-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, V3+SmQu8at0PRhQvaZYuWda9YHP84PxX/IErJU0YAnK8Dlv3awNw8OYPgzi29rz1 sVHqzW4MX1/r1ECW2SDidQ== 0000935069-04-000168.txt : 20040203 0000935069-04-000168.hdr.sgml : 20040203 20040203135328 ACCESSION NUMBER: 0000935069-04-000168 CONFORMED SUBMISSION TYPE: N-CSR PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20031130 FILED AS OF DATE: 20040203 EFFECTIVENESS DATE: 20040203 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PREFERRED INCOME FUND INC CENTRAL INDEX KEY: 0000868578 IRS NUMBER: 954305694 STATE OF INCORPORATION: MD FISCAL YEAR END: 1130 FILING VALUES: FORM TYPE: N-CSR SEC ACT: 1940 Act SEC FILE NUMBER: 811-06179 FILM NUMBER: 04562141 BUSINESS ADDRESS: STREET 1: 301 E COLORADO BLVD STE 720 STREET 2: C/O FLAHERTY & CRUMRINE INC CITY: PASADENA STATE: CA ZIP: 91101 BUSINESS PHONE: 8187957300 MAIL ADDRESS: STREET 1: 800 SCUDDERS MILL RD CITY: PLAINSBORO STATE: NH ZIP: 08536 N-CSR 1 ncsr.txt F&C PREFERRED INCOME NCSR 11/03 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 811-06179 ------------------------- FLAHERTY & CRUMRINE PREFERRED INCOME 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 Inc. 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, 2003 ------------------- Date of reporting period: NOVEMBER 30, 2003 ------------------- 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, 450 Fifth Street, NW, Washington, DC 20549-0609. The OMB has reviewed this collection of information under the clearance requirements of 44 U.S.C. ss. 3507. ITEM 1. REPORTS TO STOCKHOLDERS. FLAHERTY & CRUMRINE PREFERRED INCOME FUND Dear Shareholder: The Flaherty & Crumrine Preferred Income Fund ("PFD") wrapped up a very successful fiscal year on November 30, 2003. The Fund produced +3.1%(1) total return on net asset value ("NAV") during the fourth fiscal quarter, and +26.2%(1) for the full year. The market price of Fund shares also produced very strong returns. For the full fiscal year, the combination of income and share price appreciation totaled +27.4%. By any practical measure, those returns were very, very good. There is also good news on the dividend. Beginning in December, the regular monthly dividend has increased to $0.095 per share from $0.0915, an increase of 3.8%. In addition, the Fund made a one-time extra distribution of $0.04 per share, payable December 31 to holders of record on December 24, 2003. We have more to say about this in the Question and Answer section. The table below compares the return on your Fund with a broad composite of fixed-income, closed-end funds. Although the investment strategies used by the Fund differ significantly from those of the typical bond fund, we believe that the Flaherty &Crumrine Preferred Income Fund provides a better way of accomplishing a similar objective. AVERAGE TOTAL RETURN PER YEAR ON NET ASSET VALUE(1) FOR PERIODS ENDING NOVEMBER 30, 2003 ONE FIVE TEN LIFE OF YEAR YEARS YEARS FUND(2) ---- ----- ----- ------- Flaherty & Crumrine Preferred Income Fund 26.2% 8.6% 9.2% 12.5% Lipper Composite of Investment Grade Bond Funds(3) 9.5% 6.6% 6.8% 8.0% - -------------------------- (1) Based on monthly data provided by Lipper Inc. Distributions are assumed to be reinvested at NAV in accordance with Lipper's practice, which differs from the procedures used elsewhere in this report. (2) Since inception on January 31, 1991. (3) Includes all U.S. Government bond, mortgage bond and term trust and investment grade bond funds in Lipper's closed-end fund database at each point in time. A number of factors contributed to the outstanding performance of the Fund over the past fiscal year, but three in particular stand out: 0 A very favorable market for preferred securities; 0 Successful execution of the Fund's hedging strategy; and 0 Attractive financing rates on the Fund's Money Market Preferred ("MMP(TRADE MARK)") shares. The demand for preferred securities increased steadily over the past year. This was especially true for preferred securities that pay dividends subject to new, lower tax rates. As we have discussed in the past, preferred securities can be divided into two broad categories--"hybrid preferreds" which pay INTEREST and "traditional preferreds" which pay DIVIDENDS. Prior to 2003, the distinction was most critical for corporations because they received favorable tax treatment on dividends. Starting in 2003, however, individuals will also be taxed at lower rates on dividends, and, as a result, have increasingly become buyers of traditional preferreds. For several years the Fund has been steadily increasing its holdings of dividend-paying preferreds and thus has been well positioned to capitalize on the greater demand. These portfolio moves have been an important key to the Fund's superior performance. 79.82% of the distributions made by PFD in 2003 to Common Shareholders is considered qualified dividend income for individual taxpayers. A more detailed discussion is included in the Q&A section. The Fund's hedging strategy played a very important role in fiscal 2003. Long-term U.S. Treasury interest rates ended the year at about the same level as where they began, slightly above 5%. Over the course of the year, however, interest rates were anything but stable. The Fund's hedges performed according to design, and actually benefited from the volatility. The hedging strategy enabled the Fund to make a lot of money when interest rates declined during the spring, while protecting much of those gains as rates spiked back up during the summer. The Fund also benefited from low short-term interest rates, which kept the average rate the Fund paid on its shares of MMP(TRADE MARK) below 1 1/4%. Keep in mind that low short-term rates can be a double-edged sword--while reducing the cost of leverage, low rates typically make the Fund's hedging strategy more expensive. In the case of PFD, the cost of the leverage and the cost of the hedge should move as if they are on opposite ends of a teeter-totter--when one is going up, the other should be falling (though not necessarily by the same amount). Over the past year, however, we managed to "bend the board"--leverage cost was low AND active management of the hedge positions kept the hedge costs down. During the past few months it seems as if each passing day has brought new revelations of misdeeds by open-end mutual funds. The abuses have been almost entirely the result of certain fund complexes permitting two different types of trading strategies in funds they manage--after-hour trades and rapid or excessive trading. NOT ONE OF THESE ALLEGED ABUSES HAS INVOLVED A CLOSED-END FUND. Shares of closed-end funds, such as PFD, trade at prices determined in the market place rather than at the net asset value computed at the market's close. As a result, these abusive trading techniques simply can't work in closed-end funds. We address this topic in greater detail in the Q&A section, but we want our shareholders to know that in addition to the structural protection offered by the Fund, we are committed to following both the letter and spirit of the law, and to making certain that every investor is treated exactly the same. 2 Our approach to managing your Fund is straightforward. We intensively study and monitor the fundamental credit quality of each potential investment, and carefully evaluate the specific terms of each individual issue. If all this research produces a suitable level of comfort, we then begin the process of assessing the appropriate price for the security. Since our investment philosophy is to own the issues that offer the best OVERALL value within the universe of eligible securities, it often means that we pass up the temptation of issues offering higher absolute yields. If we make intelligent investments and continue to successfully implement the hedging strategy, then the Fund will have more money to invest and thus be able to generate more income over time. The process is arduous and ongoing, but rarely do good things come without substantial effort. We encourage you to read the Questions and Answers section beginning on the next page, which contains additional information on the Fund's strategy and operation. Sincerely, /S/ DONALD F. CRUMRINE /S/ ROBERT M. ETTINGER Donald F. Crumrine Robert M. Ettinger Chairman of the Board President January 21, 2004 3 QUESTIONS & ANSWERS WHY WAS THE FUND ABLE TO RAISE ITS DIVIDEND RATE? A number of things contributed to the dividend increase, but the key factors were the management of the investment portfolio, the success of the hedging strategy and continued low short-term interest rates. One proven strategy to increase income from an investment portfolio is to have a larger portfolio. Over the years, consistent, active management of the portfolio has been the surest way to make it grow. Sometimes our focus may be on specific securities and other times on broader sectors of the market, but the simple goal is to "buy 'em cheap and sell 'em dear". During the past year, almost anyone who purchased a preferred security probably made money. Producing returns like PFD, however, required owning the "right" preferreds. For example, the decision to increase the portfolio's allocation to traditional preferreds was a major factor in this year's performance. We also actively manage the Fund's hedge. This past spring, when yields on intermediate and long-term U.S. Treasury bonds were falling to historical lows, the Fund's put option hedges quickly became worthless, but the prices on the Fund's preferred securities kept going up! When yields reversed course and rose rapidly in mid-summer, gains on the hedge offset much of the decline in the value of the securities, and a portion of the hedge gains were used to purchase additional income producing securities. Finally, Federal Reserve monetary policy has kept short-term yields very low. Since the rates paid by the Fund on its shares of Money Market Cumulative Preferred(TRADE MARK) Stock (MMP(TRADE MARK)) are closely correlated to these yields, the Fund has more income available for shareholders. WHAT HAS HAPPENED TO THE FUND'S INCOME OVER TIME? The following chart provides the clearest answer. The chart may look familiar--it has appeared several times in the past (it is one of our favorites because it clearly demonstrates the success of the Fund's investment strategy). The solid line (measured on the left-hand scale) represents the monthly dollar income received from an original investment in 1,000 shares of the Fund. It is based on the assumption that the shareholder spent his or her regular monthly dividend income from the Fund and reinvested at net asset value only the portion of each special year-end distribution that was "above and beyond" the monthly dividends. 