High Income Opportunity Fund Inc. (“Fund”) was incorporated in Maryland and is registered as a diversified, closed-end management investment company under the Investment Company Act of 1940 (“1940 Act”), as amended.
The following are significant accounting policies consistently followed by the Fund and are in conformity with U.S. generally accepted accounting principles (“GAAP”). Estimates and assumptions are required to be made regarding assets, liabilities and changes in net assets resulting from operations when financial statements are prepared. Changes in the economic environment, financial markets and any other parameters used in determining these estimates could cause actual results to differ.
Notes to Financial Statements (continued)
compliance by the borrower with the terms of the loan agreement relating to the loan, nor any rights of set-off against the borrower and the Fund may not benefit directly from any collateral supporting the loan in which it has purchased the participation.
The Fund will assume the credit risk of both the borrower, the lender that is selling the participation and any other persons interpositioned between the Fund and borrower. In the event of the insolvency of the lender selling the participation, the Fund may be treated as a general creditor of the lender and may not benefit from any set-off between the lender and the borrower.
(e) Foreign Currency Translation. Investment securities and other assets and liabilities denominated in foreign currencies are translated into U.S. dollar amounts based upon prevailing exchange rates on the date of valuation. Purchases and sales of investment securities and income and expense items denominated in foreign currencies are translated into U.S. dollar amounts based upon prevailing exchange rates on the respective dates of such transactions.
The Fund does not isolate that portion of the results of operations resulting from changes in foreign exchange rates on investments from the fluctuations arising from changes in market prices of securities held. Such fluctuations are included with the net realized and unrealized gain or loss on investments.
Net realized foreign exchange gains or losses arise from sales of foreign currencies, including gains and losses on forward foreign currency contracts, currency gains or losses realized between the trade and settlement dates on securities transactions and the difference between the amounts of dividends, interest and foreign withholding taxes recorded on the Fund’s books and the U.S. dollar equivalent of the amounts actually received or paid. Net unrealized foreign exchange gains and losses arise from changes in the fair values of assets and liabilities, other than investments in securities, at the date of valuation, resulting from changes in exchange rates.
Foreign security and currency transactions may involve certain considerations and risks not typically associated with those of U.S. dollar denominated transactions as a result of, among other factors, the possibility of lower levels of governmental supervision and regulation of foreign securities markets and the possibility of political or economic instability.
(f) Credit and Market Risk. The Fund invests in high-yield instruments that are subject to certain credit and market risks. The yields of high-yield obligations reflect, among other things, perceived credit risk. The Fund’s investment in securities rated below investment grade typically involve risks not associated with higher rated securities including, among others, greater risk related to timely and ultimate payment of interest and principal, greater market price volatility and less liquid secondary market trading.
(g) Distributions to Shareholders. Distributions from net investment income for the Fund, if any, are declared and paid on a monthly basis. Distributions of net realized gains, if any, are declared at least annually. Distributions are recorded on the ex-dividend date and are determined in accordance with income tax regulations, which may differ from GAAP.
30 | High Income Opportunity Fund Inc. 2005 Annual Report |
Notes to Financial Statements (continued)
(h) Federal and Other Taxes. It is the Fund’s policy to comply with the federal income and excise tax requirements of the Internal Revenue Code of 1986, as amended, applicable to regulated investment companies. Accordingly, the Fund intends to distribute substantially all of its taxable income and net realized gains on investments, if any, to shareholders each year. Therefore, no federal income tax provision is required in the Fund’s financial statements.
(i) Reclassification. GAAP requires that certain components of net assets be adjusted to reflect permanent differences between financial and tax reporting. These reclassifications have no effect on net assets or net asset values per share. During the current year, the following reclassifications have been made:
| | Overdistributed Net
Investment Income | | Accumulated Net
Realized Loss | |
(a) | | | $1,643,609 | | | $(1,643,609) | |
| | | | | | | |
(a) | Reclassifications are primarily due to foreign currency transactions treated as ordinary income for tax purposes, differences between book and tax amortization of premium on fixed income securities, income from mortgage backed securities treated as capital gains for tax purposes and book/tax differences in the treatment of consent fees. |
2. Management Agreement and Other Transactions with Affiliates
Smith Barney Fund Management LLC (“SBFM”), an indirect wholly-owned subsidiary of Citigroup Inc. (“Citigroup”), acts as investment manager of the Fund. The Fund pays SBFM a management fee calculated at an annual rate of 1.15% of the Fund’s average daily net assets. This fee is calculated daily and paid monthly.
Effective October 1, 2005, the management fee will be reduced to an annual rate of 0.80% of the Fund’s average daily net assets. This fee will be calculated daily and paid monthly.
The Fund has adopted an unfunded, non-qualified compensation plan (the “Plan”) which allows non-interested directors (“Director”) to defer the receipt of all or a portion of the directors’ fees earned until a later date specified by the Director. The deferred fees earn a return based on notional investments selected by the Director. The balance of the deferred fees payable may change depending upon the investment performance. Any gains earned or losses incurred in the deferred balances are reported in the statement of operations under Directors’ fees. Under the Plan, deferred fees are considered a general obligation of the Fund and any payments made pursuant to the Plan will be made from the Fund’s general assets.
As of September 30, 2005, the Fund has accrued $18,503 as deferred compensation payable.
During the year ended September 30, 2005, SBFM reimbursed the Fund in the amount of $227,500 for losses incurred resulting from an investment transaction error.
All officers and one Director of the Fund are employees of Citigroup or its affiliates and do not receive compensation from the Fund.
