Commonly promoted for real estate, and oil and gas ventures, Limited Partnerships are fertile grounds for frauds. While most Partnerships are legitimate, many are frauds, which remain undetected due to informational barriers, investor inertia and sometimes, market indifference. Moreover, most investors are unaware of significant legal rights, while others refuse to pursue claims out of a needless fear of embarrassment. Investors can protect their hard-earned money only by avoiding fraud-facilitating conduct.
The Setup
Touted quietly, almost conspiratorially, by push salesmen; the promotional brochures and optimistic promises of fraudulent Limited Partnership offerings make investors drool. "Don't miss this opportunity," screams the broker with the urgency of a police dispatcher. He also sends 500 pages of offering materials - which few investors read, and fewer understand. Lured by tantalizing returns and aggressive marketing, unsuspecting investors trip over each other to pour money into the Partnership.
After the sales party is over, and brokers get their commissions, the returns start dwindling (or stop altogether). The sponsors lament about familiar business woes (it's the economy, stupid!), telling investors how hard they are working, how difficult it is, etc., etc. Bad news keeps piling up, but intriguingly, so do promises of a rosier tomorrow. Then comes the kicker: a restructuring plan. Under this plan, investors get back (if lucky) 10 percent of their principal investment. Frustrated investors curse their Fate (and their enthusiastic broker), without realizing that hey have been conned all along by someone else.
Recognizing the Pitfalls
To avoid being cleaned this way, investors should be aware of the pitfalls in Limited Partnerships. To begin with, nearly all of the investors' knowledge about the Partnership or its business comes from what the sponsors tell them. And yes, sponsors do not always tell them the whole truth.
That apart, most investors are not listening even when sponsors do talk to them. Thus, sponsors typically communicate through the annual reports (boring), quarterly financial statements (confusing), or letters (useless or tardy, or both). Few investors have the patience to read these documents. As a result, most miss even outrageous sponsor misconduct. Even those who brave the boredom and read the documents may not understand the "legalese". As a result, they don't detect lies - i.e., whether the sponsors are saying something now, which contradicts something said earlier. Equally common, they don't recognize concealment - i.e., whether the sponsors are disclosing something now, which should have been disclosed much earlier. Consequently, investors typically do not even realize when they have been defrauded: To know that you've been lied to, you need to know the facts!
This problem is particularly acute in partnerships whose interests are not widely traded in stock exchanges. Research analysts do not comment on such partnerships' prospects. Business reporters do not cover their developments. And brokers do not rack them. As a result, the sponsors have a stranglehold on information in such partnerships. Adding to this problem of informational barriers is widespread ignorance of investor rights. U.S. securities laws provide rights for investors which are unparalleled in effectiveness and enforceability anywhere in the world. But unfortunately, most investors remain unfamiliar with their rights (only Miranda rights get primetime TV!) - and unaccustomed to asking hardnosed questions.
Protecting Yourself
Being aware of such pitfalls puts you way ahead in the game. To that extent, the questions may be more properly framed as, "Will you protect yourself?" Understand the LP's business in a basic sense, read AND RETAIN the documents you receive (You won't be able to detect lies and concealment if you don't have the earlier documents). And be particularly alert at the fist sign of bad news.
An awareness of legal rights also helps. Investors are entitled to be informed of material developments reasonably promptly. Moreover, federal securities laws require that sponsors of large Partnerships file periodic reports with the SEC. Sponsors usually proclaim that they will distribute such reports to investors promptly; frequently, they don't. If you don't receive periodic reports, you should inquire. Even if the horse has bolted from the stable, it is better to wake up before it goes too far.
Equally important, don't be embarrassed if you realize that you have been defrauded. Every passive investment involves trusting someone else. While credulous investors may simply trust their brokers, diligent investors may check the offering materials. But no investor verifies, for example, accountants' statements about the partnership's inventories. Or the appraisers' statement about the value of the partnership's real estate. Any of these people could have goofed - or lied. But the net result is the same for the investor: benumbing losses. Hence, suffering such losses is no indication of stupidity. Courts are full of cases involving very smart investors who realized they were defrauded, but were not shamed into inaction. However resourceful and diligent an investor you may be, it is dumb to suffer in silence.