4 FLAHERTY & CRUMRINE PREFERRED INCOME FUND MONTHLY DIVIDEND INCOME On a 1,000 Share ($15,500) Initial Investment through 12/31/03 [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC Date Income 30 Yr Treasury Yield Dec-90 Jan-91 8.16% Feb-91 8.20% Mar-91 8.22% Apr-91 $122.50 8.18% May-91 $122.50 8.26% Jun-91 $122.50 8.40% Jul-91 $122.50 8.34% Aug-91 $125.00 8.06% Sep-91 $125.00 7.81% Oct-91 $125.00 7.91% Nov-91 $125.00 7.94% Dec-91 $125.00 7.40% Jan-92 $126.46 7.76% Feb-92 $126.46 7.79% Mar-92 $126.46 7.96% Apr-92 $126.46 8.03% May-92 $126.46 7.84% Jun-92 $126.46 7.78% Jul-92 $126.46 7.46% Aug-92 $126.46 7.41% Sep-92 $126.46 7.38% Oct-92 $126.46 7.62% Nov-92 $126.46 7.60% Dec-92 $126.46 7.39% Jan-93 $127.87 7.19% Feb-93 $127.87 6.90% Mar-93 $127.87 6.92% Apr-93 $127.87 6.93% May-93 $127.87 6.98% Jun-93 $127.87 6.67% Jul-93 $127.87 6.56% Aug-93 $127.87 6.09% Sep-93 $127.87 6.02% Oct-93 $127.87 5.97% Nov-93 $127.87 6.30% Dec-93 $127.87 6.35% Jan-94 $121.76 6.24% Feb-94 $121.76 6.66% Mar-94 $121.76 7.09% Apr-94 $121.76 7.30% May-94 $128.67 7.43% Jun-94 $128.67 7.61% Jul-94 $128.67 7.39% Aug-94 $128.67 7.48% Sep-94 $128.67 7.82% Oct-94 $128.67 7.96% Nov-94 $133.06 7.94% Dec-94 $133.06 7.88% Jan-95 $132.51 7.73% Feb-95 $132.51 7.55% Mar-95 $132.51 7.43% Apr-95 $132.51 7.33% May-95 $132.51 6.63% Jun-95 $125.21 6.54% Jul-95 $125.21 6.90% Aug-95 $125.21 6.61% Sep-95 $125.21 6.50% Oct-95 $125.21 6.36% Nov-95 $125.21 6.08% Dec-95 $117.63 5.95% Jan-96 $117.63 6.05% Feb-96 $117.63 6.36% Mar-96 $117.63 6.67% Apr-96 $117.63 6.83% May-96 $124.39 7.00% Jun-96 $124.39 6.95% Jul-96 $124.39 7.01% Aug-96 $124.39 7.12% Sep-96 $124.39 6.90% Oct-96 $124.39 6.81% Nov-96 $124.39 6.51% Dec-96 $124.39 6.60% Jan-97 $123.32 6.79% Feb-97 $123.32 6.80% Mar-97 $123.32 7.09% Apr-97 $123.32 6.89% May-97 $123.32 6.98% Jun-97 $123.32 6.74% Jul-97 $123.32 6.45% Aug-97 $123.32 6.61% Sep-97 $123.32 6.30% Oct-97 $123.32 6.15% Nov-97 $123.32 6.04% Dec-97 $123.32 5.95% Jan-98 $117.47 5.90% Feb-98 $117.47 6.02% Mar-98 $117.47 5.93% Apr-98 $117.47 5.95% May-98 $117.47 5.80% Jun-98 $117.47 5.62% Jul-98 $117.47 5.72% Aug-98 $117.47 5.26% Sep-98 $117.47 4.98% Oct-98 $117.47 5.15% Nov-98 $117.47 5.07% Dec-98 $117.47 5.09% Jan-99 $118.77 5.09% Feb-99 $118.77 5.58% Mar-99 $118.77 5.62% Apr-99 $118.77 5.66% May-99 $118.77 5.82% Jun-99 $127.85 5.97% Jul-99 $127.85 6.10% Aug-99 $127.85 6.06% Sep-99 $127.85 6.05% Oct-99 $127.85 6.16% Nov-99 $127.85 6.29% Dec-99 $127.85 6.48% Jan-00 $128.38 6.49% Feb-00 $128.38 6.15% Mar-00 $128.38 5.84% Apr-00 $128.38 5.96% May-00 $128.38 6.02% Jun-00 $128.38 5.89% Jul-00 $128.38 5.79% Aug-00 $128.38 5.67% Sep-00 $128.38 5.88% Oct-00 $128.38 5.79% Nov-00 $128.38 5.59% Dec-00 $128.38 5.46% Jan-01 $128.38 5.53% Feb-01 $128.38 5.34% Mar-01 $128.38 5.46% Apr-01 $128.38 5.77% May-01 $128.38 5.77% Jun-01 $128.38 5.74% Jul-01 $128.38 5.50% Aug-01 $128.38 5.37% Sep-01 $128.38 5.41% Oct-01 $128.38 4.88% Nov-01 $128.38 5.26% Dec-01 $128.38 5.47% Jan-02 $129.11 5.43% Feb-02 $129.11 5.41% Mar-02 $129.11 5.80% Apr-02 $129.11 5.59% May-02 $129.11 5.61% Jun-02 $138.56 5.52% Jul-02 $138.56 5.30% Aug-02 $138.56 4.93% Sep-02 $138.56 4.66% Oct-02 $138.56 5.00% Nov-02 $138.56 5.04% Dec-02 $138.56 4.76% Jan-03 $145.43 4.85% Feb-03 $145.43 4.67% Mar-03 $145.43 4.83% Apr-03 $145.43 4.78% May-03 $145.43 4.36% Jun-03 $145.43 4.56% Jul-03 $145.43 5.41% Aug-03 $145.43 5.22% Sep-03 $145.43 4.89% Oct-03 $145.43 5.14% Nov-03 $145.43 5.13% Dec-03 $145.43 5.07% Jan-04 $151.37 5.07% Feb-04 $151.37 5.10% The chart's message is that the MONTHLY DIVIDEND INCOME HAS INCREASED SINCE THE INCEPTION OF THE FUND FOR SHAREHOLDERS THAT REINVESTED THE "EXTRA" DISTRIBUTIONS. That increase is rather remarkable in view of the substantial decline in the interest rate on long-term U.S. Treasury bonds (the dashed line measured on the right-hand scale) over the life of the Fund from roughly 8% to slightly more than 5%. ARE DIVIDENDS PAID BY THE FUND ELIGIBLE FOR THIS YEAR'S LOWER TAX RATES? For individual investors in PFD, 79.82% of the distributions made by the Fund in CALENDAR YEAR 2003 was QUALIFIED DIVIDEND INCOME. For corporate investors, 79.45% was eligible for the inter-corporate dividend received deduction. WHAT PORTION OF 2004 DISTRIBUTIONS WILL BE QUALIFIED DIVIDEND INCOME? The short answer is "we don't know". The breakdown between dividends, interest and capital gains can only be determined once we close the books on the Fund's fiscal year-end, so the 2004 numbers can't be computed until a year from now. As can be seen in the attached portfolio listing, more than two thirds of the portfolio was invested in traditional preferred stocks at our fiscal year end. This percentage has increased since then simply because we believed these securities were undervalued. If the "pendulum of value" swings too far the other way and taxable (or "hybrid") preferreds look relatively more attractive, the portfolio composition may move more toward hybrids. In that scenario, the Fund's qualified dividend percentage would likely decline, but the dividend rate could possibly increase. 5 HOW WILL THE FUND NOTIFY SHAREHOLDERS ABOUT HOW MUCH INCOME IS ELIGIBLE FOR THE LOWER TAX RATE? If you are an individual investor and have possession of your Fund share certificate, you will receive Form 1099 from PFPC. If your shares are registered in the name of your brokerage firm, it will issue Form 1099 directly to you. In either case, Box 1b of Form 1099 includes "Qualified dividends" eligible for the lower tax rate. WHY HAS THE MARKET PRICE INCREASED RELATIVE TO THE NAV? The following chart plots the relationship of market price to net asset value over the life of the Fund. FLAHERTY & CRUMRINE PREFERRED INCOME FUND Premium/Discount of Market Price to NAV [GRAPHIC OMITTED] EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC Date Prem/Disc 12/28/90 1/4/91 1/11/91 1/18/91 1/25/91 2/1/91 2/8/91 0.0842% 2/15/91 0.0438% 2/22/91 0.0395% 3/1/91 0.0424% 3/8/91 0.0183% 3/15/91 0.0151% 3/22/91 0.0201% 3/29/91 0.0230% 4/5/91 0.0149% 4/12/91 0.0196% 4/19/91 0.0314% 4/26/91 0.0268% 5/3/91 0.0230% 5/10/91 0.0199% 5/17/91 0.0146% 5/24/91 0.0219% 5/31/91 0.0510% 6/7/91 0.0423% 6/14/91 0.0417% 6/21/91 0.0536% 6/28/91 0.0659% 7/5/91 0.0726% 7/12/91 0.0659% 7/19/91 0.0643% 7/26/91 0.0549% 8/2/91 0.0678% 8/9/91 0.0540% 8/16/91 0.0449% 8/23/91 0.0648% 8/30/91 0.0314% 9/6/91 0.0570% 9/13/91 0.0883% 9/20/91 0.0651% 9/27/91 0.0682% 10/4/91 0.0764% 10/11/91 0.0745% 10/18/91 0.0719% 10/25/91 0.0662% 11/1/91 0.0693% 11/8/91 0.0827% 11/15/91 0.0801% 11/22/91 0.0650% 11/29/91 0.0807% 12/6/91 0.0716% 12/13/91 0.0791% 12/20/91 0.0839% 12/27/91 0.1136% 1/3/92 0.1091% 1/10/92 0.1116% 1/17/92 0.0978% 1/24/92 0.0912% 1/31/92 0.0417% 2/7/92 0.0478% 2/14/92 0.0613% 2/21/92 0.0417% 2/28/92 0.0381% 3/6/92 0.0339% 3/13/92 0.0447% 3/20/92 0.0387% 3/27/92 0.0327% 4/3/92 0.0357% 4/10/92 0.0452% 4/17/92 0.0464% 4/24/92 0.0423% 5/1/92 0.0523% 5/8/92 0.0382% 5/15/92 0.0347% 5/22/92 0.0083% 5/29/92 0.0039% 6/5/92 0.0302% 6/12/92 0.0239% 6/19/92 0.0227% 6/26/92 0.0491% 7/3/92 0.0491% 7/10/92 0.0593% 7/17/92 0.0570% 7/24/92 0.0712% 7/31/92 0.0580% 8/7/92 0.0601% 8/14/92 0.0389% 8/21/92 0.0306% 8/28/92 0.0250% 9/4/92 0.0228% 9/11/92 0.0356% 9/18/92 0.0489% 9/25/92 0.0339% 10/2/92 0.0650% 10/9/92 0.0417% 10/16/92 0.0417% 10/23/92 0.0378% 10/30/92 0.0707% 11/6/92 0.0378% 11/13/92 0.0590% 11/20/92 0.0349% 11/27/92 0.0506% 12/4/92 0.0680% 12/11/92 0.0601% 12/18/92 0.0582% 12/25/92 0.0618% 1/1/93 0.0739% 1/8/93 0.0987% 1/15/93 0.1145% 1/22/93 0.1021% 1/29/93 0.0760% 2/5/93 0.0530% 2/12/93 0.0452% 2/19/93 0.0434% 2/26/93 0.0628% 3/5/93 0.0909% 3/12/93 0.0538% 3/19/93 0.0248% 3/26/93 0.0638% 4/2/93 0.0806% 4/9/93 0.0764% 4/16/93 0.0671% 4/23/93 0.0764% 4/30/93 0.0677% 5/7/93 0.0918% 5/14/93 0.0779% 5/21/93 0.0700% 5/28/93 0.0740% 6/4/93 0.0497% 6/11/93 0.0388% 6/18/93 0.0560% 6/25/93 0.0703% 7/2/93 0.0451% 7/9/93 0.0541% 7/16/93 0.0490% 7/23/93 0.0576% 7/30/93 0.0598% 8/6/93 0.0790% 8/13/93 0.0484% 8/20/93 0.0377% 8/27/93 0.0434% 9/3/93 0.0450% 9/10/93 0.0361% 9/17/93 0.0467% 9/24/93 0.0321% 10/1/93 0.0293% 10/8/93 0.0110% 10/15/93 0.0173% 10/22/93 0.0048% 10/29/93 -0.0075% 11/5/93 0.0095% 11/12/93 0.0019% 11/19/93 -0.0316% 11/26/93 0.0030% 12/3/93 -0.0175% 12/10/93 -0.0103% 12/17/93 0.0323% 12/24/93 -0.0051% 12/31/93 -0.0287% 1/7/94 0.0093% 1/14/94 0.0149% 1/21/94 -0.0126% 1/28/94 -0.0316% 2/4/94 -0.0196% 2/11/94 -0.0224% 2/18/94 -0.0741% 2/25/94 -0.0539% 3/4/94 -0.0092% 3/11/94 -0.0270% 3/18/94 -0.0379% 3/25/94 -0.0505% 4/1/94 -0.0466% 4/8/94 -0.0713% 4/15/94 -0.0596% 4/22/94 -0.0598% 4/29/94 -0.0863% 5/6/94 -0.0581% 5/13/94 -0.0635% 5/20/94 -0.0409% 5/27/94 -0.0397% 6/3/94 -0.0289% 6/10/94 0.0146% 6/17/94 -0.0037% 6/24/94 0.0175% 7/1/94 0.0006% 7/8/94 0.0299% 7/15/94 0.0188% 7/22/94 -0.0084% 7/29/94 -0.0082% 8/5/94 -0.0161% 8/12/94 -0.0215% 8/19/94 -0.0263% 8/26/94 -0.0439% 9/2/94 -0.0379% 9/9/94 -0.0232% 9/16/94 -0.0293% 9/23/94 -0.0273% 9/30/94 -0.0565% 10/7/94 -0.1141% 10/14/94 -0.1089% 10/21/94 -0.1416% 10/28/94 -0.0732% 11/4/94 -0.0783% 11/11/94 -0.0912% 11/18/94 -0.0951% 11/25/94 -0.0788% 12/2/94 -0.0593% 12/9/94 -0.0508% 12/16/94 -0.0554% 12/23/94 -0.0822% 12/30/94 -0.0836% 1/6/95 -0.0201% 1/13/95 -0.0134% 1/20/95 -0.0525% 1/27/95 -0.0697% 2/3/95 0.0061% 2/10/95 -0.0289% 2/17/95 -0.0419% 2/24/95 -0.0004% 3/3/95 0.0035% 3/10/95 -0.0445% 3/17/95 -0.0666% 3/24/95 -0.0568% 3/31/95 -0.0290% 4/7/95 -0.0256% 4/14/95 -0.0217% 4/21/95 -0.0439% 4/28/95 -0.0271% 5/5/95 -0.0398% 5/12/95 -0.0178% 5/19/95 -0.0410% 5/26/95 -0.0870% 6/2/95 -0.0259% 6/9/95 -0.0608% 6/16/95 -0.0759% 6/23/95 -0.0884% 6/30/95 -0.0753% 7/7/95 -0.0844% 7/14/95 -0.0995% 7/21/95 -0.0976% 7/28/95 -0.0917% 8/4/95 -0.0888% 8/11/95 -0.0935% 8/18/95 -0.0942% 8/25/95 -0.0832% 9/1/95 -0.0698% 9/8/95 -0.0816% 9/15/95 -0.0968% 9/22/95 -0.0978% 9/29/95 -0.0816% 10/6/95 -0.0974% 10/13/95 -0.1094% 10/20/95 -0.1048% 10/27/95 -0.1210% 11/3/95 -0.1151% 11/10/95 -0.1146% 11/17/95 -0.1117% 11/24/95 -0.1043% 12/1/95 -0.1071% 12/8/95 -0.1192% 12/15/95 -0.1244% 12/22/95 -0.1337% 12/29/95 -0.1313% 1/5/96 -0.1365% 1/12/96 -0.1354% 1/19/96 -0.1379% 1/26/96 -0.1251% 2/2/96 -0.1244% 2/9/96 -0.1238% 2/16/96 -0.1360% 2/23/96 -0.1281% 3/1/96 -0.1118% 3/8/96 -0.1332% 3/15/96 -0.1521% 3/22/96 -0.1564% 3/29/96 -0.1464% 4/5/96 -0.1343% 4/12/96 -0.1477% 4/19/96 -0.1402% 4/26/96 -0.1488% 5/3/96 -0.1477% 5/10/96 -0.1452% 5/17/96 -0.1363% 5/24/96 -0.1432% 5/31/96 -0.1111% 6/7/96 -0.1180% 6/14/96 -0.1003% 6/21/96 -0.1129% 6/28/96 -0.1049% 7/5/96 -0.0950% 7/12/96 -0.0980% 7/19/96 -0.1071% 7/26/96 -0.1077% 8/2/96 -0.1105% 8/9/96 -0.0574% 8/16/96 -0.0714% 8/23/96 -0.0705% 8/30/96 -0.0669% 9/6/96 -0.0824% 9/13/96 -0.0756% 9/20/96 -0.1186% 9/27/96 -0.1106% 10/4/96 -0.0861% 10/11/96 -0.0941% 10/18/96 -0.1077% 10/25/96 -0.0858% 11/1/96 -0.0778% 11/8/96 -0.0831% 11/15/96 -0.0833% 11/22/96 -0.0653% 11/29/96 -0.0606% 12/6/96 -0.0667% 12/13/96 -0.0831% 12/20/96 -0.0749% 12/27/96 -0.0750% 1/3/97 -0.0242% 1/10/97 -0.0291% 1/17/97 -0.0465% 1/24/97 -0.0410% 1/31/97 -0.0459% 2/7/97 -0.0675% 2/14/97 -0.0544% 2/21/97 -0.0539% 2/28/97 -0.0550% 3/7/97 -0.0584% 3/14/97 -0.0637% 3/21/97 -0.0752% 3/28/97 -0.0584% 4/4/97 -0.0627% 4/11/97 -0.0881% 4/18/97 -0.0976% 4/25/97 -0.0852% 5/2/97 -0.0451% 5/9/97 -0.0578% 5/16/97 -0.0529% 5/23/97 -0.0554% 5/30/97 -0.0541% 6/6/97 -0.0510% 6/13/97 -0.0486% 6/20/97 -0.0486% 6/27/97 -0.0429% 7/4/97 -0.0308% 7/11/97 -0.0537% 7/18/97 -0.0583% 7/25/97 -0.0519% 8/1/97 -0.0498% 8/8/97 -0.0583% 8/15/97 -0.0708% 8/22/97 -0.0739% 8/29/97 -0.0469% 9/5/97 -0.0595% 9/12/97 -0.0623% 9/19/97 -0.0651% 9/26/97 -0.0604% 10/3/97 -0.0299% 10/10/97 -0.0385% 10/17/97 -0.0477% 10/24/97 -0.0558% 10/31/97 -0.0517% 11/7/97 -0.0425% 11/14/97 -0.0554% 11/21/97 -0.0670% 11/28/97 -0.0313% 12/5/97 -0.0431% 12/12/97 -0.0519% 12/19/97 -0.0632% 12/26/97 -0.0621% 1/2/98 -0.0090% 1/9/98 -0.0211% 1/16/98 -0.0012% 1/23/98 -0.0431% 1/30/98 -0.0358% 2/6/98 -0.0364% 2/13/98 -0.0474% 2/20/98 -0.0466% 2/27/98 -0.0446% 3/6/98 -0.0480% 3/13/98 -0.0595% 3/20/98 -0.0437% 3/27/98 -0.0518% 4/3/98 -0.0645% 4/10/98 -0.0509% 4/17/98 -0.0580% 4/24/98 -0.0663% 5/1/98 -0.0422% 5/8/98 -0.0589% 5/15/98 -0.0681% 5/22/98 -0.0702% 5/29/98 -0.0496% 6/5/98 -0.0556% 6/12/98 -0.0586% 6/19/98 -0.0599% 6/26/98 -0.0479% 7/3/98 -0.0496% 7/10/98 -0.0558% 7/17/98 -0.0565% 7/24/98 -0.0645% 7/31/98 -0.0503% 8/7/98 -0.0614% 8/14/98 -0.0779% 8/21/98 -0.0750% 8/28/98 -0.0448% 9/4/98 -0.0448% 9/11/98 -0.0379% 9/18/98 -0.0326% 9/25/98 -0.0367% 10/2/98 -0.0379% 10/9/98 -0.0249% 10/16/98 -0.0228% 10/23/98 -0.0117% 10/30/98 -0.0091% 11/6/98 -0.0140% 11/13/98 -0.0423% 11/20/98 -0.0394% 