High Income Opportunity Fund Inc. 2005 Annual Report | 31 |
Notes to Financial Statements (continued)
3. Investments
During the year ended September 30, 2005, the aggregate cost of purchases and proceeds from sales of investments (excluding short-term investments) were as follows:
Purchases | | $ | 109,460,221 | |
Sales | | | 120,557,069 | |
At September 30, 2005, the aggregate gross unrealized appreciation and depreciation of investments for federal income tax purposes were as follows:
Gross unrealized appreciation | | $ | 42,377,375 | |
Gross unrealized depreciation | | | (31,379,078 | ) |
Net unrealized appreciation | | $ | 10,998,297 | |
4. Capital Shares
Capital stock transactions were as follows:
| | Year Ended
September 30, 2005 | | Year Ended
September 30, 2004 | |
| | Shares | | Amount | | Shares | | Amount | |
Shares issued on reinvestment | | — | | — | | 82,419 | | $586,748 | |
5. Income Tax Information and Distributions to Shareholders
Subsequent to the fiscal year end, the Fund has made the following distributions:
Record Date | | Payable Date | | | |
10/25/2005 | | 10/28/2005 | | $0.0420 | |
The tax character of distributions paid during the fiscal years ended September 30 were as follows:
| | 2005 | | 2004 | |
Distributions paid from: | | | | | | | |
Ordinary Income | | $ | 40,364,240 | | $ | 42,390,691 | |
Total Taxable Distributions | | $ | 40,364,240 | | $ | 42,390,691 | |
Tax Return of Capital | | | — | | | 1,961,500 | |
Total Distributions Paid | | $ | 40,364,240 | | $ | 44,352,191 | |
As of September 30, 2005, the components of accumulated earnings on a tax basis were as follows:
32 | High Income Opportunity Fund Inc. 2005 Annual Report |
Notes to Financial Statements (continued)
Undistributed ordinary income | | $ | — | |
Undistributed long-term capital gains | | | — | |
Total undistributed earnings | | | — | |
Capital loss carryforward(*) | | $ | (321,370,180 | ) |
Other book/tax temporary differences(a) | | | (1,493,048 | ) |
Unrealized appreciation(b) | | | 10,998,297
| |
Total accumulated earnings/(losses) | | $ | (311,864,931 | ) |
(*) | During the taxable year ended September 30, 2005, the Fund utilized $4,844,593 of its capital loss carryover available from prior years. As of September 30, 2005, the Fund had the following net capital loss carryforwards remaining: |
Year of
Expiration | Amount | |
| | | |
9/30/2007 | $ (6,230,750 | ) | |
9/30/2008 | (39,805,822 | ) | |
9/30/2009 | (69,256,717 | ) | |
9/30/2010 | (141,417,884 | ) | |
9/30/2011 | (62,116,725 | ) | |
9/30/2012 | (2,542,282 | ) | |
| $(321,370,180 | ) | |
These amounts will be available to offset any future taxable capital gains.
(a) | Other book/tax temporary differences are attributable primarily to the deferral of post-October currency losses for tax purposes and differences in the book/tax treatment of various items. |
(b) | The difference between book-basis and tax-basis unrealized appreciation is attributable primarily to the tax deferral of losses on wash sales and the difference between book & tax amortization methods for discount and premiums on fixed income securities and book/tax differences in the treatment of consent fees. |
6. Regulatory Matters
On May 31, 2005, the U.S. Securities and Exchange Commission (“SEC”) issued an order in connection with the settlement of an administrative proceeding against Smith Barney Fund Management LLC (“SBFM”) and Citigroup Global Markets Inc. (“CGMI”) relating to the appointment of an affiliated transfer agent for the Smith Barney family of mutual funds (the “Funds”).
The SEC order finds that SBFM and CGMI willfully violated Section 206(1) of the Investment Advisers Act of 1940 (“Advisers Act”). Specifically, the order finds that SBFM and CGMI knowingly or recklessly failed to disclose to the boards of the Funds in 1999 when proposing a new transfer agent arrangement with an affiliated transfer agent that: First Data Investors Services Group (“First Data”), the Funds’ then-existing transfer agent, had offered to continue as transfer agent and do the same work for substantially less money than before; and that Citigroup Asset Management (“CAM”), the Citigroup business unit that includes the fund’s investment manager and other investment advisory companies, had entered into a side letter with First Data under which CAM agreed to recommend the appointment of First Data as sub-transfer agent to the affiliated transfer agent in exchange, among other things, for a guarantee by First Data of specified amounts of asset management and investment banking fees to CAM and CGMI. The order also finds that SBFM and CGMI willfully violated Section 206(2) of the Advisers Act by
High Income Opportunity Fund Inc. 2005 Annual Report | 33 |
Notes to Financial Statements (continued)
virtue of the omissions discussed above and other misrepresentations and omissions in the materials provided to the Funds’ boards, including the failure to make clear that the affiliated transfer agent would earn a high profit for performing limited functions while First Data continued to perform almost all of the transfer agent functions, and the suggestion that the proposed arrangement was in the Funds’ best interests and that no viable alternatives existed. SBFM and CGMI do not admit or deny any wrongdoing or liability. The settlement does not establish wrongdoing or liability for purposes of any other proceeding.
The SEC censured SBFM and CGMI and ordered them to cease and desist from violations of Sections 206(1) and 206(2) of the Advisers Act. The order requires Citigroup to pay $208.1 million, including $109 million in disgorgement of profits, $19.1 million in interest, and a civil money penalty of $80 million. Approximately $24.4 million has already been paid to the Funds, primarily through fee waivers. The remaining $183.7 million, including the penalty, has been paid to the U.S. Treasury and will be distributed pursuant to a plan prepared by Citigroup and submitted for approval by the SEC. The order also requires that transfer agency fees received from the Funds since December 1, 2004 less certain expenses be placed in escrow and provides that a portion of such fees may be subsequently distributed in accordance with the terms of the order.
The order requires SBFM to recommend a new transfer agent contract to the Fund boards within 180 days of the entry of the order; if a Citigroup affiliate submits a proposal to serve as transfer agent or sub-transfer agent, an independent monitor must be engaged at the expense of SBFM and CGMI to oversee a competitive bidding process. Under the order, Citigroup also must comply with an amended version of a vendor policy that Citigroup instituted in August 2004. That policy, as amended, among other things, requires that when requested by a Fund board, CAM will retain at its own expense an independent consulting expert to advise and assist the board on the selection of certain service providers affiliated with Citigroup.
At this time, there is no certainty as to how the proceeds of the settlement will be distributed, to whom such distributions will be made, the methodology by which such distributions will be allocated, and when such distributions will be made. Although there can be no assurance, Citigroup does not believe that this matter will have a material adverse effect on the Funds.
