Limited partnerships, which were popular in the late 1980s and early 1990s, are among the high risk investments that have experienced a resurgence in recent years. The reason for this, by and large, is simple. In this period of sustained low interest rates and stock market volatility, as in other similar periods, many investors have either stayed on the sidelines or searched for alternative investments that, at least in theory, are not highly correlated with traditional stock and bond investments.
In broad terms, an alternative investment can be any investment other than traditional stock and bond investments. Many alternatives are private offerings that claim to be exempt from registration under a regulation known as Regulation D, or Reg D. Many of these Reg D private offerings are structured as limited partnerships.
A limited partnership is a form of business organization. It consists of a general partner, which may be an individual or a business entity, and a number of limited partners. The limited partnership is managed by the general partner. The limited partners do not participate in the management or policies of the limited partnership. The term “limited” denotes limited liability, meaning that the limited partners are not automatically liable for acts and omissions of the limited partnership, as general partners are.
It is this “passive investment” nature of a limited partnership interest (as distinguished from the “active management” nature of the general partner) that makes it a security and, therefore, subject to the securities laws.
Limited partnerships are favored vehicles for natural resource investments, such as oil and gas and real estate (e.g., non-traded real estate investment trusts, or REITs, and hedge funds. Scam artists favor private (Reg D) offerings because they are largely unregulated. That has not stopped regulators from issuing innumerable warnings to investors to beware of such investments.
Like other forms of alternative investments, limited partnerships are generally high-risk and illiquid and lack the transparency of exchange-traded securities. The securities industry has encouraged investors’ demand for limited partnerships and other alternatives for various reasons including the fact that they generate high fees and commissions. Hedge funds, which are often structured as limited partnerships, were famously dubbed “manager compensation schemes” by Warren Buffett.
The bulk of savings of average Americans are held in investment retirement accounts (“IRAs”). Traditional IRAs have rules that prevent them from holding private (Reg D) investments like limited partnerships. Scam artists, however, have learned to set up so-called “self-directed IRAs” for customers because they allow such investments. Unscrupulous brokers favor such accounts for the additional reason that the custodian is unlikely to perform any type of “due diligence” investigation into the investment that might turn up risks and problems that would cause the customer to decline to invest.
Twenty plus years ago, Prudential, among many other Wall Street firms, sold risky limited partnerships to thousands of ordinary Americans as “safe” investments, just like a certificate of deposit, they said. When these falsely valued, high-fee, illiquid limited partnerships soured, investors and their dreams were crushed. With help, however, many of them were able to recover their money. Some of their stories are told in a book entitled “Serpent on the Rock,” by Kurt Eichenwald.
The economy today is strikingly similar to the early 1990s. Abuses involving limited partnerships flourished then, and we see these same abuses today. The high fees, illiquidity and false valuations of many limited partnerships was a bad mix for investors then, and is a bad mix for investors today.
If you have investment losses or problems involving limited partnerships, call the lawyers at Page Perry for experienced representation at (404) 567-4400 or (877) 673-0047 (toll free).