11/27/98 -0.0267% 12/4/98 -0.0373% 12/11/98 -0.0212% 12/18/98 -0.0355% 12/25/98 -0.0127% 1/1/99 -0.0106% 1/8/99 -0.0182% 1/15/99 -0.0372% 1/22/99 -0.0557% 1/29/99 -0.0557% 2/5/99 -0.0536% 2/12/99 -0.0687% 2/19/99 -0.0647% 2/26/99 -0.1014% 3/5/99 -0.0826% 3/12/99 -0.0747% 3/19/99 -0.0935% 3/26/99 -0.1060% 4/2/99 -0.0802% 4/9/99 -0.0969% 4/16/99 -0.1003% 4/23/99 -0.0957% 4/30/99 -0.0946% 5/7/99 -0.0962% 5/14/99 -0.0928% 5/21/99 -0.1146% 5/28/99 -0.1048% 6/4/99 -0.1014% 6/11/99 -0.0991% 6/18/99 -0.0927% 6/25/99 -0.1031% 7/2/99 -0.0979% 7/9/99 -0.0938% 7/16/99 -0.1037% 7/23/99 -0.0747% 7/30/99 -0.0751% 8/6/99 -0.0792% 8/13/99 -0.0963% 8/20/99 -0.0946% 8/27/99 -0.0911% 9/3/99 -0.1071% 9/10/99 -0.0892% 9/17/99 -0.1065% 9/24/99 -0.0788% 10/1/99 -0.0703% 10/8/99 -0.0727% 10/15/99 -0.1442% 10/22/99 -0.1279% 10/29/99 -0.1431% 11/5/99 -0.1368% 11/12/99 -0.1373% 11/19/99 -0.1078% 11/26/99 -0.1207% 12/3/99 -0.1115% 12/10/99 -0.1164% 12/17/99 -0.1277% 12/24/99 -0.1624% 12/31/99 -0.1084% 1/7/00 -0.0771% 1/14/00 -0.0451% 1/21/00 -0.1203% 1/28/00 -0.1392% 2/4/00 -0.0511% 2/11/00 -0.0641% 2/18/00 -0.0872% 2/25/00 -0.0812% 3/3/00 -0.0585% 3/10/00 -0.0526% 3/17/00 -0.0706% 3/24/00 -0.1058% 3/31/00 -0.1052% 4/7/00 -0.0782% 4/14/00 -0.0904% 4/21/00 -0.0868% 4/28/00 -0.0757% 5/5/00 -0.0591% 5/12/00 -0.0608% 5/19/00 -0.0438% 5/26/00 -0.0407% 6/2/00 -0.0482% 6/9/00 -0.0639% 6/16/00 -0.0670% 6/23/00 -0.0678% 6/30/00 -0.0800% 7/7/00 -0.0807% 7/14/00 -0.0755% 7/21/00 -0.0842% 7/28/00 -0.0816% 8/4/00 -0.0851% 8/11/00 -0.0865% 8/18/00 -0.0672% 8/25/00 -0.0851% 9/1/00 -0.0681% 9/8/00 -0.0794% 9/15/00 -0.0858% 9/22/00 -0.0905% 9/29/00 -0.1071% 10/6/00 -0.0866% 10/13/00 -0.0872% 10/20/00 -0.0845% 10/27/00 -0.0695% 11/3/00 -0.0571% 11/10/00 -0.0734% 11/17/00 -0.0991% 11/24/00 -0.1379% 12/1/00 -0.0864% 12/8/00 -0.0877% 12/15/00 -0.1171% 12/22/00 -0.0939% 12/29/00 -0.0965% 1/5/01 -0.0328% 1/12/01 0.0028% 1/19/01 -0.0285% 1/26/01 -0.0360% 2/2/01 -0.0414% 2/9/01 -0.0290% 2/16/01 -0.0314% 2/23/01 -0.0321% 3/2/01 0.0007% 3/9/01 -0.0517% 3/16/01 -0.0586% 3/23/01 -0.0288% 3/30/01 -0.0203% 4/6/01 -0.0094% 4/13/01 0.0117% 4/20/01 -0.0229% 4/27/01 -0.0088% 5/4/01 0.0072% 5/11/01 -0.0146% 5/18/01 0.0029% 5/25/01 -0.0160% 6/1/01 0.0180% 6/8/01 -0.0215% 6/15/01 -0.0405% 6/22/01 -0.0503% 6/29/01 -0.0258% 7/6/01 0.0064% 7/13/01 -0.0410% 7/20/01 0.0021% 7/27/01 0.0308% 8/3/01 -0.0175% 8/10/01 -0.0473% 8/17/01 -0.0282% 8/24/01 -0.0221% 8/31/01 -0.0475% 9/7/01 -0.0007% 9/14/01 -0.0007% 9/21/01 -0.0173% 9/28/01 -0.0120% 10/5/01 0.0069% 10/12/01 0.0230% 10/19/01 -0.0090% 10/26/01 0.0275% 11/2/01 0.0089% 11/9/01 0.0034% 11/16/01 0.0178% 11/23/01 0.0220% 11/30/01 -0.0096% 12/7/01 0.0138% 12/14/01 0.0152% 12/21/01 0.0430% 12/28/01 0.0271% 1/4/02 0.0437% 1/11/02 0.0323% 1/18/02 0.0447% 1/25/02 0.0608% 2/1/02 0.0754% 2/8/02 0.0924% 2/15/02 0.0755% 2/22/02 0.1158% 3/1/02 0.1186% 3/8/02 0.0395% 3/15/02 0.0437% 3/22/02 0.0212% 3/29/02 0.0212% 4/5/02 0.0246% 4/12/02 0.0423% 4/19/02 0.0539% 4/26/02 0.0312% 5/3/02 0.0468% 5/10/02 0.0408% 5/17/02 0.0434% 5/24/02 0.0542% 5/31/02 0.0543% 6/7/02 0.0704% 6/14/02 0.0505% 6/21/02 0.0478% 6/28/02 0.0870% 7/5/02 0.0691% 7/12/02 0.0545% 7/19/02 0.1276% 7/26/02 0.1241% 8/2/02 0.1051% 8/9/02 0.0865% 8/16/02 0.1032% 8/23/02 0.1103% 8/30/02 0.1209% 9/6/02 0.1169% 9/13/02 0.0972% 9/20/02 0.0948% 9/27/02 0.0932% 10/4/02 0.1110% 10/11/02 0.1724% 10/18/02 0.0412% 10/25/02 0.0914% 11/1/02 0.0724% 11/8/02 0.1039% 11/15/02 0.1113% 11/22/02 0.0550% 11/29/02 0.1005% 12/6/02 0.1217% 12/13/02 0.0917% 12/20/02 0.1085% 12/27/02 0.1129% 1/3/03 0.1149% 1/10/03 0.0859% 1/17/03 0.1459% 1/24/03 0.1461% 1/31/03 0.1557% 2/7/03 0.1483% 2/14/03 0.1544% 2/21/03 0.1450% 2/28/03 0.1285% 3/7/03 0.1442% 3/14/03 0.1508% 3/21/03 0.1146% 3/28/03 0.1098% 4/4/03 0.1478% 4/11/03 0.1382% 4/18/03 0.1384% 4/25/03 0.1251% 5/2/03 0.0749% 5/9/03 0.0459% 5/16/03 0.0373% 5/23/03 0.0371% 5/30/03 0.0701% 6/6/03 0.0286% 6/13/03 0.0336% 6/20/03 0.0453% 6/27/03 0.0483% 7/4/03 0.0605% 7/11/03 0.0217% 7/18/03 0.0090% 7/25/03 0.0020% 8/1/03 -0.0282% 8/8/03 -0.0206% 8/15/03 -0.0230% 8/22/03 -0.0148% 8/29/03 -0.0019% 9/5/03 0.0026% 9/12/03 -0.0051% 9/19/03 -0.0151% 9/26/03 -0.0393% 10/3/03 -0.0233% 10/10/03 -0.0196% 10/17/03 -0.0309% 10/24/03 -0.0220% 10/31/03 0.0314% 11/7/03 0.0076% 11/14/03 0.0413% 11/21/03 0.0882% 11/28/03 0.1136% 12/5/03 0.1202% 12/12/03 0.1321% 12/19/03 0.1348% 12/26/03 0.1471% 1/2/04 0.1550% We can only speculate on what factors are driving the market price, but increased interest in qualified dividend income appears to be the primary reason. IS THE FUND SUSCEPTIBLE TO TRADING ABUSES LIKE THE ONES IN THE NEWS RECENTLY? In a word, the answer is NO! A critical difference between closed-end funds such as PFD and open-end mutual funds, which have been grabbing all the headlines, is the way in which they are purchased and sold. Orders to buy or sell shares of PFD on the NYSE can be placed throughout the trading day, and limit prices can be specified. The investor has control over the transaction price, and the trade takes place only if there is a willing seller and buyer. This degree of control is not possible in an open-end mutual fund because orders placed throughout the day are completed AFTER the close of business, based upon the closing net asset value. 6 Transactions in open-end mutual funds take place between the investor and the mutual fund company. At the close of business (typically 4:00 PM Eastern Time), the fund company computes the mutual fund's net asset value. This price is used to redeem shares from sellers or issue new shares to buyers who placed orders earlier that day. The rules prohibit fund companies from accepting orders after the close of business, but some fund companies have permitted favored clients to place orders AFTER the close, but at that day's NAV. All gains from "late trading" are at the expense of the other investors in the fund. The other frequently mentioned abuse in open-end mutual funds is fund companies permitting "frequent trading" practices by favored clients. Although not illegal, this practice may harm investors because these favored clients' gains are again at the expense of the other investors in the fund and usually force the fund to maintain larger cash positions than would otherwise be appropriate. Managers of closed-end funds don't face this problem either. If a holder of a closed-end fund wishes to sell shares, the market must facilitate the trade, not the fund. Therefore a closed-end fund can remain fully invested without regard to possible redemptions. 7 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund FINANCIAL DATA PER SHARE OF COMMON STOCK - -------------------------------------------------------------- TOTAL DIVIDEND DIVIDENDS NET ASSET NYSE REINVESTMENT PAID VALUE CLOSING PRICE PRICE (1) --------- --------- ------------- ------------ December 31, 2002 Extra $0.1285 $13.65 $15.10 $14.35 December 31, 2002 ..... 0.0915 13.65 15.10 14.35 January 31, 2003 ...... 0.0915 14.45 16.70 15.87 February 28, 2003 ..... 0.0915 14.55 16.42 15.60 March 31, 2003 ........ 0.0915 14.64 16.10 15.30 April 30, 2003 ........ 0.0915 14.83 16.20 15.39 May 31, 2003 .......... 0.0915 15.54 16.63 15.80 June 30, 2003 ......... 0.0915 15.84 16.35 15.84 July 31, 2003 ......... 0.0915 15.58 15.34 15.27 August 31, 2003 ....... 0.0915 15.64 15.61 15.64 September 30, 2003 .... 0.0915 16.04 15.62 15.45 October 31, 2003 ...... 0.0915 15.94 16.44 15.94 November 30, 2003 ..... 0.0915 15.85 17.65 16.77 December 31, 2003 Extra 0.0400 15.90 18.40 17.48 December 31, 2003 ..... 0.0950 15.90 18.40 17.48 - ------------- (1) Whenever the net asset value per share of the Fund's common stock is less than or equal to the market price per share on the payment date, new shares issued will be valued at the higher of net asset value or 95% of the then current market price. Otherwise, the reinvestment shares of common stock will be purchased in the open market. The accompanying notes are an integral part of the financial statements. 8 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund PORTFOLIO OF INVESTMENTS NOVEMBER 30, 2003 ----------------------------------------- VALUE SHARES/$ PAR (NOTE 2) - ------------ -------- PREFERRED SECURITIES -- 91.7% ADJUSTABLE RATE PREFERRED SECURITIES -- 9.7% BANKING -- 9.3% 75,000 Cobank, Adj. Rate Pfd., 144A**** ...............$ 4,188,000* J.P. Morgan Chase & Co.: 136,675 Series A, Adj. Rate Pfd. ............... 13,154,969* 19,000 Series L, Adj. Rate Pfd. ............... 1,900,000* 125,700 Series N, Adj. Rate Pfd. ............... 3,166,069* ----------- TOTAL BANKING ADJUSTABLERATE PREFERRED SECURITIES .................... 22,409,038 ----------- FINANCIAL SERVICES -- 0.2% 10,500 Bear Stearns Companies, Inc., Series A, Adj. Rate Pfd. ............... 530,250* ----------- UTILITIES -- 0.2% 7,465 Northern Indiana Public Service Company, Series A, Adj. Rate Pfd. ............... 378,382* ----------- TOTAL ADJUSTABLE RATE PREFERRED SECURITIES .............................. 23,317,670 ----------- FIXED RATE PREFERRED SECURITIES -- 81.2% BANKING -- 21.7% ABN AMRO North America, Inc.: 2,625 6.46% Pfd., 144A**** ................... 2,746,026* 4,000 6.59% Pfd., 144A**** ................... 4,183,020* BancWest Corporation: 400 BancWest Capital I, 9.50% 12/01/30 QUIPS ................... 11,394 $2,250,000 First Hawaiian Capital I, 8.343% 07/01/27 Capital Security, Series B ............................... 2,570,490 Bank of America Corporation: $ 750,000 Barnett Capital II, 7.95% 12/01/26 Capital Security ........ 845,771 $ 674,000 NB Capital Trust II, 7.83% 12/15/26 Capital Security ........ 759,295 Citigroup, Inc.: 151,177 5.864% Pfd., Series M .................. 7,897,486* 12,676 6.213% Pfd., Series G .................. 674,300* 11,000 6.231% Pfd., Series H .................. 589,875* VALUE SHARES/$ PAR (NOTE 2) ------------ -------- 30,000 Cobank, ABC, 7.00% Pfd., 144A**** ...................$ 1,543,650* Comerica, Inc.: $500,000 Comerica (Imperial) Capital Trust I, Series B, 9.98% 12/31/26 Capital Security .............. 622,727 Deutsche Bank: $1,500,000 BT Preferred Capital Trust II, 7.875% 02/25/27 Capital Security ....... 1,679,122 GreenPoint Financial Corporation: $12,820,000 GreenPoint Capital Trust I, 9.10% 06/01/27 Capital Security ........ 14,903,378 HSBC USA, Inc.: 34,200 $2.8575 Pfd. ........................... 1,749,159* $2,635,000 Republic New York Capital II, 7.53% 12/04/26 Capital Security, STOPS . 2,844,206 $ 270,000 Keycorp Institutional Capital B, 8.25% 12/15/26 Capital Security ........ 308,657 16,500 Regions Financial Trust I, 8.00% 02/28/31 Pfd. .................... 450,120 Wachovia Corporation: $1,500,000 First Union Capital II, 7.95% 11/15/29 Capital Security ........ 1,816,403 $1,906,000 First Union Institutional Capital I, 8.04% 12/01/26 Capital Security ........ 2,193,520 $1,820,000 First Union Institutional Capital II, 7.85% 01/01/27 Capital Security ........ 2,066,301 $1,500,000 Wachovia Capital Trust V, 7.965% 06/01/27 Capital Security., 144A**** ............................... 1,715,153 7,500 Wachovia Preferred Funding, 7.25% Pfd., Series A, REIT ............. 207,675 ----------- TOTAL BANKING FIXED RATE PREFERRED SECURITIES .................... 52,377,728 ----------- FINANCIAL SERVICES -- 10.0% Bear Stearns Companies, Inc.: 96,000 5.49% Pfd., Series G ................... 4,789,440* 12,540 5.72% Pfd., Series F ................... 634,775* Lehman Brothers Holdings, Inc.: 65,400 5.67% Pfd., Series D ................... 3,331,149* 151,275 5.94% Pfd., Series C ................... 7,766,458* The accompanying notes are an integral part of the financial statements. 