The Fund did not implement the transfer agent arrangement described above and therefore will not receive any portion of the distributions.
7. Legal Matters
Beginning in August 2005, five class action lawsuits alleging violations of federal securities laws and state law were filed against CGMI and SBFM, (collectively, the “Defendants”) based on the May 31, 2005 settlement order issued against the Defendants by the SEC described in Note 6. The complaints seek injunctive relief and compensatory and punitive damages, removal of SBFM as the advisor for the Smith Barney family of funds, rescission of the Funds’ management and other contracts with SBFM, recovery of all fees paid to SBFM pursuant to such contracts, and an award of attorneys’ fees and litigation expenses.
34 | High Income Opportunity Fund Inc. 2005 Annual Report |
Notes to Financial Statements (continued)
On October 5, 2005, a motion to consolidate the five actions and any subsequently-filed, related action was filed. That motion contemplates that a consolidated amended complaint alleging substantially similar causes of action will be filed in the future.
As of the date of this report, CAM believes that resolution of the pending lawsuit will not have a material effect on the financial position or results of operations of the Funds or the ability of the Advisers and their affiliates to continue to render services to the Funds under their respective contracts.
* * *
Beginning in June 2004, class action lawsuits alleging violations of the federal securities laws were filed against Citigroup Global Markets Inc. (the “Distributor”) and a number of its affiliates, including SBFM and SBAM (the “Advisers”), substantially all of the mutual funds managed by the Advisers, including the Fund (the “Funds”), and directors or trustees of the Funds (collectively, the “Defendants”). The complaints alleged, among other things, that the CGMI created various undisclosed incentives for its brokers to sell Smith Barney and Salomon Brothers funds. In addition, according to the complaints, the Advisers caused the Funds to pay excessive brokerage commissions to the CGMI for steering clients towards proprietary funds. The complaints also alleged that the defendants breached their fiduciary duty to the Funds by improperly charging Rule 12b-1 fees and by drawing on fund assets to make undisclosed payments of soft dollars and excessive brokerage commissions. The complaints also alleged that the Funds failed to adequately disclose certain of the allegedly wrongful conduct. The complaints sought injunctive relief and compensatory and punitive damages, rescission of the Funds’ contracts with the Advisers, recovery of all fees paid to the Advisers pursuant to such contracts and an award of attorneys’ fees and litigation expenses.
On December 15, 2004, a consolidated amended complaint (the “Complaint”) was filed alleging substantially similar causes of action. While the lawsuit is in its earliest stages, to the extent that the Complaint purports to state causes of action against the Funds, CAM believes the Funds have significant defenses to such allegations, which the Funds intend to vigorously assert in responding to the Complaint. Additional lawsuits arising out of these circumstances and presenting similar allegations and requests for relief may be filed against the Defendants in the future. As of the date of this report, CAM and the Funds believe that the resolution of the pending lawsuit will not have a material effect on the financial position or results of operations of the Funds or the ability of the Advisers and their affiliates to continue to render services to the Funds under their respective contracts.
The Defendants have moved to dismiss the Complaint. Those motions are pending before the court.
8. Other Matters
On June 24, 2005, Citigroup announced that it has signed a definitive agreement under which Citigroup will sell substantially all of its worldwide asset management business to Legg Mason, Inc. (“Legg Mason”).
High Income Opportunity Fund Inc. 2005 Annual Report | 35 |
Notes to Financial Statements (continued)
As part of this transaction, SBFM (the “Adviser”), currently an indirect wholly owned subsidiary of Citigroup, would become an indirect wholly owned subsidiary of Legg Mason. The Adviser is the investment adviser to the Fund.
The transaction is subject to certain regulatory approvals, as well as other customary conditions to closing. Subject to such approvals and the satisfaction of the other conditions, Citigroup expects the transaction to be completed later this year.
Under the Investment Company Act of 1940, consummation of the transaction will result in the automatic termination of the fund’s investment advisory contract with the adviser. Therefore, the Trust’s Board of Trustees has approved a new investment advisory contract between the Fund and the Adviser to become effective upon the closing of the sale to Legg Mason. The new investment advisory contract has been presented to the shareholders of the fund for their approval.
* * *
The Fund has received information from Citigroup Asset Management (“CAM”) concerning Smith Barney Fund Management LLC (“SBFM”), an investment advisory company that is part of CAM. The information received from CAM is as follows:
On September 16, 2005, the staff of the Securities and Exchange Commission (the “Commission”) informed SBFM that the staff is considering recommending that the Commission institute administrative proceedings against SBFM for alleged violations of Sections 19(a) and 34(b) of the Investment Company Act (and related Rule 19a-1). The notification is a result of an industry wide inspection undertaken by the Commission and is based upon alleged deficiencies in disclosures regarding dividends and distributions paid to shareholders of certain funds. In connection with the contemplated proceedings, the staff may seek a cease and desist order and/or monetary damages from SBFM.
Although there can be no assurance, SBFM believes that this matter is not likely to have a material adverse effect on the Fund or SBFM’s ability to perform investment advisory services relating to the Fund.
The Commission staff’s recent notification will not affect the sale by Citigroup Inc. of substantially all of CAM’s worldwide business to Legg Mason, Inc., which Citigroup continues to expect will occur in the fourth quarter of this year.
9. Special Shareholder Notice (unaudited)
Since the inception of this Fund, shareholders have been receiving printed reports on a quarterly basis. Because there are a number of sources that provide important information about the Fund on a timely basis, and because of the expense to the Fund of printing and mailing shareholder reports quarterly, in the future shareholders will only receive full shareholder reports semi-annually, after the end of the first six months of the Fund’s fiscal year and then after the end of the fiscal year. These reports will continue to provide a complete portfolio of holdings as of the end of each period and letters from the fund’s portfolio managers about the Fund’s performance during the period as well as detailed financial information.
