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MADDOX: Let’s better protect our retirement accounts

Attorney Mark Maddox wrote an article for the Indianapolis Business Journal this past week on the topic of protecting our retirement accounts.

Here is a link to the article:

http://www.ibj.com/articles/58208-maddox-lets-better-protect-our-retirement-accounts

Master Limited Partnerships (MLPs) in Retirement Accounts – Recipe for Disaster?

One of the hottest investment products being pitched by Wall Street, in the low interest environment that has persisted over the past few years, has been Energy Master Limited Partnerships (“MLPs”) – an investment product with above average yields and, all too often, above average commissions for the financial advisors who have touted them.

Unfortunately, for many investors, one of the material facts associated with MLPs, that never seems to have been included in the sales presentations of their financial advisors, is the fact that tax-exempt accounts, such as IRAs and employee benefit plans, may incur substantial income tax liabilities if they own a MLP.

There is a concept in the tax code (I.R.C. §§511-514) called “unrelated business income tax” (“UBIT”). Under the UBIT rules, tax-exempt organizations and retirement accounts must pay tax on their “unrelated business taxable income” (UBTI) – income from a business that is not related to their exempt purpose.

If your IRA invests in an MLP, it becomes a limited partner in that MLP, just as you would if you invested directly. Because an MLP, like all partnerships, is a pass-through entity (no tax paid by the partnership, all tax items flow through to the limited partners/shareholders, who pay tax on their share), the partners are treated by the tax code as if they are directly earning the MLP’s income. Thus, as a partner in the MLP, the IRA or other account is considered to be “earning” its share of the MLP’s business income. The MLP’s business is not related to the retirement account’s tax-exempt purpose; therefore the IRA’s share of the MLP’s income is treated as UBTI and is taxed accordingly.

The latest U.S. Securities & Exchange Commission filings by a number of energy-related MLPs provide a clear example of the undisclosed income tax ramifications that could potentially impact investors in these products.

A case in point is clearly illustrated, for example, by the specific risk factor disclosure that was contained within the annual report (“Form 10-K”) that was filed by Energy Transfer Partners, L.P. (NYSE:ETP) on February 29, 2016 for its fiscal year that ended on December 31, 2015:

Tax-exempt entities and non-U.S. persons face unique tax issues from owning Common Units that may result in adverse tax consequences to them.

“Investment in Common Units by tax-exempt entities, including employee benefit plans and individual retirement accounts (known as IRAs) and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to Unit holders who are organizations exempt from federal income tax, including IRAs and other retirement plans, will be ‘unrelated business taxable income’ and will be taxable to them . . . If you are a tax exempt entity or non-U.S. person, you should consult your tax advisor before investing in our common units.”

Another clear illustration is the specific risk factor disclosure that was contained within the annual report (“Form 10-K”) that was filed by Plains All American Pipeline L.P. (NYSE:PAA) on February 25, 2016 for its fiscal year that ended on December 31, 2015:

Tax-exempt entities and non-U.S. persons face unique tax issues from owning our common units that may result in adverse tax consequences to them.

“Investment in common units by tax-exempt entities, such as employee benefit plans and IRAs, and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them . . . Tax-exempt entities and non-U.S. persons should consult their tax advisor before investing in our common units.”

Finally there is the specific risk factor disclosure that was contained within the annual report (“Form 10-K”) that was filed by Buckeye Partners L.P. (NYSE:BPP) on February 25, 2016 for its fiscal year that ended on December 31, 2015:

Tax-exempt entities and non-U.S. persons face unique tax issues from owning our LP Units that may result in adverse tax consequences to them.

“Investment in LP Units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (“IRAs”), and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them . . . If you are a tax-exempt entity or a non-U.S. person, you should consult your tax advisor before investing in our LP Units.”

The common theme that emerges from all of these risk disclosures – investors in MLPs who hold these products in their retirement accounts or other tax-exempt accounts may owe taxes, in some instances substantial taxes, on the “unrelated business income” that is allocated to their holdings.

If you are an individual or institutional investor who has any concerns about your investment in any Master Limited Partnership investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Energy Master Limited Partnerships (MLPs) – What Your Financial Advisor Never Told You

One of the hottest investment products being pitched by Wall Street, in the low interest environment that has persisted over the past few years, has been Energy Master Limited Partnerships (“MLPs”) – an investment product with above average yields and, all too often, above average commissions for the financial advisors who have touted them.

Unfortunately, for many investors, one of the material facts associated with MLPs, that never seems to have been included in the sales presentations of their financial advisors, is the fact that investors in these products often have to file income tax returns in every state where the MLP conducts its business.

The latest U.S. Securities & Exchange Commission filings by a number of energy-related MLPs provide a clear example of the undisclosed income tax ramifications that could potentially impact investors in these products.