9 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund PORTFOLIO OF INVESTMENTS (CONTINUED) NOVEMBER 30, 2003 - ----------------------------------------- VALUE SHARES/$ PAR (NOTE 2) ------------ -------- PREFERRED SECURITIES -- (CONTINUED) FIXED RATE PREFERRED SECURITIES -- (CONTINUED) FINANCIAL SERVICES-- (CONTINUED) 20,000 6.50% Pfd. Series F ....................$ 529,500* 123,805 SLM Corporation, 6.97% Pfd., Series A ................... 7,059,361* ----------- TOTAL FINANCIAL SERVICES FIXED RATE PREFERRED SECURITIES .................... 24,110,683 ----------- INSURANCE -- 9.5% 47,000 ACE Ltd., 7.80% Pfd., Series C ................... 1,253,255** AON Corporation: $1,645,000 AON Capital Trust A, 8.205% 01/01/27 Capital Security ....... 1,827,579 1,250 Fortis Funding Trust, 7.68% Pfd., 144A**** ................... 1,423,837* SAFECO Corporation: $ 549,000 SAFECO Capital Trust I, 8.072% 07/15/37 Capital Security ....... 616,500 The St. Paul Companies, Inc.: $5,800,000 MMI Capital Trust I, 7.625% 12/15/27 Capital Security, Series B ............................... 6,190,369 12,000 St. Paul Capital Trust I, 7.60% Pfd. ............................. 321,540 UnumProvident Corporation: $4,000,000 Provident Financing Trust I, 7.405% 03/15/38 Capital Security ....... 3,454,300 Zurich RegCaPS Fund Trust I: 6,500 6.01% Pfd., 144A**** ................... 6,537,570* 1,200 6.58% Pfd., 144A**** ................... 1,211,874* ----------- TOTAL INSURANCE FIXED RATE PREFERRED SECURITIES .................... 22,836,824 ----------- UTILITIES -- 34.6% Alabama Power Company: 5,734 4.72% Pfd. ............................. 518,411* 5 4.95% Pfd. ............................. 519,218* 91,100 5.20% Pfd. ............................. 2,236,960* 2,049 Appalachian Power Company, 5.92% Sinking Fund Pfd. ................ 206,191* VALUE SHARES/$ PAR (NOTE 2) ------------ -------- 26,125 Avista Corporation, $6.95 Sinking Fund Pfd., Series K ......$ 2,534,125* 10,000 Boston Edison Company, 4.78% Pfd. ............................. 874,950* 10,457 Carolina Power & Light Company, $5.44 Pfd. ............................. 1,017,518* CenterPoint Energy, Inc.: 45,000 Houston Light & Power, Capital Trust I, 8.125% QUIPS ........................... 1,128,375 $3,500,000 Houston Light & Power, Capital Trust II, 8.257%, 02/01/37 Capital Security, Series B ............................... 3,510,062 60,150 REI Trust I, 7.20% TOPrS, Series C .................. 1,408,713 Central Hudson Gas & Electric Corporation: 5,000 4.35% Pfd., Series D, Pvt. ............. 379,525* 750 4.96% Pfd., Series E, Pvt. ............. 63,821* Central Illinois Light Company: 10,000 4.64% Pfd. ............................. 853,850* 7,000 5.85% Sinking Fund Pfd. ................ 708,400* 27,799 Central Vermont Public Service Corporation, 8.30% Pvt. Sinking Fund Pfd. ........... 2,895,405* Connecticut Light & Power Company: 5,323 $3.24 Pfd. ............................. 279,245* 9,300 5.28% Pfd. ............................. 423,057* 200 6.56% Pfd., Series 1968 ................ 10,366* 2,100 Consolidated Edison Company of New York, 4.65% Pfd., Series C ................... 182,931* 6,870 Dayton Power and Light Company, 3.90% Pfd., Series C ................... 445,554* Duke Energy Corporation: 4,556 4.50% Pfd., Series C, Pvt. ............. 369,970* 31,965 6.75% Pfd., Series X, Sinking Fund Pfd. 3,328,196* 519 7.04% Pfd., Series Y ................... 53,680* 25,762 7.85% Pfd., Series S ................... 2,675,899* Duquesne Light Company: 5,490 $2.10 Pfd. Series A .................... 180,511* 7,675 4.10% Pfd. ............................. 246,329* 6,330 4.15% Pfd. ............................. 205,630* 910 4.20% Pfd. ............................. 29,921* 5,000 Energy East Capital Trust I, 8.25% TOPrS ............................ 134,175 The accompanying notes are an integral part of the financial statements. 10 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund PORTFOLIO OF INVESTMENTS (CONTINUED) NOVEMBER 30, 2003 ----------------------------------------- VALUE SHARES/$ PAR (NOTE 2) ------------ -------- PREFERRED SECURITIES -- (CONTINUED) FIXED RATE PREFERRED SECURITIES -- (CONTINUED) UTILITIES -- (CONTINUED) Entergy Arkansas, Inc.: 3,370 7.32% Pfd. .............................$ 352,569* 11,350 7.40% Pfd. ............................. 1,183,464* 1,322 7.88% Pfd. ............................. 138,261* 30,000 $1.96 Pfd. ............................. 762,300* 4,440 Entergy Gulf States, Inc., 7.56% Pfd. ............................. 452,347* Entergy Louisiana, Inc.: 260 7.84% Pfd. ............................. 27,222* 106,138 8.00% Pfd., Series 92 .................. 2,681,046* 8,500 Entergy Mississippi, Inc., 7.44% Pfd. ............................. 881,918* Florida Power Company: 4,448 4.58% Pfd. ............................. 375,122* 5,157 4.60% Pfd. ............................. 434,761* 8,935 4.75% Pfd., Pvt. ....................... 777,836* 170 Florida Power & Light Company, 4.50% Pfd., Series A, Pvt. ............. 14,537* 50,000 Georgia Power Capital Trust V, 7.125% Pfd. ............................ 1,352,000 2,010 Great Plains Energy, Inc., 4.50% Pfd. ............................. 148,137* Hawaiian Electric Company, Inc.: 20,000 HECO Capital Trust I, 8.05% QUIPS ............................ 509,400 2,717 Idaho Power Co., 7.68% Pfd., Series 1 ................... 281,087* 8,000 Indiana Michigan Power Company, 6.875% Sinking Fund Pfd. ............... 811,400* 32,650 Indianapolis Power & Light Company, 5.65% Pfd. ............................. 2,737,539* 384,000 Interstate Power & Light Company, 8.375% Pfd., Series B .................. 12,226,560* 4,500 Kentucky Utilities Company, 6.53% Pfd. ............................. 465,773* 5,000 Mississippi Power Company, 7.00% Pfd. ............................. 522,900* 14,250 Narragansett Electric Company, 4.64% Pfd. ............................. 596,933* VALUE SHARES/$ PAR (NOTE 2) ------------ -------- 3,905 Northern Indiana Public Service Company, 7.44% Pfd. .............................$ 399,638* 6,170 Ohio Edison Company, 4.44% Pfd. ............................. 419,097* 2,500 Ohio Power Company, 5.90% Sinking Fund Pfd. ................ 250,238* 5,000 PECO Energy Company, $4.40 Pfd., Series C ................... 405,275* 5,000 PPL Electric Utilities Corporation, 6.75% Pfd. ............................. 523,450* 9,410 PSI Energy, Inc., 4.32% Pfd. ............................. 177,990* PacifiCorp: 1,225 $4.56 Pfd. ............................. 95,642* 14,542 $4.72 Pfd. ............................. 1,175,212* 16,444 $7.48 Sinking Fund Pfd. ................ 1,708,038* Pacific Enterprises: 18,830 $4.50 Pfd. ............................. 1,534,927* 10,000 $4.75 Pfd., Series 53 .................. 860,400* 790 Pennsylvania Power Company, 7.75% Pfd. ............................. 80,292* 12,722 Portland General Electric, 7.75% Sinking Fund Pfd. ................ 1,322,325* 19,209 Potomac Electric Power Company, $3.40 Sinking Fund Pfd. ................ 962,563* 10,000 Public Service Company of New Mexico, 4.58% Pfd. ............................. 678,100* Public Service Enterprise Group, Inc.: 10,800 Enterprise Capital Trust I, 7.44% TOPrS, Series A .................. 273,294 Rochester Gas & Electric Corporation: 4,984 4.10% Pfd., Series H ................... 364,904* 10,000 4.55% Pfd., Series M, Pvt. ............. 812,500* 20,000 6.60% Sinking Fund Pfd., Series V ...... 2,015,100* San Diego Gas & Electric Company: 40,000 $1.70 Pfd .............................. 1,045,200* 23,750 $1.7625 Sinking Fund Pfd. .............. 611,919* 1,200 4.40% Pfd. ............................. 19,566* South Carolina Electric & Gas Company: 25,373 5.125% Purchase Fund Pfd., Pvt. ........ 1,246,322* 6,703 6.00% Purchase Fund Pfd., Pvt. ......... 342,791* The accompanying notes are an integral part of the financial statements. 11 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund PORTFOLIO OF INVESTMENTS (CONTINUED) NOVEMBER 30, 2003 - ----------------------------------------- VALUE SHARES/$ PAR (NOTE 2) ------------ -------- PREFERRED SECURITIES -- (CONTINUED) FIXED RATE PREFERRED SECURITIES -- (CONTINUED) UTILITIES -- (CONTINUED) 60,000 Southern Union Company, 7.55% Pfd. .............................$ 1,560,900* TXU US Holdings Company: $ 750,000 TXU Electric Capital V, 8.175% 1/30/37 Capital Security ........ 813,476 8,150 Union Electric Company, 4.56% Pfd. ............................. 708,235* 12,500 Virginia Electric & Power, $7.05 Pfd. ............................. 1,292,063* 1,220 Wisconsin Power & Light, 4.50% Pfd. ............................. 97,563* Xcel Energy, Inc.: 16,030 $4.08 Pfd., Series B ................... 1,099,658* 26,200 $4.10 Pfd., Series C ................... 1,806,097* 22,000 $4.11 Pfd., Series D ................... 1,520,310* 17,750 $4.16 Pfd., Series E ................... 1,241,524* 10,000 $4.56 Pfd., Series G ................... 766,650* ----------- TOTAL UTILITIES FIXED RATE PREFERRED SECURITIES .................... 83,385,359 ----------- OIL AND GAS -- 3.5% 17,200 Anadarko Petroleum Corporation, 5.46% Pfd. ............................. 1,695,662* 36,300 Apache Corporation, 5.68% Pfd., Series B ................... 3,641,616* 1,860 EOG Resources, Inc., 7.195% Pfd., Series B .................. 2,023,829* ENI, S.p.A.: 10,000 Lasmo America Limited, 8.15% Pfd., 144A**** ................... 1,158,450* ----------- TOTAL OIL AND GAS FIXED RATE PREFERRED SECURITIES .................... 8,519,557 ----------- MISCELLANEOUS INDUSTRIES-- 1.9% 13,600 E.I. Du Pont de Nemours and Company, $4.50 Pfd., Series B ................... 1,249,976* 36,200 Farmland Industries, Inc., 8.00% Pfd., 144A**** ................... 31,675*+ VALUE SHARES/$ PAR (NOTE 2) ------------ -------- 33,250 Ocean Spray Cranberries, Inc., 6.25% Pfd., 144A**** ...................$ 2,514,697* 26,000 Touch America Holdings, $6.875 Pfd. ............................ 39,000*+ 9,520 Viad Corporation, $4.75 Sinking Fund Pfd. ................ 896,213* ----------- TOTAL MISCELLANEOUS INDUSTRIES FIXED RATE PREFERRED SECURITIES .............................. 4,731,561 ----------- TOTAL FIXED RATE PREFERRED SECURITIES ..............................195,961,712 ----------- INVERSE FLOATING RATE PREFERRED -- 0.8% 18 Premium Assets, Series A, Zurich Financial Reg. Capital .......... 1,854,596* ----------- TOTAL PREFERRED SECURITIES (Cost $198,830,795) .....................221,133,978 ----------- CORPORATE DEBT SECURITIES -- 1.3% 45,000 Northern States Power Company, 8.00% PINES ............................ 1,244,475 36,200 Ohio Power Company, 7.375% Senior Notes .................... 919,661 $1,000,000 Oneamerica Financial Partners, 7.00% 10/15/33 Capital Security, 144A**** ............................... 985,705 ----------- TOTAL CORPORATE DEBT SECURITIES (Cost $2,975,617) ....................... 3,149,841 ----------- COMMON STOCKS AND CONVERTIBLE SECURITIES -- 4.3% 5,000 American Electric Power, 9.25% Pfd., Convertible ................ 210,275 102,500 CenterPoint Energy, Inc. ................. 994,250* 2,308 Conseco, Inc. ............................ 44,579*+ 9,231 Conseco, Inc., Warrants .................. 59,078*+ 107,500 Duke Energy Corporation .................. 1,942,525* 65,000 FPL Group, Inc., 8.50% Pfd., Convertible ................ 3,668,600 80,831 Reliant Resources, Inc. .................. 531,464*+ 40,000 TXU Corporation, 8.75% Pfd., Convertible ................ 1,283,600 The accompanying notes are an integral part of the financial statements. 