There are a number of sources from which you can obtain current information about the Fund. The Citigroup Asset Management website, www.citigroupam.com, includes
36 | High Income Opportunity Fund Inc. 2005 Annual Report |
Notes to Financial Statements (continued)
detailed information about the Fund that is updated daily and provides a link to the Fund’s shareholder reports and press releases. The Fund issues a press release each quarter that summarizes its portfolio allocation and other portfolio characteristics that is accessible on the website. The Fund files complete portfolios of holdings as of the end of the first and third quarter of its fiscal year with the SEC on Form N-Q; these reports can be found on the SEC’s website, www.sec.gov. If you have questions about the Fund please call our investor relations number, 1-800-735-6507.
High Income Opportunity Fund Inc. 2005 Annual Report | 37 |
Report of Independent Registered Public Accounting Firm
The Shareholders and Board of Directors
High Income Opportunity Fund Inc.:
We have audited the accompanying statement of assets and liabilities, including the schedule of investments, of High Income Opportunity Fund Inc. as of September 30, 2005, and the related statement of operations for the year then ended, the statements of changes in net assets for each of the years in the two-year period then ended and financial highlights for each of the years in the five-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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of September 30, 2005, by correspondence with the custodian and brokers or by other appropriate auditing procedures where replies from brokers were not received. As to securities purchased or sold but not yet received or delivered, we performed other appropriate auditing procedures. 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 High Income Opportunity Fund Inc. as of September 30, 2005, and the results of its operations for the year then ended, the changes in its net assets for each of the years in the two-year period then ended and the financial highlights for each of the years in the five-year period then ended, in conformity with U.S. generally accepted accounting principles.
| | | 
|
New York, New York
November 18, 2005
| | | |
38 | High Income Opportunity Fund Inc. 2005 Annual Report |
Financial Data (unaudited)
For a share of capital stock outstanding throughout each period:
| | NYSE
Closing Price | | Net Asset
Value* | | Distribution
Paid | | Dividend
Reinvestment
Price | |
| | | | | | | | | |
Fiscal Year 2003 | | | | | | | | | | | | | | | | | |
October 22 | | | $5.69 | | | | $5.86 | | | | $0.0570 | | | | $5.83 | | |
November 25 | | | 6.36 | | | | 6.26 | | | | 0.0570 | | | | 6.26 | | |
December 23 | | | 6.17 | | | | 6.28 | | | | 0.0570 | | | | 6.28 | | |
January 28 | | | 6.70 | | | | 6.40 | | | | 0.0570 | | | | 6.40 | | |
February 25 | | | 6.88 | | | | 6.40 | | | | 0.0570 | | | | 6.54 | | |
March 25 | | | 6.91 | | | | 6.51 | | | | 0.0570 | | | | 6.57 | | |
April 22 | | | 6.92 | | | | 6.73 | | | | 0.0570 | | | | 6.73 | | |
May 27 | | | 7.13 | | | | 6.88 | | | | 0.0570 | | | | 6.88 | | |
June 24 | | | 7.25 | | | | 7.07 | | | | 0.0570 | | | | 7.07 | | |
July 22 | | | 6.93 | | | | 7.05 | | | | 0.0570 | | | | 7.04 | | |
August 26 | | | 7.04 | | | | 6.90 | | | | 0.0570 | | | | 6.90 | | |
September 23 | | | 7.00 | | | | 7.05 | | | | 0.0570 | | | | 7.05 | | |
Fiscal Year 2004 | | | | | | | | | | | | | | | | | |
October 28 | | | 7.09 | | | | 7.12 | | | | 0.0500 | | | | 7.12 | | |
November 24 | | | 7.04 | | | | 7.17 | | | | 0.0500 | | | | 7.13 | | |
December 22 | | | 7.12 | | | | 7.30 | | | | 0.0500 | | | | 7.17 | | |
January 27 | | | 7.27 | | | | 7.45 | | | | 0.0500 | | | | 7.36 | | |
February 24 | | | 7.20 | | | | 7.30 | | | | 0.0500 | | | | 7.26 | | |
March 23 | | | 7.04 | | | | 7.28 | | | | 0.0500 | | | | 7.10 | | |
April 27 | | | 6.43 | | | | 7.27 | | | | 0.0500 | | | | 6.59 | | |
May 25 | | | 6.56 | | | | 7.07 | | | | 0.0500 | | | | 6.67 | | |
June 22 | | | 6.50 | | | | 7.12 | | | | 0.0500 | | | | 6.58 | | |
July 27 | | | 6.73 | | | | 7.15 | | | | 0.0500 | | | | 6.84 | | |
August 24 | | | 6.82 | | | | 7.21 | | | | 0.0500 | | | | 6.92 | | |
September 21 | | | 6.84 | | | | 7.28 | | | | 0.0500 | | | | 6.90 | | |
Fiscal Year 2005 | | | | | | | | | | | | | | | | | |
October 26 | | | 6.91 | | | | 7.32 | | | | 0.0500 | | | | 6.96 | | |
November 22 | | | 6.76 | | | | 7.40 | | | | 0.0500 | | | | 6.84 | | |
December 28 | | | 6.68 | | | | 7.42 | | | | 0.0500 | | | | 6.73 | | |
January 25 | | | 6.55 | | | | 7.35 | | | | 0.0450 | | | | 6.63 | | |
February 22 | | | 6.54 | | | | 7.40 | | | | 0.0450 | | | | 6.66 | | |
March 21 | | | 6.30 | | | | 7.26 | | | | 0.0450 | | | | 6.31 | | |
April 26 | | | 6.22 | | | | 7.10 | | | | 0.0450 | | | | 6.27 | | |
May 24 | | | 6.32 | | | | 7.00 | | | | 0.0450 | | | | 6.39 | | |
June 21 | | | 6.46 | | | | 7.15 | | | | 0.0450 | | | | 6.49 | | |
July 26 | | | 6.59 | | | | 7.24 | | | | 0.0420 | | | | 6.64 | | |
August 23 | | | 6.55 | | | | 7.27 | | | | 0.0420 | | | | 6.58 | | |
September 27 | | | 6.37 | | | | 7.16 | | | | 0.0420 | | | | 6.40 | | |
* As of record date.