A case in point is clearly illustrated, for example, by the specific risk factor disclosure that was contained within the annual report (“Form 10-K”) that was filed by Energy Transfer Partners, L.P. (NYSE:ETP) on February 29, 2016 for its fiscal year that ended on December 31, 2015:

Unitholders will likely be subject to state and local taxes and return filing requirements in states where they do not live as a result of investing in our Common Units.

“In addition to federal income taxes, the Unit holders may be subject to other taxes, including state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business or own property now or in the future, even if they do not live in any of those jurisdictions. Unitholders may be required to file state and local income tax returns and pay state and local income taxes in some or all of the jurisdictions. We currently own property or conduct business in many states, most of which impose an income tax on individuals, corporations and other entities. As we make acquisitions or expand our business, we may control assets or conduct business in additional states that impose a personal or corporate income tax. Further, Unitholders may be subject to penalties for failure to comply with those requirements. It is the responsibility of each Unitholder to file all federal, state and local tax returns.”

Another clear illustration is the specific risk factor disclosure that was contained within the annual report (“Form 10-K”) that was filed by Buckeye Partners, L.P. (NYSE:BPL) on February 25, 2016 for its fiscal year that ended on December 31, 2015:

You will likely be subject to state and local taxes and income tax return filing requirements in jurisdictions where you do not live as a result of investing in our LP Units.

“In addition to U.S. federal income taxes, you may be subject to other taxes, including non-U.S., state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business or own property now or in the future, even if you do not live in any of those jurisdictions.  You will likely be required to file non-U.S., state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions.  Further, you may be subject to penalties for failure to comply with those requirements.  We own property and conduct business in a number of states in the United States.  Most of these states impose an income tax on individuals, corporations and other entities . . . As we make acquisitions or expand our business, we may own assets or conduct business in additional states or non-U.S. jurisdictions that impose a personal income tax.  It is a unit holder’s responsibility to file all non-U.S., federal, state and local tax returns.”

Finally there is the specific risk factor disclosure that was contained within the annual report (“Form 10-K”) that was filed by Enterprise Product Partners L.P. (NYSE:EPD) on February 26, 2016 for its fiscal year that ended on December 31, 2015:

Our common unitholders will likely be subject to state and local taxes and return filing requirements in states where they do not live as a result of an investment in our common units.

“In addition to federal income taxes, our common unit holders will likely be subject to other taxes, such as state and local income taxes, unincorporated business taxes and estate, inheritance or intangible taxes imposed by the various jurisdictions in which we do business or own property even if the unit holder does not live in any of those jurisdictions.  Our common unit holders will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions.  Further, our unit holders may be subject to penalties for failure to comply with those requirements. We currently own property or conduct business in many states, most of which impose an income tax on individuals, corporations and other entities.  As we make acquisitions or expand our business, we may control assets or conduct business in additional states that impose a personal or corporate income tax.  It is the responsibility of each unit holder to file its own federal, state and local tax returns, as applicable.”

The common sense interpretation of this complicated legalese – investors in MLPs may owe state and local taxes, in some instances substantial taxes, in every state where their MLP conducts its business and may incur substantial penalties if they fail to file the required tax returns in all of the applicable states.

If you are an individual or institutional investor who has any concerns about your investment in any Master Limited Partnership investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Sticker Shock for Investors in Direct Participation & Non-Traded REIT Products

Investors in a multitude of direct participation and non-traded REIT products are about to get a rude awakening as to the value of their investments.

On April 11, 2016, new rules were implemented by the Financial Industry Regulatory Authority (“FINRA”) which substantially modified the requirements relating to the inclusion of per share estimated values for direct participation program (DPP) and unlisted/non-traded real estate investment trust (REIT) securities on customer account statements.

Prior to these new rules, many brokerage firms had used the original offering price of DPP and REIT securities as the per share estimated value during the offering period, which could continue for as long as seven and one-half years. The offering price, typically $10 per share, often remained constant on customer account statements during the offering period even though various costs and fees had reduced investors’ principal and the underlying DPP and REIT assets may have decreased in value.

As a result, the true value of many of these investments was concealed from investors who were falsely led to believe – for years – that their shares were still worth $10.00 per share.

Brokerage firms will now be required to provide more accurate per share estimated values on customer account statements, shorten the time period before a valuation is determined based on an appraisal and provide various important disclosures.

In fact, under the new rules, brokerage firms will be required to include in customer account statements a per share estimated value for a DPP or REIT security developed in a manner reasonably designed to ensure that the per share estimated value is reliable.