12 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund PORTFOLIO OF INVESTMENTS (CONTINUED) NOVEMBER 30, 2003 ----------------------------------------- VALUE SHARES/$ PAR (NOTE 2) ------------ -------- COMMON STOCKS AND CONVERTIBLE SECURITIES -- (CONTINUED) 50,000 UnumProvident Corporation, 8.25% Pfd., Convertible ................$ 1,607,500 ----------- TOTAL COMMON STOCKS AND CONVERTIBLE SECURITIES (Cost $12,203,019) ...................... 10,341,871 ----------- OPTION CONTRACTS-- 1.1% (Cost $2,307,409) 1,409 Put Options on U.S. Treasury, Bond March Futures, Expiring 02/21/2004 .................... 2,699,859+ ----------- MONEY MARKET FUND -- 0.6% (Cost $1,396,193) 1,396,193 BlackRock Provident Institutional TempFund, 0.95% ........................ 1,396,193 ----------- TOTAL INVESTMENTS (Cost $217,713,033***) ................... 99.0% 238,721,742 OTHER ASSETS AND LIABILITIES (Net) ......... 1.0% 2,270,266 ----- ----------- TOTAL NET ASSETS AVAILABLE TO COMMON AND PREFERRED STOCK ....................... 100.0%++ $240,992,008 ----- ----------- MONEY MARKET CUMULATIVE PREFERRED STOCK (MMP)(TRADE MARK) REDEMPTION VALUE (80,000,000) ACCUMULATED UNDECLARED DISTRIBUTIONS TO MMP(TRADE MARK) (67,837) ----------- TOTAL NET ASSETS AVAILABLE TO COMMON STOCK $160,924,171 ============ * Securities eligible for the Dividends Received Deduction and distributing Qualified Dividend Income. ** Securities distributing Qualified Dividend Income only. *** Aggregate cost of securities held. **** Securities exempt from registration under Rule 144A of the Securities Act of 1933. These securities may by resold in transactions exempt from registration to qualified institutional buyers. + Non-income producing. ++ The percentage shown for each investment category is the total value of that category as a percentage of net assets available to Common and Preferred Stock. ABBREVIATIONS (Note 7): PINES -- Public Income Notes QUIPS -- Quarterly Income Preferred Securities REIT -- Real Estate Investment Trust STOPS -- Semi-Annual Trust Originated Pass Through Securities TOPRS -- Trust Originated Preferred Securities PFD. -- Preferred Securities PVT. -- Private Placement Securities Capital Securities are treated as debt instruments for financial statement purposes and the amounts shown in the Shares/$ Par column are dollar amounts of par value. The accompanying notes are an integral part of the financial statements. 13 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund STATEMENT OF ASSETS AND LIABILITIES NOVEMBER 30, 2003 - ----------------------------------------- ASSETS: Investments, at value (Cost $217,713,033) (See accompanying Portfolio of Investments) ...... $238,721,742 Dividends and interest receivable .................. 2,562,319 Prepaid expenses ................................... 109,589 ------------- Total Assets ............................... 241,393,650 LIABILITIES: Dividends payable to Common Shareholders ........... $ 169,033 Investment advisory fee payable .................... 109,541 Administration, Transfer Agent and Custodian fees and expenses payable ............................. 30,764 Professional fees payable .......................... 59,796 Directors' fees payable ............................ 2,969 Accrued expenses and other payables ................ 29,539 Accumulated undeclared distributions to Money Market Cumulative Preferred(TRADE MARK) Stock ...................... 67,837 --------- Total Liabilities .......................... 469,479 ------------- MONEY MARKET CUMULATIVE PREFERRED(TRADE MARK) STOCK (800 SHARES OUTSTANDING) REDEMPTION VALUE ........ 80,000,000 ------------- NET ASSETS AVAILABLE TO COMMON STOCK .................. $160,924,171 ------------- NET ASSETS AVAILABLE TO COMMON STOCK consist of: Undistributed net investment income ................ $ 660,652 Accumulated net realized loss on investments sold .. (6,684,704) Unrealized appreciation of investments ............. 21,008,709 Par value of Common Stock .......................... 101,527 Paid-in capital in excess of par value of Common Stock ....................................... 145,837,987 ------------- Total Net Assets Available to Common Stock . $160,924,171 ============= NET ASSET VALUE PER SHARE OF COMMON STOCK: Common Stock (10,152,716 shares outstanding) ....... $ 15.85 ============= The accompanying notes are an integral part of the financial statements. 14 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund STATEMENT OF OPERATIONS FOR THE YEAR ENDED NOVEMBER 30, 2003 ----------------------------------------- INVESTMENT INCOME: Dividends .................................... $ 12,067,785 Interest ..................................... 3,291,133 ------------- Total Investment Income ................. 15,358,918 EXPENSES: Investment advisory fee ...................... $ 1,290,190 Administrator's fee .......................... 233,190 Money Market Cumulative Preferred(TRADE MARK) Stock broker commissions and auction agent fees .............................. 222,501 Professional fees ............................ 113,734 Insurance expense ............................ 148,952 Shareholder servicing agent fees and expenses 94,182 Directors' fees and expenses ................. 72,693 Custodian fees and expenses .................. 26,654 Other ........................................ 108,935 ----------- Total Expenses .......................... 2,311,031 ------------- NET INVESTMENT INCOME ............................. 13,047,887 ------------- REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS Net realized gain on investments sold during the year .................................. 3,098,132 Change in net unrealized appreciation of investments during the year ............... 19,645,164 ------------- NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS ... 22,743,296 ------------- DISTRIBUTIONS TO MONEY MARKET CUMULATIVE PREFERRED(TRADE MARK)STOCK SHAREHOLDERS: From net investment income (including changes in accumulated undeclared distributions) ..... (1,055,700) ------------- NET INCREASE IN NET ASSETS TO COMMON STOCK RESULTING FROM OPERATIONS ................................ $ 34,735,483 ============= The accompanying notes are an integral part of the financial statements. 15 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund STATEMENTS OF CHANGES IN NET ASSETS - -----------------------------------------
YEAR ENDED YEAR ENDED NOVEMBER 30, 2003 NOVEMBER 30, 2002 ----------------- ----------------- OPERATIONS: Net investment income ..................................................... $ 13,047,887 $ 12,922,272 Net realized gain/(loss) on investments sold during the year .............. 3,098,132 (2,835,267) Change in net unrealized appreciation/(depreciation) of investments held during the year .................................... 19,645,164 (7,213,141) Distributions to Money Market Cumulative Preferred(TRADE MARK) Stock Shareholders from net investment income, including changes in accumulated undeclared distributions ................................... (1,055,700) (1,253,932) -------------- -------------- Net increase in net assets resulting from operations ...................... 34,735,483 1,619,932 DISTRIBUTIONS: Dividends paid from net investment income to Common Stock Shareholders ........................................................... (12,392,105) (10,982,983) Distributions paid from net realized capital gains to Common Stock Shareholders ........................................................... -- -- -------------- -------------- FUND SHARE TRANSACTIONS: Increase from Common Stock transactions ................................... 1,830,875 1,963,583 Decrease due to Money Market Cumulative Preferred(TRADE MARK) Stock transactions (See Note 6.) ....................................... (6,318) (493,959) -------------- -------------- NET INCREASE/(DECREASE)IN NET ASSETS AVAILABLE TO COMMON STOCK FOR THE YEAR .............................................. 24,167,935 (7,893,427) NET ASSETS AVAILABLE TO COMMON STOCK: Beginning of year ......................................................... 136,756,236 144,649,663 -------------- -------------- End of year (including undistributed net investment income of $660,652 and $845,613, respectively) ......................... $ 160,924,171 $ 136,756,236 ============= =============
The accompanying notes are an integral part of the financial statements. 16 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund FINANCIAL HIGHLIGHTS FOR A COMMON SHARE OUTSTANDING THROUGHOUT EACH PERIOD. ------------------------------------------------------ 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, ------------------------------------------------- 2003 2002 2001 2000 1999 -------- -------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period ............................. $ 13.63 $ 14.62 $ 13.41 $ 14.41 $ 16.43 -------- -------- -------- -------- -------- INVESTMENT OPERATIONS: Net investment income ............................................ 1.28 1.29 1.23 1.32 1.29 Net realized and unrealized gain/(loss) on investments ........... 2.27 (1.01) 1.19 (0.56) (1.35) DISTRIBUTIONS TO MMP(TRADE MARK)* SHAREHOLDERS: From net investment income ....................................... (0.10) (0.12) (0.23) (0.29) (0.23) From net realized capital gains .................................. -- -- -- (0.01) (0.08) -------- -------- -------- -------- -------- Total from investment operations ................................. 3.45 0.16 2.19 0.46 (0.37) -------- -------- -------- -------- -------- Cost of Issuance of Additional MMP(TRADE MARK)* (Note 5) ......... -- (0.05) -- -- -- DISTRIBUTIONS TO COMMON SHAREHOLDERS: From net investment income ....................................... (1.23) (1.10) (0.98) (1.04) (1.12) From net realized capital gains .................................. -- -- -- (0.42) (0.53) -------- -------- -------- -------- -------- Total distributions to Common Shareholders ....................... (1.23) (1.10) (0.98) (1.46) (1.65) -------- -------- -------- -------- -------- Net asset value, end of period ................................... $ 15.85 $ 13.63 $ 14.62 $ 13.41 $ 14.41 ======== ======== ======== ======== ======== Market value, end of period ...................................... $ 17.65 $ 15.00 $ 14.47 $ 12.13 $ 12.75 ======== ======== ======== ======== ======== Total investment return based on net asset value** ............... 25.87% 0.58% 17.01% 4.55% (1.81)% ======== ======== ======== ======== ======== Total investment return based on market value**. ................. 27.35% 11.84% 28.02% 6.88% (10.43)% ======== ======== ======== ======== ======== RATIOS TO AVERAGE NET ASSETS AVAILABLE TO COMMON STOCK SHAREHOLDERS: Total net assets, end of period (in 000's) . ................ $160,924 $136,756 $144,650 $131,892 $141,802 Operating expenses .......................................... 1.51% 1.48% 1.42% 1.41% 1.37% Net investment income*** .................................... 7.84% 8.32% 7.21% 7.58% 6.66% - -------------------------------------------- SUPPLEMENTAL DATA:+ Portfolio turnover rate. .................................... 28% 30% 39% 66% 65% Total net assets available to Common and Preferred Stock, end of period (in 000's) .................................... $240,992 $216,974 $202,412 $189,983 $199,863 Ratio of operating expenses to total average net assets available to Common and Preferred Stock ................... 0.99% 0.99% 1.00% 0.98% 0.99% * Money Market Cumulative Preferred(TRADE MARK) Stock. ** Assumes reinvestment of distributions at the price obtained by the Fund's Dividend Reinvestment Plan. *** The net investment income ratios reflect income net of operating expenses and payments to MMP(TRADE MARK)* Shareholders. + Information presented under heading Supplemental Data includes MMP(TRADE MARK)*.