High Income Opportunity Fund Inc. 2005 Annual Report | 39 |
Board Approval of Management Agreement (unaudited)
Background
The members of the Board of High Income Opportunity Fund Inc. (the “Fund”), including the Fund’s independent, or non-interested, Board members (the “Independent Board Members”), received information from the Fund’s manager (the “Manager”) to assist them in their consideration of the Fund’s management agreement (the “Management Agreement”). The Board received and considered a variety of information about the Manager, as well as the advisory arrangement for the Fund and other funds overseen by the Board, certain portions of which are discussed below.
The presentation made to the Board encompassed the Fund and all the funds for which the Board has responsibility. Some funds overseen by the Board have an investment advisory agreement and an administration agreement and some funds have an investment management agreement that encompasses both functions. The discussion below covers both advisory and administrative functions being rendered by the Manager whether a fund has a single agreement in place or both an advisory and administration agreement. The terms “Management Agreement”, “Contractual Management Fee” and “Actual Management Fee” are used in a similar manner to refer to both advisory and administration agreements and their related fees whether a fund has a single agreement or separate agreements in place.
Board Approval of Management Agreement
In approving the Management Agreement, the Fund’s Board, including the Independent Board Members, considered the following factors:
Nature, Extent and Quality of the Services under the Management Agreement
The Board received and considered information regarding the nature, extent and quality of services provided to the Fund by the Manager under the Management Agreement during the past year. The Board also received a description of the administrative and other services rendered to the Fund and its shareholders by the Manager. The Board noted information received at regular meetings throughout the year related to the services rendered by the Manager about the management of the Fund’s affairs and the Manager’s role in coordinating the activities of the Fund’s other service providers. The Board’s evaluation of the services provided by the Manager took into account the Board’s knowledge and familiarity gained as Board members of funds in the Citigroup Asset Management (“CAM”) fund complex, including the scope and quality of the Manager’s investment management and other capabilities and the quality of its administrative and other services. The Board observed that the scope of services provided by the Manager had expanded over time as a result of regulatory and other developments, including maintaining and monitoring its own and the Fund’s expanded compliance programs. The Board also considered the Manager’s response to recent regulatory compliance issues affecting it and the CAM fund complex. The Board reviewed information received from the Manager regarding the implementation to date of the Fund’s compliance policies and procedures established pursuant to Rule 38a-1 under the Investment Company Act of 1940.
40 | High Income Opportunity Fund Inc. 2005 Annual Report |
Board Approval of Management Agreement (unaudited) (continued)
The Board reviewed the qualifications, backgrounds and responsibilities of the Fund’s senior personnel and the portfolio management team primarily responsible for the day-to-day portfolio management of the Fund. The Board also considered the degree to which the Manager implemented organizational changes to improve investment results and the services provided to the CAM fund complex. The Board noted that the Manager’s Office of the Chief Investment Officer, composed of the senior officers of the investment teams managing the funds in the CAM complex, participates in reporting to the Board on investment matters. The Board also considered, based on its knowledge of the Manager and its affiliates, the financial resources available to CAM and its parent organization, Citigroup Inc.
The Board also considered the Manager’s brokerage policies and practices, the standards applied in seeking best execution, the Manager’s policies and practices regarding soft dollars, the use of a broker affiliated with the Manager and the existence of quality controls applicable to brokerage allocation procedures. In addition, management also reported to the Board on, among other things, its business plans, recent organizational changes and portfolio manager compensation plan.
At the Board’s request following the conclusion of the 2004 contract continuance discussions, the Manager prepared and provided to the Board in connection with the 2005 discussions an analysis of complex-wide management fees, which, among other things, set out a proposed framework of fees based on asset classes. The Board engaged the services of independent consultants to assist it in evaluating the Fund’s fees generally and within the context of the framework.
The Board concluded that, overall, the nature, extent and quality of services provided (and expected to be provided) under the Management Agreement were acceptable.
Fund Performance
The Board received and considered performance information for the Fund as well as for a group of funds (the “Performance Universe”) selected by Lipper, Inc. (“Lipper”), an independent provider of investment company data. The Board was provided with a description of the methodology Lipper used to determine the similarity of the Fund with the funds included in the Performance Universe. The Board also noted that it had received and discussed with management information throughout the year at periodic intervals comparing the Fund’s performance against its benchmark(s).
The information comparing the Fund’s performance to that of its Performance Universe, consisting of all non-leveraged closed-end funds classified as “high current yield funds” by Lipper, showed that the Fund’s performance for all periods presented was below the median. The Board noted that the performance universe for periods in excess of the one-year period consisted of only four non-leveraged funds and as a result they gave little weight to the comparative information. The Board noted that in July 2002 there had been a change in the portfolio management team. Based on their review, the Board continues to retain confidence in the Manager to seek to achieve the Fund’s investment objective and carry out its investment strategies.
High Income Opportunity Fund Inc. 2005 Annual Report | 41 |
Board Approval of Management Agreement (unaudited) (continued)
Management Fees and Expense Ratios
The Board reviewed and considered the contractual management fee (the “Contractual Management Fee”) payable by the Fund to the Manager in light of the nature, extent and quality of the management services provided by the Manager.
Additionally, the Board received and considered information comparing the Fund’s Contractual Management Fees and Actual Management Fee and the Fund’s overall expenses with those of funds in both the relevant expense group and a broader group of funds, each selected and provided by Lipper. The Board also reviewed information regarding fees charged by the Manager to other U.S. clients investing primarily in an asset class similar to that of the Fund including, where applicable, separate accounts. The Manager reviewed with the Board the significant differences in scope of services provided to the Fund and to these other clients, noting that the Fund is provided with administrative services, office facilities, Fund officers (including the Fund’s chief executive, chief financial and chief compliance officers), and that the Manager coordinates and oversees the provision of services to the Fund by other Fund providers. The Board considered the fee comparisons in light of the differences required to manage these different types of accounts. The Board received an analysis of complex-wide management fees provided by the Manager, which, among other things, set out a proposed framework of fees based on asset classes.
