempt any person, security, or transaction from any 
provision of the Act if and to the extent necessary or appropriate in 
the public interest and consistent with the protection of investors and 
the purposes fairly intended by the policy and provisions of the Act.
    4. Applicants request that the Commission issue an Order under 
section 6(c) of the Act to exempt each Fund from the 300% asset 
coverage requirements set forth in sections 18(a)(1)(A) and (B) of the 
Act. Specifically, applicants seek relief to permit each Fund, for the 
Exemption Period, to issue or incur post-Order debt for the purpose of 
redeeming all or a portion of its APS Shares that were issued prior to 
February 1, 2008 and that are outstanding at the time of such issuance 
or incurrence, as well as any refinancing of such debt until the 
expiration of the Exemption Period, subject to asset coverage of 200% 
ordinarily applicable to a senior security that is stock, rather than 
the asset coverage of 300% ordinarily applicable to a senior security 
constituting indebtedness. Applicants also seek relief to permit each 
Fund to declare dividends or any other distributions on, or purchase, 
capital stock during the Exemption Period, provided that any such post-
Order debt has asset coverage of at least 200% after deducting the 
amount of such transaction. Applicants state that, except as permitted 
under the requested Order, if issued, the Funds would meet all of the 
asset coverage requirements of section 18(a) of the Act. In addition, 
applicants state that within the Exemption Period each Fund that 
borrows in reliance on the Order will either pay down or refinance the 
post-Order debt so that the Fund would, then and thereafter, have asset 
coverage of at least 300% for each class of senior security 
representing indebtedness to the extent required by the Act.
    5. Applicants state that section 18 reflects congressional concerns 
regarding preferential treatment for certain classes of shareholders, 
complex capital structures, and the use of excessive leverage. 
Applicants submit that another concern was that senior securities gave 
the misleading impression of safety from risk. Applicants believe that 
the request for temporary relief is necessary, appropriate and in the 
public interest and that such relief is consistent with the protection 
of investors and the purposes intended by the policy and provisions of 
the Act.
    6. Applicants note that the illiquidity of APS Shares is a unique, 
exigent situation that is posing severe hardships on APS Shares 
shareholders. Applicants represent that the proposed replacement of the 
APS Shares with debt would provide liquidity for the Funds' APS Shares 
shareholders while the Funds continue their efforts to obtain a more 
permanent form of financing (such as through the issuance of preferred 
equity-based instruments) that fully complies with the asset coverage 
requirements of section 18.\4\
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    \4\ See supra note 1.
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    7. Applicants represent that the Order would help avoid the 
potential harm to common shareholders that could result if the Funds 
were to deleverage their portfolios in the current difficult market 
environment \5\ or that could result if a reduction in investment 
return reduced the market price of common shares. Applicants also state 
that the requested Order would permit the Funds to continue to provide 
their common shareholders with the enhanced returns that leverage may 
provide.
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    \5\ Applicants state that each Fund's portfolio consists 
primarily of preferred securities. Applicants further state that 
Flaherty & Crumrine concluded that preferred securities were 
significantly undervalued and traded at historically wide spreads to 
benchmark fixed-income asset classes. Applicants state they believe 
that further deleveraging in the current market environment would 
not be a reasonable method to provide liquidity to their remaining 
APS Shares shareholders.
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    8. Applicants believe that the interests of both classes of the 
Funds' current investors would be well served by the requested order--
the APS Shares shareholders because they would achieve the liquidity 
that the market currently cannot provide (as well as full recovery of 
the liquidation value of their shares), and the common shareholders 
because the adverse consequences of forced deleveraging would be 
avoided and each Fund's investment return would be enhanced to the 
extent that the cost of the new form of leverage is lower than the cost 
of continuing to pay the Maximum Rate on outstanding APS Shares.
    9. Applicants represent that the proposed borrowing would be 
obtained from banks, insurance companies or qualified institutional 
buyers (as defined in Rule 144(a)(1) under the Securities Act of 1933) 
who would be capable of assessing the risk associated with the 
transaction. Applicants also state that, to the extent the Act's asset 
coverage requirements were aimed at limiting leverage because of its 
potential to magnify losses as well as gains, they believe that the 
proposal would not unduly increase the speculative nature of the Funds' 
common shares because the relief is temporary and the Funds would be no 
more highly leveraged if they replace the existing APS Shares with 
borrowing.\6\ Applicants also state that the proposed liquidity 
solution actually could simplify the Funds' capital structures, and 
would not make them more complex, opaque, or hard to understand or 
result in pyramiding or inequitable distribution of control.
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    \6\ Applicants acknowledge that managing any portfolio that 
relies on borrowing for leverage entails the risk that, when the 
borrowing matures and must be repaid or refinanced, an economically 
attractive form of replacement leverage may not be available in the 
capital markets. For that reason, any portfolio that relies on 
borrowing for leverage is subject to the risk that it may have to 
forcibly deleverage, which could be disadvantageous to the 
portfolio's common shareholders. Applicants therefore state that 
they regard leveraging through borrowing as potentially a temporary, 
interim step, with the issuance of new preferred equity-based 
instruments as a possible longer-term replacement source of 
portfolio leverage.
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    10. Applicants state that the current state of the credit markets, 
which has affected the APS Shares, is an historic event of unusual 
severity, which requires a creative and flexible response on the part 
of both the public and private sectors. Applicants believe that these 
issues have created an urgent need for limited, quick, thoughtful and 
responsive solutions. Applicants believe that the request meets the 
standards for exemption under section 6(c) of the Act.

Applicants' Conditions

    Applicants agree that any order granting the requested relief shall 
be subject to the following conditions:
    1. Each Fund that borrows subject to 200% asset coverage under the 
order

[[Page 22769]]

will do so only if such Fund's Board, including a majority of the 
directors who are not ``interested persons'' (as defined in section 
2(a)(19) of the Act) (``Independent Directors''), shall have determined 
that such borrowing is in the best interests of such Fund, its common 
shareholders, and its APS Shares shareholders. Each Fund shall make and 
preserve for a period of not less than six years from the date of such 
determination, the first two years in an easily accessible place, 
minutes specifically describing the deliberations by the Board and the 
information and documents supporting those deliberations, the factors 
considered by the Board in connection with such determination, and the 
basis of such determination.
    2. Upon expiration of the Exemption Period, each Fund will have 
asset coverage of at least 300% for each class of senior security 
representing indebtedness.
    3. The Board of any Fund that has borrowed in reliance on the order 
shall receive and review, no less frequently than quarterly during the 
Exemption Period, detailed progress reports prepared by management (or 
other parties selected by the Independent Directors) regarding and 
assessing the efforts that the Fund has undertaken, and the progress 
that the Fund has made, towards achieving compliance with the 
appropriate asset coverage requirements under section 18 by the 
expiration of the Exemption Period. The Board, including a majority of 
the Independent Directors, will make such adjustments as it deems 
necessary or appropriate to ensure that the applicant comes into 
compliance with section 18 of the Act within a reasonable period of 
time, not to exceed the expiration of the Exemption Period. Each Fund 
will make and preserve minutes describing these reports and the Board's 
review, including copies of such reports and all other information 
provided to or relied upon by the Board, for a period of not less than 
six years, the first two years in an easily accessible place.

    For the Commission, by the Division of Investment Management, 
under delegated authority.
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-11234 Filed 5-13-09; 8:45 am]
BILLING CODE 8010-01-P