The accompanying notes are an integral part of the financial statements. 17 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund FINANCIAL HIGHLIGHTS (CONTINUED) - ----------------------------------------- The table below sets out information with respect to Money Market Cumulative Preferred(TRADE MARK) Stock currently outstanding. INVOLUNTARY AVERAGE ASSET LIQUIDATING MARKET TOTAL SHARES COVERAGE PREFERENCE VALUE DATE OUTSTANDING(1) PER SHARE(3) PER SHARE(2) PER SHARE(1)&(2) ---------- --------------- ------------- ------------- ---------------- 11/30/03 800 $301,240 $100,000 $100,000 11/30/02 800 271,218 100,000 100,000 11/30/01 575 352,021 100,000 100,000 11/30/00 575 330,404 100,000 100,000 11/30/99 575 347,588 100,000 100,000 11/30/98 575 381,562 100,000 100,000 - --------------- (1) See Note 6. (2) Excludes accumulated undeclared dividends. (3) Calculated by subtracting the Fund's total liabilities (excluding the MMP(TRADE MARK)) from the Fund's total assets and dividing that amount by the number of MMP(TRADE MARK) shares outstanding. The accompanying notes are an integral part of the financial statements. 18 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund NOTES TO FINANCIAL STATEMENTS ----------------------------------------- 1. ORGANIZATION Flaherty & Crumrine Preferred Income Fund Incorporated (the "Fund"), (formerly known as Preferred Income Fund Incorporated) was incorporated as a Maryland corporation on September 28, 1990, and commenced operations on January 31, 1991 as a diversified, closed-end management investment company under the Investment Company Act of 1940, as amended. 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 financial statements is in conformity with accounting principles generally accepted in the United States of America 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 by dividing the value of the Fund's net assets attributable to common shares 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, (ii) the aggregate liquidation value of the outstanding Money Market Cumulative Preferred(TRADE MARK) Stock and (iii) accumulated and unpaid dividends on the outstanding Money Market Cumulative Preferred(TRADE MARK) Stock. Securities listed on a national securities exchange are valued on the basis of the last sale on such exchange on the day of valuation, except as described hereafter. In the absence of sales of listed securities and with respect to (a) securities for which the most recent sale prices are not deemed to represent fair market value and (b) unlisted securities (other than money market instruments), securities are valued at the mean between the closing bid and asked prices when quoted prices for investments are readily available. Investments in over-the-counter derivative instruments, such as interest rate swaps and options thereon ("swaptions"), are valued at the prices obtained from the broker/dealer or bank that is the counterparty to such instrument, subject to comparison of such valuation with a valuation obtained from a broker/dealer or bank that is not a counterparty to the particular derivative instrument. 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. Investments in money market instruments, 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. 19 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) - ------------------------------------------ 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 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 those fixed income securities, including capital securities and bonds, which trade and are quoted on an "accrued income" basis. The AICPA Audit and Accounting Guide, Audits of Investment Companies, requires that, for book accounting purposes, the Fund amortize premiums and accrete discounts on those fixed-income securities, such as capital securities, which trade and are quoted on an "accrued income" basis. Prior to December 1, 2001, the Fund was not required to amortize premiums and accrete discounts for these securities. Adopting these accounting principles has not affected the Fund's net asset value, but changes the classification of certain amounts between interest income and realized and unrealized gain/loss in the Statement of Operations. The adoption of this principle was not material to the financial statements. The Statements of Changes in Net Assets and Financial Highlights for prior periods have not been restated to reflect these changes in presentation. OPTIONS: Upon the purchase of an option by the Fund, the total purchase price paid is recorded as an investment. The market valuation is determined as set forth in the preceding portfolio valuation paragraph. 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. 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. DIVIDENDS AND DISTRIBUTIONS TO SHAREHOLDERS: The Fund expects to declare dividends on a monthly basis to Shareholders of Common Stock ("Shareholder"). The Shareholders of Money Market Cumulative Preferred(TRADE MARK) Stock are entitled to receive cumulative cash dividends as declared by the Fund's Board of Directors. Distributions to Shareholders are recorded on 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's qualifying as a regulated investment company, any taxes paid by the Fund on such net realized long-term gains may be used by the Fund's Shareholders as a credit against their own tax liabilities. 20 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) ----------------------------------------- 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. Income and capital gain distributions are determined and characterized in accordance with income tax regulations which may differ from generally accepted accounting principles. 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 "accrued 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 MMP(TRADE MARK) shareholders, during 2003 and 2002 was as follows: DISTRIBUTIONS PAID IN DISTRIBUTIONS PAID IN FISCAL YEAR 2003 FISCAL YEAR 2002 --------------------- --------------------- LONG-TERM LONG-TERM ORDINARY INCOME CAPITAL GAINS ORDINARY INCOME CAPITAL GAINS --------------- ------------- --------------- ------------- Common $12,392,105 -- $ 10,982,983 -- Preferred $ 1,055,700 -- $ 1,253,932 -- As of November 30, 2003, 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: CAPITAL LOSS UNDISTRIBUTED UNDISTRIBUTED UNREALIZED CARRYFORWARD ORDINARY INCOME LONG-TERM GAIN APPRECIATION/(DEPRECIATION) - ------------ --------------- -------------- --------------------------- $(5,713,607) $1,035,610 -- $20,037,612 At November 30, 2003, the composition of the Fund's $5,713,607 accumulated realized capital losses was $4,444,626, $513,821 and $755,160 in 2000, 2001 and 2002, respectively. These losses may be carried forward and offset against any future capital gains through 2008, 2009 and 2010, respectively. 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 is subject to pay an estimated $21,000 of Federal excise taxes attributable to calendar year 2003. During the fiscal year ending November 30, 2003, the Fund paid $1,812 of Federal excise taxes attributable to calendar year 2002. 21 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) - ----------------------------------------- 3. INVESTMENT ADVISORY FEE, DIRECTORS' FEES, ADMINISTRATION FEE, TRANSFER AGENT FEE AND CUSTODIAN FEE Flaherty & Crumrine Incorporated (the "Adviser") serves as the Fund's investment adviser. 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 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. 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. Effective October 17, 2003, the Audit Committee Chairman will receive an annual fee of $2,500. In addition, the Fund will reimburse all Directors for travel and out-of-pocket expenses incurred in connection with such meetings. PFPC Inc., a member of the PNC Financial Services Group, Inc. ("PNC Financial Services"), serves as the Fund's Administrator and Transfer Agent. As Administrator, PFPC Inc. calculates the net asset value of the Fund's shares and generally assists in all aspects of the Fund's administration and operation. As compensation for PFPC Inc.'s services as Administrator, the Fund paid PFPC Inc. a monthly fee at an annual rate of 0.10% of the Fund's average monthly total net assets available to Common and Preferred Stock through October 31, 2003. Effective November 1, 2003, the fee structure changed to a monthly fee at an annual rate of 0.10% on the first $200 million of the Fund's average weekly total managed assets, 0.04% on the next $300 million of the Fund's average weekly total managed assets, 0.03% on 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. PFPC Inc. also serves as the Fund's Common Stock servicing agent (transfer agent), dividend-paying agent and registrar and, as compensation for PFPC Inc.'s services as such, the Fund paid PFPC Inc. a fee at an annual rate of 0.02% of the Fund's average monthly total net assets available to Common and Preferred Stock plus certain out-of-pocket expenses through October 31, 2003. Effective November 1, 2003, the fee structure changed to a fee at an annual rate of 0.02% on the first $150 million of the Fund's average weekly net assets attributable to common shares, 0.01% on the next $350 million of the Fund's average weekly net assets attributable to common shares, 0.005% on the next $500 million of the Fund's average weekly net assets attributable to common shares and 0.0025% on the Fund's average weekly net assets attributable to common shares above $1 billion, plus certain out of pocket expenses. For the purpose of calculating such fee, the Fund's average weekly net assets attributable to common shares will be deemed to be the average weekly value of the Fund's total assets minus the sum of the Fund's liabilities, and accumulated dividends, if any, on Preferred Stock. For this calculation, the Fund's liabilities are deemed to INCLUDE the aggregate liquidation preference of any outstanding Fund preferred shares. 22 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) ----------------------------------------- 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 paid PFPC Trust a monthly fee at the annual rate of 0.01% of the Fund's average monthly total net assets available to Common and Preferred Stock through October 31, 2003. Effective November 1, 2003, the fee structure changed to a monthly fee at an annual rate of 0.010% on the first $200 million of the Fund's average weekly total managed assets, 0.008% on the next $300 million of the Fund's average weekly total managed assets, 0.006% on the next $500 million of the Fund's average weekly total managed assets and 0.005% on the Fund's average weekly total managed assets above $1 billion. 4. PURCHASES AND SALES OF SECURITIES Cost of purchases and proceeds from sales of securities for the year ended November 30, 2003, excluding short-term investments, aggregated $68,428,170 and $62,098,646, respectively. At November 30, 2003, aggregate gross unrealized appreciation for all securities in which there is an excess of value over tax cost was $27,672,886 and aggregate gross unrealized depreciation for all securities in which there is an excess of tax cost over value was $7,635,274. 5. COMMON STOCK At November 30, 2003, 240,000,000 shares of $0.01 par value Common Stock were authorized. Common Stock transactions, excluding costs arising from additional MMPsTM issuance in June 2002 (See Note 6), were as follows: YEAR ENDED YEAR ENDED 11/30/03 11/30/02 ---------- ---------- SHARES AMOUNT SHARES AMOUNT ------ ------ ------ ------ Issued as reinvestment of dividends under the Dividend Reinvestment and Cash Purchase Plan 120,171 $1,830,875 135,557 $1,963,583 ------- ---------- ------- ---------- 6. MONEY MARKET CUMULATIVE PREFERRED(TRADE MARK) STOCK (MMP(TRADE MARK)) The Fund's Articles of Incorporation authorize the issuance of up to 10,000,000 shares of $0.01 par value preferred stock. The Money Market Cumulative Preferred(TRADE MARK) Stock 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 MMP(TRADE MARK) Stock are cumulative. The Fund is required to meet certain asset coverage tests with respect to the MMP(TRADE MARK) Stock. 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, MMP(TRADE MARK) Stock 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, 23 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) - ----------------------------------------- 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. Under Emerging Issues Task Force (EITF) promulgation Topic D-98, Classification and Measurement of Redeemable Securities, which was issued on July 19, 2001, preferred securities that are redeemable for cash or other assets are to be classified outside of permanent equity to the extent that the redemption is at a fixed or determinable price and at the option of the holder or upon the occurrence of an event that is not solely within the control of the issuer. Subject to the guidance of the EITF, the Fund's MMP(TRADE MARK) Stock, which was previously classified as a component of total net assets, has been reclassified outside of permanent equity (net assets available to common stock) in the accompanying financial statements. Prior year amounts have also been reclassified to conform with this presentation. The impact of this reclassification creates no change to the net assets available to Common Stock Shareholders. If the Fund allocates any net gains or income ineligible for the Dividends Received Deduction to shares of the MMP(TRADE MARK) Stock, the Fund is required to make additional distributions to MMP(TRADE MARK) Stock 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. Net assets available to MMP(TRADE MARK) Stock at November 30, 2003 included an accrued additional distribution of $57,259. The amount subsequently calculated and then paid to the MMP(TRADE MARK) Stock Shareholders for the fiscal year ended November 30, 2003 was $65,064.(See Note 11-- "Subsequent Events.") Estimates of additional distributions payable to MMP(TRADE MARK) Stock are accrued on a regular basis in advance of declaration by the Board of Directors. The amount of additional distributions payable for any year may be highly uncertain and will not be known until after a fiscal year has been completed. An auction of the MMP(TRADE MARK) Stock is generally held every 49 days. Existing shareholders may submit an order to hold, bid or sell such shares at par value on each auction date. MMP(TRADE MARK) Stock Shareholders may also trade shares in the secondary market between auction dates. On June 4, 2002, the Fund issued 225 shares of additional MMPTM Stock with an initial dividend rate equal to 2.04%. These newly issued shares are identical to the previously outstanding 575 shares in all respects on and after their first auction date, which was June 5, 2002. Consequently, the Fund now has 800 shares of MMPTM Stock outstanding in one series, which represents a par value of $80 million. The newly issued shares were underwritten by Lehman Brothers. The underwriter's discount of 1.25% of the $22.5 million face value totaled $281,250 and was immediately charged to common equity capital upon completion of the offering. Costs of the issue, including legal, printing, registration, rating fees, etc. of $219,027 were charged against common equity capital. The sum of underwriters discount and cost of the issue totaled $500,277. 