The information comparing the Fund’s Contractual and Actual Management Fees as well as its actual total expense ratio to its Expense Group, consisting of 7 non-leveraged and leveraged closed-end funds (including the Fund) classified as “high current yield funds” by Lipper, showed that the Fund’s Contractual and Actual Management Fees were higher than the range of management fees paid by the other funds in the Expense Group. The Board noted that the Fund’s actual total expense ratio was also higher than the median. After discussion with the Board, the Manager offered to and will reduce the Contractual Management Fee of the Fund, effective October 1, 2005.
Taking all of the above into consideration, the Board determined that the Management Fee was reasonable in light of the nature, extent and quality of the services provided to the Fund under the Management Agreement.
Manager Profitability
The Board received and considered a profitability analysis of the Manager and its affiliates in providing services to the Fund. The Board also received profitability information with respect to the CAM fund complex as a whole. In addition, the Board received information with respect to the Manager’s allocation methodologies used in preparing this profitability data as well as a report from an outside consultant that had reviewed the Manager’s methodology. The Manager’s profitability was considered not excessive in light of the nature, extent and quality of the services provided to the Fund.
42 | High Income Opportunity Fund Inc. 2005 Annual Report |
Board Approval of Management Agreement (unaudited) (continued)
Economies of Scale
The Board received and discussed information concerning whether the Manager realizes economies of scale as the Fund’s assets grow beyond current levels. However, because of the nature of the Manager’s business, the Board could not reach definitive conclusions as to whether the Manager might realize economies of scale or how great they may be.
The Board noted that the Fund’s asset level exceeded the breakpoints (or would exceed any proposed breakpoints) and, as a result, the Fund and its shareholders realized or would realize the benefit of a lower total expense ratio than if no breakpoints had been in place. The Board also noted that as the Fund’s assets have increased over time, it has realized other economies of scale as certain expenses, such as fees for Board members, auditors and legal fees, become a smaller percentage of overall assets.
The Board noted that Management Fee effective on October 1, 2005 will be 0.80%.
Other Benefits to the Manager
The Board considered other benefits received by the Manager and its affiliates as a result of its relationship with the Fund, including soft dollar arrangements, receipt of brokerage and the opportunity to offer additional products and services to Fund shareholders.
In light of the costs of providing investment management and other services to the Fund and the Manager’s ongoing commitment to the Fund, the profits and other ancillary benefits that the Manager and its affiliates received were considered reasonable.
In light of all of the foregoing, the Board approved the Management Agreement to continue for another year.
No single factor reviewed by the Board was identified by the Board as the principal factor in determining whether to approve the Management Agreement. The Independent Board Members were advised by separate independent legal counsel throughout the process. The Board discussed the proposed continuance of the Management Agreement in a private session with their independent legal counsel at which no representatives of the Manager were present.
High Income Opportunity Fund Inc. 2005 Annual Report | 43 |
Additional Information (unaudited)
Information about Directors and Officers
The business and affairs of the High Income Opportunity Fund Inc. (“Fund”) are managed under the direction of the Board of Directors. Information pertaining to the Directors and Officers of the Fund is set forth below.
Name, Address
and Birth Year | | Position(s)
Held with
Fund | | Term of
Office*
and Length
of Time
Served | | Principal
Occupation(s)
During Past
Five Years | | Number of
Portfolios
in Fund
Complex
Overseen
by Director | | Other
Board
Memberships
Held by
Director | |
Non-Interested Directors: | | | | | | | | | | | |
Lee Abraham
13732 LeHavre Drive
Frenchman’s Creek
Palm Beach Gardens,
FL 33410
Birth Year: 1927 | | Director | | Since
1999 | | Retired; Former Director of Signet Group PLC | | 27 | | None | |
Jane F. Dasher
Korsant Partners
283 Greenwich Avenue
Greenwich, CT 06830
Birth Year: 1949 | | Director | | Since
1999 | | Controller of PBK Holdings Inc., a family investment company | | 27 | | None | |
Donald R. Foley
3668 Freshwater Drive
Jupiter, FL 33477
Birth Year: 1922 | | Director | | Since
1993 | | Retired | | 27 | | None | |
Richard E. Hanson, Jr.
2751 Vermont Route 140
Poultney, VT 05764
Birth Year: 1941 | | Director | | Since
1999 | | Retired; Former Head of the New Atlanta Jewish Community High School | | 27 | | None | |
Paul Hardin
12083 Morehead
Chapel Hill, NC
27514-8426
Birth Year: 1931 | | Director | | Since
1996 | | Professor of Law & Chancellor Emeritus at the University of North Carolina | | 34 | | None | |
Roderick C. Rasmussen
9 Cadence Court
Morristown, NJ 07960
Birth Year: 1926 | | Director | | Since
1993 | | Investment Counselor | | 27 | | None | |
John P. Toolan
13 Chadwell Place
Morristown, NJ 07960
Birth Year: 1930 | | Director | | Since
1993 | | Retired | | 27 | | None | |
44 | High Income Opportunity Fund Inc. 2005 Annual Report |
Additional Information (unaudited) (continued)
Name, Address
and Birth Year | | Position(s)
Held with
Fund | | Term of
Office* and
Length
of Time
Served | | Principal
Occupation(s)
During Past
Five Years | | Number of
Portfolios
in Fund
Complex
Overseen
by Director | | Other
Board
Memberships
Held by
Director | |
Interested Director:
R. Jay Gerken, CFA**
Citigroup Asset
Management (“CAM”)
399 Park Avenue
Mezzanine
New York, NY 10022
Birth Year: 1951 | |
Chairman, President and Chief Executive Officer | |
Since
2002 | |
Managing Director of Citigroup Global Markets Inc. (“CGM”); Chairman, President and Chief Executive Officer of Smith Barney Fund Management LLC (“SBFM”), and Citi Fund Management, Inc. (“CFM”); President and Chief Executive Officer of certain mutual funds associated with Citigroup Inc. (“Citigroup”); Formerly Portfolio Manager of Smith Barney Allocation Series Inc. (from 1996-2001) and Smith Barney Growth and Income Fund (from 1996-2000); Chairman, President and Chief Executive Officer of Travelers Investment Advisers, Inc. (“TIA”) (from 2002 to 2005) | |
171 | |
None | |
Officers:
Andrew B. Shoup
CAM
125 Broad Street
11th Floor
New York, NY 10004
Birth Year: 1956 | |
Senior Vice President and Chief Administrative Officer | |
Since
2003 | |
Director of CAM; Senior Vice President and Chief Administrative Officer of mutual funds associated with Citigroup; Treasurer of certain mutual funds associated with Citigroup; Head of International Funds Administration of CAM (from 2001 to 2003); Director of Global Funds Administration of CAM (from 2000 to 2001); Head of U.S. Citibank Funds Administration of CAM (from 1998 to 2000) | |
N/A | |
N/A | |
High Income Opportunity Fund Inc. 2005 Annual Report | 45 |
Additional Information (unaudited) (continued)
Name, Address
and Birth Year | | Position(s)
Held with
Fund | | Term of
Office* and
Length
of Time
Served | | Principal
Occupation(s)
During Past
Five Years | | Number of
Portfolios
in Fund
Complex
Overseen
by Director | | Other
Board
Memberships
Held by
Director | |
| | | | | | | | | | | |
Robert J. Brault
CAM
125 Broad Street
11th Floor
New York, NY 10004
Birth Year: 1965 | | Chief Financial
Officer and
Treasurer | | Since
2004 | | Director of CGM; Chief Financial Officer and Treasurer of certain mutual funds associated with Citigroup; Director of Internal Control for CAM U.S. Mutual Fund Administration (from 2002-2004); Director of Project Management & Information Systems for CAM U.S. Mutual Fund Administration (from 2000 to 2002); Vice President, of Mutual Fund Administration at Investors Capital Services (from 1999-2000) | | N/A | | N/A | |
Beth A. Semmel, CFA
CAM
399 Park Avenue
4th Floor
New York, NY 10022
Birth Year: 1960 | | Vice President
and Investment
Officer | | Since
2002 | | Managing Director of Salomon Brothers Asset Management Inc. (“SBAM”) | | N/A | | N/A | |
Peter J. Wilby, CFA
CAM
399 Park Avenue
4th Floor
New York, NY10022
Birth Year: 1958 | | Vice President
and Investment
Officer | | Since
2002 | | Managing Director,
Chief Investment
Officer of SBAM | | N/A | | N/A | |
46 | High Income Opportunity Fund Inc. 2005 Annual Report |
Additional Information (unaudited) (continued)
Name, Address
and Birth Year | | Position(s)
Held with
Fund | | Term of
Office* and
Length
of Time
Served | | Principal
Occupation(s)
During Past
Five Years | | Number of
Portfolios
in Fund
Complex
Overseen
by Director | | Other
Board
Memberships
Held by
Director | |
| | | | | | | | | | | |
Andrew Beagley
CAM
399 Park Avenue
4th Floor
New York, NY 10022
Birth Year: 1962 | | Chief
Anti-Money
Laundering
Compliance
Officer
Chief
Compliance
Officer | | Since
2002
Since
2004 | | Director of CGM (since 2000); Director of Compliance, North America, CAM (since 2000); Chief Anti-Money Laundering Compliance Officer, Chief Compliance Officer and Vice President of certain mutual funds associated with Citigroup; Director of Compliance, Europe, the Middle East and Africa, Citigroup Asset Management (from 1999 to 2000); Chief Compliance Officer, SBFM and CFM; Formerly Chief Compliance Officer, TIA (from 2002 to 2005) | | N/A | | N/A | |
Robert I. Frenkel
CAM
300 First Stamford Place
4th Floor
Stamford, CT 06902
Birth Year: 1954 | | Secretary
and Chief
Legal Officer | | Since
2003 | | Managing Director and General Counsel of Global Mutual Funds for CAM and its predecessor (since 1994); Secretary of CFM (from 2001 to 2004); Secretary and Chief Legal Officer of mutual funds associated with Citigoup | | N/A | | N/A | |
* | Each Director and Officer serves until his or her successor has been duly elected and qualified. |
** | Mr. Gerken is an “interested person” of the Fund as defined in the Investment Company Act of 1940, as amended, because Mr. Gerken is an officer of SBFM and certain of its affiliates. |
High Income Opportunity Fund Inc. 2005 Annual Report | 47 |
Annual Chief Executive Officer and Chief Financial Officer Certification (unaudited)
The Fund’s CEO has submitted to the NYSE the required annual certification and, the Fund also has included the Certifications of the Fund’s CEO and CFO required by Section 302 of the Sarbanes-Oxley Act in the Fund’s Form N-CSR filed with the SEC, for the period of this report.
48 | High Income Opportunity Fund Inc. 2005 Annual Report |
Additional Shareholder Information (unaudited)
Result of Annual Meeting to Shareholders
The Annual Meeting of Shareholders of High Income Opportunity Fund Inc. was held on April 29, 2005, for the purpose of considering and voting upon the election of two Class I Directors, each for a three year term. The following table provides information concerning the matters voted upon at the Meeting:
Election of Directors*
| Nominees | | Votes For | | Votes Withheld | |
| Lee Abraham | | 63,148,742 | | 2,603,669 | |
| Richard E. Hanson, Jr. | | 63,231,605 | | 2,520,806 | |
* | The following Directors, representing the balance of the Board of Directors, continue to serve as Directors: Jane F. Dasher, Donald R. Foley, R. Jay Gerken, Paul Hardin, Roderick C. Rasmussen and John P. Toolan. |
High Income Opportunity Fund Inc. 2005 Annual Report | 49 |
Dividend Reinvestment Plan (unaudited)
Under the Fund’s Dividend Reinvestment Plan (“Plan”), a shareholder whose shares of Common Stock are registered in his own name will have all distributions from the Fund reinvested automatically by PFPC Inc. (“PFPC”), as purchasing 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”) will be reinvested by the broker or nominee in additional shares under the Plan, unless the service is not provided by the broker or nominee or the shareholder elects to receive distributions in cash. Investors who own common stock registered in street name should consult their broker-dealers for details regarding reinvestment. All distributions to shareholders who do not participate in the Plan will be paid by check mailed directly to the record holder by or under the direction of PFPC as dividend paying agent.