24 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) ----------------------------------------- At November 30, 2003, 800 shares of MMP(TRADE MARK) Stock were outstanding at the annual rate of 1.19%. The dividend rate, as set by the auction process, is generally expected to vary with short-term interest rates. 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 traditional DRD-eligible preferred securities (i.e., adjustable and fixed rate preferred and preference stocks) and similar hybrid, i.e., 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 least 25% of its assets, in securities issued by utilities and at least 25% of its 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 risks could adversely affect the ability and inclination of companies in these industries to declare and pay dividends or interest and the ability of holders of securities of such companies to realize any value from the assets of the issuer upon liquidation or bankruptcy. 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 judged to be comparable in quality, in either 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 percentage limitation was raised from 15% by the Fund's Board of Directors at its regular board meeting on April 19, 2002. 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, such as TOPrS, TIPS, QUIPS, MIPS, QUIDS, QUICS, QIB's, STOPS, CorTS, REIT, Capital Securities, and other similar or related investments, will be subject to the foregoing 20% limitation to the extent that, in the opinion of the Fund's Investment 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. 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 25 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund NOTES TO FINANCIAL STATEMENTS (CONTINUED) - ----------------------------------------- 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 fundamental investment policies, involving any or all of the following: lending of portfolio securities, short sales of securities, futures contracts, interest rate swaps, options on futures contracts, options on securities and swaptions. As in the case of when-issued securities, the use of over-the-counter derivatives, such as interest rate swaps and swaptions, may expose the Fund to greater credit, operations, and market value risk than is the case with regulated, exchange traded futures and options. With the exception of purchasing securities on a when-issued or delayed delivery basis or lending portfolio securities, these transactions are used for hedging or other appropriate risk-management purposes or, under certain other circumstances, to increase income. As of November 30, 2003, the Fund owned put options on U.S. Treasury bond futures contracts. 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. 26 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders Flaherty & Crumrine Preferred Income Fund Incorporated: We have audited the accompanying statement of assets and liabilities of Flaherty & Crumrine Preferred Income Fund Incorporated (formerly, Preferred Income Fund Incorporated), including the fund's portfolio of investments, as of November 30, 2003, and the related statement of operations for the year then ended, statement of changes in net assets for each of the years in the two-year period then ended and financial highlights for each of the years in the three-year period then ended. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform our 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, 2003 by correspondence with the custodian and brokers. 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 Fund Incorporated as of November 30, 2003, the results of its operations for the year then ended, changes in its net assets for each of the years in the two-year period then ended and financial highlights for each of the years in the three-year period then ended in conformity with accounting principles generally accepted in the United States of America. /S/ KPMG LLP Boston, Massachusetts January 16, 2004 27 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund SUPPLEMENTARY TAX INFORMATION (UNAUDITED) - ----------------------------------------- For Fiscal 2003, the distributions attributable both to Common Stock and MMP(TRADE MARK) are characterized as follows for purposes of Federal income taxes: for individual investors, 80.56% consisted of Qualified Dividend Income ("QDI") eligible for the maximum 15% personal tax rate while 19.44% consisted of ordinary income taxable at regular personal tax rates. For corporate investors, 80.21% consisted of income eligible for the inter-corporate Dividends Received Deduction ("DRD") while 19.79% consisted of ordinary income taxable at regular corporate rates. For Calendar 2003, the distributions to Common Stock are characterized as follows for purposes of Federal income taxes: for individual investors, 79.82% consisted of Qualified Dividend Income ("QDI") eligible for the maximum 15% personal tax rate while 20.18% consisted of ordinary income taxable at regular personal tax rates. For corporate investors, 79.46% consisted of income eligible for the inter-corporate Dividends Received Deduction ("DRD") while 20.54% consisted of ordinary income taxable at regular corporate rates. 28 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund 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 own name will have all distributions reinvested automatically by PFPC Inc. 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, PFPC Inc. will buy shares of the Fund's Common Stock in the open market, on the New York Stock Exchange 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 PFPC Inc. 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, PFPC Inc. 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 PFPC Inc.'s open market purchases in connection with the reinvestment of dividends or capital gains distributions. For the period ended November 30, 2003, $628 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 29 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund ADDITIONAL INFORMATION (UNAUDITED) (CONTINUED) - ---------------------------------------------- dividend payment date, a dividend or distribution in an amount equal to the cash that the participant could have received instead of shares. 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 PFPC Inc. 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 PFPC Inc. in writing, by completing the form on the back of the Plan account statement and forwarding it to PFPC Inc. or by calling PFPC Inc. directly. A termination will be effective immediately if notice is received by PFPC Inc. 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, PFPC Inc. 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 PFPC Inc. at 1-800-331-1710. PROXY VOTING POLICIES 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, (ii) on the Fund's website at www.preferredincome.com and (iii) on the Securities and Exchange Commission's website at www.sec.gov. 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, Stimes, 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 beginning on page 31. SUBSEQUENT EVENTS As a result of the income realized by the Fund that did not qualify for the inter-corporate Dividends Received Deduction ("DRD"), a portion of the distributions paid to the Fund's Money Market Cumulative Preferred(TRADE MARK) Stock shareholders from January 1, 2003 through November 30, 2003 has been designated as being non-DRD income, as required by Internal Revenue Services Ruling 89-81, with respect to the Internal Revenue Code of 1986, as amended. On December 22, 2003, the Fund declared an additional distribution of $65,064, payable December 24, 2003, to Money Market Cumulative Preferred(TRADE MARK) Stock shareholders as required by the Fund's Articles Supplementary (See Note 6.) 30 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund 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: - --------- MARTIN BRODY Director Class II Director Retired 4 Director, Jaclyn, Inc. c/o HMK Associates since 1991 (luggage and 30 Columbia Turnpike accessories). Director Florham Park, NJ 07932 Emeritus, Smith Barney Age: 82 Mutual Funds (18 Funds). Flaherty & Crumrine Preferred Income Fund, Flaherty & Crumrine Preferred Income Opportunity Fund and Flaherty & Crumrine Claymore/ Preferred Securities Income Fund. DAVID GALE Director Class I Director President & CEO of 4 Director, Golden Delta Dividend Group, Inc. since 1997 Delta Dividend Group, State Vintners, Inc. 220 Montgomery Street Inc. (investments). (wine pressing). Suite 426 Flaherty &Crumrine San Francisco, CA 94104 Preferred Income Fund, Age: 54 Flaherty &Crumrine Preferred Income Opportunity Fund and Flaherty &Crumrine Claymore/Preferred Securities Income Fund. - ------------------------------- * 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 initial term for each class expires as follows: CLASS I DIRECTORS - three year term expires at the Fund's 2005 Annual Meeting of Shareholders; directors may continue in office until their successors are duly elected and qualified. CLASS II DIRECTORS - three year term expires at the Fund's 2006 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 2004 Annual Meeting of Shareholders; directors may continue in office until their successors are duly elected and qualified.
31 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund 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: - --------- MORGAN GUST+ Director Class III Director From March 2002, 4 Flaherty &Crumrine Giant Industries, Inc. since 1991 President of Giant Preferred Income Fund, 23733 N. Scottsdale Road Industries, Inc.(petroleum Flaherty &Crumrine Scottsdale, AZ 85255 refining and marketing); Preferred Income Age: 56 and for more than five Opportunity Fund and years prior thereto, Flaherty &Crumrine Executive Vice President, Claymore/Preferred and various other Vice Securities Income Fund. President positions at Giant Industries, Inc. ROBERT F. WULF Director Class II Director Financial Consultant; 4 Flaherty &Crumrine 3560 Deerfield Drive South since 1991 Trustee, University of Preferred Income Fund, Salem, OR 97302 Oregon Foundation; Flaherty &Crumrine Age: 66 Trustee, San Francisco Preferred Income Theological Seminary. Opportunity Fund and Flaherty &Crumrine Claymore/Preferred Securities Income Fund. - ------------------------------- * 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 initial term for each class expires as follows: CLASS I DIRECTORS - three year term expires at the Fund's 2005 Annual Meeting of Shareholders; directors may continue in office until their successors are duly elected and qualified. CLASS II DIRECTORS - three year term expires at the Fund's 2006 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 2004 Annual Meeting of Shareholders; directors may continue in office until their successors are duly elected and qualified. + As a Director, represents holders of shares of the Fund's Money Market Cumulative Preferred(TM) Stock.
32 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund 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 - ------------- -------------- ------------ ---------- -------------- ------------------- INTERESTED DIRECTORS: - --------- DONALD F. CRUMRINE+, ++ Director, Class II Director Chairman of the Board, 4 Flaherty & Crumrine 301 E. Colorado Boulevard Chairman since 1991 Director of Flaherty & Preferred Income Suite 720 of the Board Crumrine. Opportunity Fund, Pasadena, CA 91101 and Chief Flaherty & Crumrine/ Age: 56 Executive Officer Claymore Preferred Securities Income Fund and Flaherty & Crumrine/ Claymore Total Return Fund. ROBERT M. ETTINGER++ Director, Class III Director President and Director of 2 Flaherty & Crumrine 301 E. Colorado Boulevard President since 2002 Flaherty & Crumrine. Preferred Income Suite 720 Opportunity Fund. Pasadena, CA 91101 Age: 45 OFFICERS: - --------- PETER C. STIMES Chief Financial Since Vice President of -- -- 301 E. Colorado Boulevard Officer, 1991 Flaherty & Crumrine Suite 720 Chief Accounting Incorporated. Pasadena, CA 91101 Officer, Vice President, Age: 48 Treasurer, and Assistant Secretary - ------------------------------- * 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 initial term for each class expires as follows: CLASS I DIRECTORS - three year term expires at the Fund's 2005 Annual Meeting of Shareholders; directors may continue in office until their successors are duly elected and qualified. CLASS II DIRECTORS - three year term expires at the Fund's 2006 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 2004 Annual Meeting of Shareholders; directors may continue in office until their successors are duly elected and qualified. + As a Director, represents holders of shares of the Fund's Money Market Cumulative Preferred(TM) Stock. ++ "Interested person" of the Fund as defined in the Investment Company Act of 1940. Messrs. Crumrine and Ettinger are each considered an "interested person" because of their affiliation with Flaherty & Crumrine Incorporated which acts as the Fund's investment adviser.
33 - -------------------------------------------------------------------------------- Flaherty & Crumrine Preferred Income Fund 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 - ------------- -------------- ------------ ---------- -------------- ------------------- OFFICERS: - --------- BRADFORD S. STONE Vice President Since Since May 2003, Vice -- -- 392 Springfield Avenue and Assistant July 2003 President of Flaherty & Mezzanine Suite Treasurer Crumrine; from June Summit, NJ 07901 2001 to April 2003, Age: 44 Director of US Market Strategy at Barclays Capital; from February 1987 to June 2001, Vice President of Goldman, Sachs & Company as Director of US Interest Rate Strategy and, previously, Vice President of Interest Rate Product Sales. R. ERIC CHADWICK Vice President, Since Since August 2001, -- -- 301 E.Colorado Boulevard Secretary and October 2002 Vice President of Suite 720 Assistant Flaherty & Crumrine Pasadena, CA 91101 Treasurer Incorporated; from Age: 28 January 1997 through November 1998, portfolio manager of Koch Industries, Inc.