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. When the market price of the common stock is equal to or exceeds the net asset value (“NAV”) per share of the common stock on the determination date (generally, the record date for the distribution), the Plan participants will be issued shares of common stock by the Fund at a price equal to the greater of NAV determined as described below or 95% of the market price of the common stock.
If the market price of the common stock is less than the NAV of the common stock at the time of valuation (which is the close of business on the determination date) PFPC will buy common stock in the open market, on the stock exchange or elsewhere, for the participants’ accounts. If following the commencement of the purchases and before PFPC has completed its purchases, the market price exceeds the NAV of the common stock as of the valuation time, PFPC will attempt to terminate purchases in the open market and cause the Fund to issue the remaining portion of the dividend or distribution in shares at a price equal to the greater of (a) NAV as of the valuation time or (b) 95% of the then current market price. In this case, the number of shares received by a Plan 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. To the extent PFPC is unable to stop open market purchases and cause the Fund to issue the remaining shares, the average per share purchase price paid by PFPC may exceed the NAV of the common stock as of the valuation time, resulting in the acquisition of fewer shares than if the distribution had been paid in common stock issued by the Fund at such net asset value. PFPC will begin to purchase common stock on the open market as soon as practicable after the determination date for distributions, but in no event shall such purchases continue later than 30 days after the payment date for such distribution, or the record date for a succeeding distribution, except when necessary to comply with applicable provisions of the federal securities laws.
PFPC maintains all shareholder accounts in the Plan and furnishes written confirmation of all transactions in each account, including information needed by a shareholder for personal and tax records. The automatic reinvestment of distributions will not relieve Plan participants of any income tax that may be payable on the distributions.
50 | High Income Opportunity Fund Inc. 2005 Annual Report |
Dividend Reinvestment Plan (unaudited) (continued)
Common stock in the account of each Plan participant will be held by PFPC in uncertificated form in the name of each Plan participant.
Plan participants are subject to no charge for reinvesting distributions under the Plan. PFPC’s fees for handling the reinvestment of distributions will be paid by the Fund. No brokerage charges apply with respect to shares of common stock issued directly by the Fund under the Plan. Each Plan participant will, however, bear a proportionate share of any brokerage commissions actually incurred with respect to any open market purchases made under the Plan.
Experience under the Plan may indicate that changes to it are desirable. The Fund reserves the right to amend or terminate the Plan as applied to any distribution paid subsequent to written notice of the change sent to participants at least 30 days before the record date for the distributions. The Plan also may be amended or terminated by PFPC, with the Fund’s prior written consent, on at least 30 days’ written notice to Plan participants. All correspondence concerning the Plan should be directed by mail to PFPC Inc., P.O. Box 43027, Providence, RI 02940-3027 or by telephone at 1-800-331-1710.
Notice is hereby given in accordance with Section 23(c) of the Investment Company Act of 1940, as amended, that from time to time the fund may purchase, at market price, shares of its common stock in the open market.
High Income Opportunity Fund Inc. 2005 Annual Report | 51 |
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| | High Income Opportunity Fund Inc. | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | DIRECTORS | | INVESTMENT MANAGER | |
| | Lee Abraham | | Smith Barney Fund | |
| | Jane F. Dasher | | Management LLC | |
| | Donald R. Foley | | | |
| | R. Jay Gerken, CFA | | CUSTODIAN | |
| | Chairman | | State Street Bank and | |
| | Richard E. Hanson, Jr. | | Trust Company | |
| | Paul Hardin | | 225 Franklin Street | |
| | Roderick C. Rasmussen | | Boston, Massachusetts 02110 | |
| | John P. Toolan | | | |
| | | | TRANSFER AGENT | |
| | OFFICERS | | PFPC Inc. | |
| | R. Jay Gerken, CFA | | P.O. Box 43027 | |
| | President and Chief | | Providence, RI 02940-3027 | |
| | Executive Officer | | | |
| | | | INDEPENDENT | |
| | Andrew B. Shoup | | REGISTERED PUBLIC | |
| | Senior Vice President and | | ACCOUNTING FIRM | |
| | Chief Administrative Officer | | KPMG LLP | |
| | | | 345 Park Avenue | |
| | Robert J. Brault | | New York, New York 10154 | |
| | Chief Financial Officer | | | |
| | and Treasurer | | | |
| | | | | |
| | Beth A. Semmel, CFA | | | |
| | Vice President and | | | |
| | Investment Officer | | | |
| | | | | |
| | Peter J. Wilby, CFA | | | |
| | Vice President and | | | |
| | Investment Officer | | | |
| | | | | |
| | Andrew Beagley | | | |
| | Chief Compliance Officer | | | |
| | | | | |
| | Robert I. Frenkel | | | |
| | Secretary and | | | |
| | Chief Legal Officer | | | |
| | | | | |
| | | | | |
| | | | | |
High Income Opportunity Fund Inc.
HIGH INCOME OPPORTUNITY FUND INC.
Smith Barney Mutual Funds
125 Broad Street
10th Floor, MF-2
New York, New York 10004
The Fund files its complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The Fund’s Forms N-Q are available on the Commission’s website at www.sec.gov. The Fund’s Forms N-Q may be reviewed and copied at the Commission’s Public Reference Room in Washington, D.C., and information on the operation of the Public Reference Room may be obtained by calling 1-800-SEC-0330. To obtain information on Form N-Q from the Fund, shareholders can call 1-800-451-2010.
Information on how the Fund voted proxies relating to portfolio securities during the most recent 12-month period ended June 30 and a description of the policies and procedures that the Fund uses to determine how to vote proxies relating to portfolio securities is available (1) without charge, upon request, by calling 1-800-451-2020, (2) on the Fund’s website at www.citigroupam.com and (3) on the SEC’s website at www.sec.gov.
This report is intended only for the shareholders of the High Income Opportunity Fund Inc. 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 the report.
www.citigroupam.com
©2005 Citigroup Global Markets Inc. Member NASD, SIPC
FD0802 11/05 05-9310