34 [This page intentionally left blank] DIRECTORS Martin Brody Donald F. Crumrine, CFA Robert M. Ettinger, CFA David Gale Morgan Gust Robert F. Wulf, CFA OFFICERS Donald F. Crumrine, CFA Chairman of the Board and Chief Executive Officer Robert M. Ettinger, CFA President Peter C. Stimes, CFA Chief Financial Officer, Chief Accounting Officer, Vice President, Treasurer, and Assistant Secretary Bradford S. Stone Vice President and Assistant Treasurer R. Eric Chadwick, CFA Vice President, Secretary and Assistant Treasurer INVESTMENT ADVISER Flaherty & Crumrine Incorporated e-mail: flaherty@fin-mail.com QUESTIONS CONCERNING YOUR SHARES OF FLAHERTY & CRUMRINE PREFERRED INCOME FUND? 0 If your shares are held in a brokerage Account, contact your broker. 0 If you have physical possession of your shares in certificate form, contact the Fund's Transfer Agent & Shareholder Servicing Agent -- PFPC Inc. P.O. Box 43027 Providence, RI 02940-3027 1-800-331-1710 THIS REPORT IS SENT TO SHAREHOLDERS OF FLAHERTY & CRUMRINE PREFERRED INCOME FUND 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. [LOGO OMITTED] FLAHERTY & CRUMRINE PREFERRED INCOME FUND ANNUAL REPORT NOVEMBER 30, 2003 web site: 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. (b) 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. (c) 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 and Robert F. Wulf are each qualified to serve as an audit committee financial expert serving on its audit committee and that they both are "independent," as defined by the Securities and Exchange Commission. ITEM 4. PRINCIPAL ACCOUNTANT FEES AND SERVICES. Not applicable. ITEM 5. AUDIT COMMITTEE OF LISTED REGISTRANTS. Not applicable. ITEM 6. [RESERVED] ITEM 7. DISCLOSURE OF PROXY VOTING POLICIES AND PROCEDURES FOR CLOSED-END MANAGEMENT INVESTMENT COMPANIES. FLAHERTY & CRUMRINE INCORPORATED (THE "ADVISER") POLICIES AND PROCEDURES FOR VOTING PROXIES FOR CLIENTS (The definition of clients includes Flaherty & Crumrine Preferred Income Fund Incorporated, Flaherty & Crumrine Preferred Income Opportunity Fund Incorporated, Flaherty & Crumrine/Claymore Preferred Securities Income Fund Incorporated, and Flaherty & Crumrine/Claymore Total Return Fund Incorporated - collectively, the "Funds") PURPOSE ------- These Policies and Procedures are designed to satisfy the Adviser'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 the Adviser'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 the Adviser exercises proxy authority. This document is available to any client or Fund shareholder upon request and the Adviser will make available to such clients and Fund shareholders the record of the Adviser's votes promptly upon request and to the extent required by Federal law and regulations.1 FUNDAMENTAL STANDARD -------------------- The Adviser will be guided by the principle that, in those cases where it has discretion, it is bound to vote proxies and take such other corporate actions consistent with the interest of its clients with regard to the objective of wealth maximization. GENERAL ------- The Adviser 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 the Adviser 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., the - -------- 1 This will include Fund web site reporting of proxy votes on Form N-PX no later than 8/31/2004 for the twelve month period ended 6/30/2004. Adviser 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 of an issuer. Where the Adviser does not have authority, it will keep appropriate written records evidencing that such discretionary authority has not been granted. The Adviser 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, the Adviser will keep appropriate written records in its files or in reasonably accessible storage. Similarly, the Adviser will keep in its files, or reasonably accessible storage, work papers and other materials that were significant to the Adviser in making a decision how to vote. For purposes of decision making, the Adviser 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 the Adviser 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 the Adviser has determined the matter in question to be beneficial while, at the same time, voting "against" for those securities or classes where the Adviser 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. The Adviser 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. The Adviser 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, the Adviser 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, the Adviser 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, the Adviser 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 the Adviser'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 ------------------------------ The Adviser 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, the Adviser 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, the Adviser, 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, the Adviser will attempt, wherever possible, to quantify 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"), the Adviser 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. The Adviser will vote on a case-by-case basis, reflecting the principles set forth elsewhere in this document. However, in those instances where the common shares of an issuer are held by a holding company and where, because of that, the election outcome is not in doubt, the Adviser 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 the Adviser and the Adviser's clients may arise when the Adviser's relationships with an issuer or with a related third party conflict or appear to conflict with the best interests of the Adviser's clients. The Adviser will indicate in its voting records available to clients whether or not a material conflict exists or appears to exist. In addition, the Adviser will communicate with the client (which shall mean the independent Directors or Director(s) they may so designate in the case of the Funds) in instances when a material conflict of interest may be apparent. The Adviser shall describe the conflict to the client and state the Adviser's voting recommendation and the basis therefore. 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), the Adviser shall vote in accordance with the recommendation it had made to the client. In all such instances, the Adviser 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 the Adviser but will not become effective, in the case of the Funds, unless they are approved by majority vote of the non-interested Directors of the Funds. Any such modifications will be made to the Adviser's clients by mail and/or other electronic means in a timely manner. These Policies and Procedures, and any amendments thereto, will be posted on the Funds' webs sites and will be disclosed in reports to shareholders as required by law. Dated: 7/24/2003 ITEM 8. PURCHASES OF EQUITY SECURITIES BY CLOSED-END MANAGEMENT INVESTMENT COMPANY AND AFFILIATED PURCHASERS. Not applicable. ITEM 9. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Not applicable. ITEM 10. 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 last fiscal half-year (the registrant's second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. ITEM 11. 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 Section 302 of the Sarbanes-Oxley Act of 2002 are attached hereto. (a)(3) Not applicable. (b) Certifications pursuant to 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 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 JANUARY 29, 2004 ---------------------------------------------------------------------------- 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 JANUARY 29, 2004 ---------------------------------------------------------------------------- By (Signature and Title)* /S/PETER C. STIMES -------------------------------------------------------- Peter C. Stimes, Chief Financial and Accounting Officer, Vice President, Treasurer & Assistant Secretary (principal financial officer) Date JANUARY 29, 2004 ---------------------------------------------------------------------------- * Print the name and title of each signing officer under his or her signature. EX-99.CODE ETH 3 code.txt CODE OF ETHICS FLAHERTY & CRUMRINE PREFERRED INCOME FUND INCORPORATED CODE OF ETHICS FOR SENIOR FINANCIAL OFFICERS I. Introduction This Code has been written and adopted in conformity with Section 406 of the Sarbanes-Oxley Act of 2002 as implemented by SEC rules and regulations. This Code sets forth principles and establishes rules of conduct for Senior Officers (as defined below) of the Flaherty & Crumrine Preferred Income Fund Incorporated. This Code supplements other Codes that the Fund or its Investment Adviser has adopted or may adopt in connection with other matters. II. General Principles It is the ethical and legal obligation of the Fund's Senior Officers to strive to insure the full, fair, timely, and comprehensible financial disclosure to shareholders, regulatory authorities, and the general public. It is also the obligation of the Fund's Senior Officers to establish and/or maintain adequate internal control safeguards for the purposes of (1) utilizing the Fund's financial resources in the manner authorized by the Fund's Board of Directors and permitted by applicable law and (2) laying the foundation for proper financial accounting. It is the obligation of the Fund's Senior Officers to avoid improper conflicts of interest. As a guiding principle, a Senior Officer is expected to act in a manner that he would wish another to act towards him if the roles were reversed. III. Applicability For purposes of this Code, a Senior Officer of the Fund means either the Chief Executive Officer or the Chief Financial Officer or such other officer performing the tasks of such officers in an official capacity. IV. Compliance with Applicable Law and Regulations A Senior Officer shall maintain working knowledge of and comply with all applicable laws, rules, and regulations of any government, government agency, regulatory organization and licensing agencies governing matters of internal controls and financial statement disclosure. A Senior Officer will not knowingly participate or assist in any violation of such laws, rules, or regulations. V. Financial Disclosure Procedures The following procedures and rules are to apply in all manners regarding financial disclosure. Financial disclosure includes, without limitation, regular periodic reports to shareholders (e.g., Annual, Semi-Annual, and Quarterly Reports), press releases, reports to regulatory authorities or securities exchanges, reports to taxing authorities, web pages, information released to statistical subscriber services, etc. A Senior Officer will not knowingly misstate a material fact nor will such Officer fail to state a fact that is material under the circumstances. A Senior Officer will use his best efforts to seek to assure that financial disclosure is clear and comprehensible. In manners regarding financial disclosure, a Senior Officer will avoid selectively disclosing information, except to service providers of the Fund and applicable regulatory authorities that are expected to maintain confidentiality in accordance with ethical business practice. A Senior Officer will make every reasonable effort to make sure that financial disclosure is made in a timely manner. A Senior Officer will provide and/or cause to be provided full cooperation with financial auditors and/or other regulatory/criminal investigators. A Senior Officer will maintain familiarity with such basic principles of GAAP, AICPA standards, FASB pronouncements, etc., as are necessary to carrying out the obligation of fair and full financial accounting disclosure. VI. Internal Control Procedures A Senior Officer will maintain working knowledge of the Fund's foundational governance documents, key contracts, and actions/resolutions of its Board of Directors and Board Committees. A Senior Officer will make every reasonable effort to insure that the terms of the Fund governance documents, key contracts, and actions of the Board and its Committees are faithfully carried out. A Senior Officer will make every reasonable effort to insure, including the establishment of procedures as may be necessary, the proper authorization of securities transactions and the compliance with requisite investment guidelines and requirements. A Senior Officer will make every reasonable effort to insure, including the establishment of procedures as may be necessary, that payments for investments, expenses, shareholder distributions, and other purposes have been properly made. This may include the designation of certain persons as authorized agents. A Senior Officer will review the operations of the Fund and review the adequacy of internal controls through the mechanism of the Fund's Disclosure and Internal Controls Committee and such Committee's Procedures. VII. Actual and Apparent Conflicts of Interest A "conflict of interest" occurs when a Senior Officer's private interest interferes with the interests of, or his service to, the Fund. Certain conflicts of interest arise out of relationships between Senior Officers and the Fund and already are subject to conflict of interest provisions in the Investment Company Act of 1940 (the "Investment Company Act") and the Investment Advisers Act of 1940 (the "Investment Advisers Act"). The Fund's and the investment adviser's compliance programs and procedures are designed to prevent, identify and correct, violations of these provisions. This Code does not, and is not intended to, repeat or replace these programs and procedures, and such conflicts fall outside the parameter of this Code. Although typically not presenting an opportunity for improper personal benefit, conflicts arise from, or as a result of, the contractual relationship between the Fund and the investment adviser of which the Senior Officers are also officers or employees. As a result, this Code recognizes that the Senior Officers will, in the normal course of their duties (whether formally for the Fund or for the adviser, or for both), be involved in establishing policies and implementing decisions that will have different effects on the adviser and the Fund. The participation of the Senior Officers in such activities is inherent in the contractual relationship between the Fund and the adviser and is consistent with the performance by the Senior Officers of their duties as officers of the Fund. Thus, if performed in conformity with the provisions of the Investment Company Act and the Investment Advisers Act, such activities will be deemed to have been handled ethically. In addition, it is recognized by the Fund's Board of Directors that the Senior Officers may also be officers or employees of one or more other investment companies covered by this or other codes. Other conflicts of interest are covered by this Code, even if such conflicts of interest are not subject to the provisions in the Investment Company Act and the Investment Advisers Act. The overarching principle is that the personal interest of a Senior Officer should not be placed improperly before the interest of the Fund. A Senior Officer must: (1) not use his personal influence or personal relationships improperly to influence investment decisions or financial reporting by the Fund whereby the Senior Officer would benefit personally to the detriment of the Fund; (2) not cause the Fund to take action, or to refrain from taking action, for the individual personal benefit of the Senior Officer rather than for the benefit of the Fund; (3) not use material non-public knowledge of portfolio transactions made or contemplated by the Fund to trade personally or cause others to trade personally in contemplation of the market effect of such transactions. VIII. Supervision A Senior Officer will exercise appropriate supervision over employees, officers, and other service providers to seek to insure that the foregoing procedures are followed. IX. Standard of Care A Senior Officer will exercise reasonable care in the carrying out of all duties under this Code and as an officer of the Fund. X. Reporting and Accountability A Senior Officer must promptly notify the President of the Fund, or a Vice President he may designate, promptly if he knows of any violation of this Code. Failure to do so is itself a violation of this Code. The President of the Fund, or a Vice President he may designate, is responsible for applying this Code to specific situations in which questions are presented under it and has the authority to interpret this Code in any particular situation. The Fund will follow these procedures in investigating and enforcing this Code: (1) the President, or a Vice President he may designate, will take all appropriate action to investigate any potential violations reported to him; (2) if, after such investigation, the President or Vice President believes that no violation has occurred, no further action is required; (3) any matter that the President or Vice President believes is a violation will be reported to the Audit Committee; (4) if the Audit Committee concurs that a violation has occurred, it will inform the Board, which will consider appropriate action, which may include review of, and appropriate modifications to, applicable policies and procedures, notification of appropriate personnel of the investment adviser or its board, or a recommendation to dismiss the Senior Officer. The Board will be responsible for granting waivers, as appropriate, such waiver also requiring a majority vote of the independent directors. However, any changes to or waivers of this Code will, to the extent required, be disclosed as provided by rules of the SEC. XI. XII. Consequences of Failure to Comply with this Code In the event that a Senior Officer has not complied with any provision of this Code, the Audit Committee shall refer the matter to the Fund's Board of Directors. The Board may impose appropriate sanctions including, among other things, censure and suspension or termination of such person's officership. XIII. XIV. Other Policies and Procedures This Code shall be the sole code of ethics adopted by the Fund for purposes of Section 406 of the Sarbanes-Oxley Act and the rules and forms applicable to registered investment companies thereunder. Insofar as other policies or procedures of the Fund, the Fund's Investment Adviser or other service providers govern or purport to govern the behavior or activities of the Senior Officers who are subject to this Code, they are superseded by this Code to the extent that they overlap or conflict with the provisions of this Code. The Fund's and its Investment Adviser's codes of ethics under Rule 17J-1 under the Investment Company Act and the Investment Adviser's other compliance and control policies and procedures are separate requirements applying to the Senior Officers and others, and are not part of this Code. XV. XVI. Acknowledgment Upon the adoption of this Code and annually thereafter and upon the appointment of any individual to a position as a Senior Officer, he or she is required to sign the affirmation set forth on Exhibit A. XVII. Annual Review and Amendments This Code of Ethics shall be reviewed and approved by the Fund's Board of Directors no less frequently than annually. The Directors may at any time make such amendments as they deem necessary or appropriate to effectuate the purposes of this Code. Such amendments require a majority vote of the Board of Directors and a majority vote of the non-interested Directors. XVIII. Internal Use This Code is intended solely for the internal use of the Fund and does not constitute an admission, by or on behalf of the Fund, as to any fact, circumstance, or legal conclusion. Adopted by the Flaherty & Crumrine Preferred Income Fund Incorporated Board of Directors at its Meeting of July 18, 2003 EXHIBIT A XIX. Affirmation I have read this Code of Ethics for Senior Officers. I further confirm that I am a Senior Officer as defined therein and have complied with the requirements of this Code. - --------------------- ----------------------------- ------------ NAME TITLE DATE EX-99.CERT 4 threecert.txt 302 CERTIFICATION CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT I, Donald F. Crumrine, certify that: 1. I have reviewed this report on Form N-CSR of Flaherty & Crumrine Preferred Income Fund Incorporated; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [Omitted] (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal half-year (the registrant's second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: JANUARY 29, 2004 /S/DONALD F. CRUMRINE ------------------------ --------------------------------------------- Donald F. Crumrine, Director, Chairman of the Board and Chief Executive Officer (principal executive officer) CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT I, Peter C. Stimes, certify that: 1. I have reviewed this report on Form N-CSR of Flaherty & Crumrine Preferred Income Fund Incorporated; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations, changes in net assets, and cash flows (if the financial statements are required to include a statement of cash flows) of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [Omitted] (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of a date within 90 days prior to the filing date of this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal half-year (the registrant's second fiscal half-year in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize, and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: JANUARY 29, 2004 /S/PETER C. STIMES ------------------------ ----------------------------------------------- Peter C. Stimes, Chief Financial and Accounting Officer, Vice President, Treasurer & Assistant Secretary (principal financial officer) EX-99.906 5 ninecert.txt 906 CERTIFICATION CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT I, Donald F. Crumrine, Director, Chairman of the Board and Chief Executive Officer of Flaherty & Crumrine Preferred Income Fund Incorporated (the "Registrant"), certify that: 1. The Form N-CSR of the Registrant (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: JANUARY 29, 2004 /S/DONALD F. CRUMRINE ----------------------- ---------------------------------------------- Donald F. Crumrine, Director, Chairman of the Board and Chief Executive Officer (principal executive officer) I, Peter C. Stimes, Chief Financial and Accounting Officer, Vice President, Treasurer & Assistant Secretary of Flaherty & Crumrine Preferred Income Fund Incorporated (the "Registrant"), certify that: 1. The Form N-CSR of the Registrant (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant. Date: JANUARY 29, 2004 /S/PETER C. STIMES ------------------------ ----------------------------------------------- Peter C. Stimes, Chief Financial and Accounting Officer, Vice President, Treasurer & Assistant Secretary (principal financial officer) -----END PRIVACY-ENHANCED MESSAGE-----