The two methodologies for calculating the per share estimated value for a DPP or REIT security, that will be deemed to have been developed in a manner reasonably designed to ensure that it is reliable, are:

(a) the net investment methodology which will reflect either the ‘‘amount available for investment’’ percentage in the “Estimated Use of Proceeds’’ section of the offering prospectus or, where the ‘‘amount available for investment’’ is not provided, the amount which reflects the estimated percentage deduction from the aggregate dollar amount of securities registered for sale to the public of sales commissions, dealer manager fees and estimated issuer offering and organization expenses; or

(b) the appraised value methodology which will reflect the appraised valuation of the assets and liabilities disclosed in the most recent periodic or current report filed with the SEC by the issuer of the DPP or REIT.

Any brokerage firm that uses the “net investment” valuation methodology will also be required to prominently disclose, if applicable, enhanced disclosure relating as to whether any part of their distribution from the DPP or REIT investment included a return of the investor’s own capital.

Finally, brokerage firms will now be required to disclose that the DPP or REIT securities are not listed on a securities exchange, are generally illiquid and that, even if a customer is able to sell the securities, the price received may be less than the per share estimated value provided in the account statement.

If you are an individual or institutional investor who has any concerns about your investment in any direct participation or non-traded REIT investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Attorney Mark Maddox particpated in ABA’s 18th Annual Spring Conference

Attorney Mark Maddox sat on a panel to discuss his work on the FINRA Task Force Report last Friday at the American Bar Association’s 18th Annual Spring Conference.

A Warning Shot Across the Bow for Investors in Business Development Companies (“BDCs”)

An April 10, 2016 article in The Wall Street Journal (“A $2.5 Billion BDC Halts Redemptions After Limit Reached”) describes how volatile markets have prompted a “rush of investors” to attempt to redeem their investments in non-traded Business Development Companies.

The Business Development Corporation of America (“BDCA”), a $2.5 billion fund, said in a securities filing last month that it is halting redemptions for the quarter after the fund’s pre-established limit was hit. The move comes as volatile markets have hurt some of the value of the underlying assets of such funds, prompting investors to flee over the past several months.

Even in normal times, non-traded business development companies typically only allow investors to cash out every three months. This, however, appears to be the first time one has bumped up against internal restrictions that limit the amount of shares a fund is able to redeem at one time, experts say. The fund had limited redemptions to 2.5% of its outstanding shares per quarter, which is typical for its peers.

Investors had reportedly asked to cash in about 7.4 million shares, but the fund allowed only 41% of those redemptions, according to the filing dated March 11.

The fund’s net asset value fell by 7.9% last year. The shares that were redeemed were worth about $28 million, the filing shows.

Non-traded BDCs make loans to small and medium-size companies with less than stellar credit. They attracted $22 billion from investors over the past several years, as interest rates near zero sent investors in search of higher yields.

BDCA, which invests in loans to midsize companies in the U.S., is among the largest. In addition to halting redemptions in its latest offering, the fund recently changed its policy to allow withdrawals only twice a year rather than once a quarter. Investors will be able to cash in as much as 5% of the fund’s outstanding shares in each of those periods.

Investors pulled a total of $64 million from non-traded BDCs in the fourth quarter of 2015, the latest data available, up from withdrawals of $47 million in the third quarter, setting another industry record, according to Summit Investment Research.

More funds are likely to hit the redemption limit if the trend towards escalating redemptions should continue.

As noted in the article, although the funds typically promise protection from market volatility and yields as high as 8%, they include a number of risks to investors which include withdrawal limits, upfront fees of at least 10% and the opinion that non-traded BDCs also are considered to be less transparent than regular mutual funds.

Sales also have been slowing as performance among the funds has dropped with the net asset value of non-traded BDCs having reportedly declined by an average of a 12.5% in 2015.

If you are an individual or institutional investor who has any concerns about your investment in any Business Development Company investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Will Energy Master Limited Partnerships (MLPs) Decimate Unsuspecting Investors?

Recent statistics indicate that there are over 110 MLPs trading on major exchanges, with oil & gas midstream activities – gathering, processing, natural gas compression, pipelines, storage, refining, distribution, and marketing – representing the dominant activity.

The latest U.S. Securities & Exchange Commission filings by a number of Energy Master Limited Partnerships (“MLPs”), however, provide yet another example of the treacherous income tax ramifications that could potentially whip saw investors if oil and natural gas prices continue to be depressed.

A case in point is clearly illustrated, for example, by the specific risk factor disclosures that were contained within the annual report (“Form 10-K”) that was filed by Energy Transfer Partners, L.P. (NYSE:ETP) on February 29, 2016 for its fiscal year that ended on December 31, 2015.

These risk factor disclosures included the following two (2) specific warnings:

Unitholders may be required to pay taxes on their share of our income even if they do not receive any cash distributions from us.

“Unit-holders will be required to pay any federal income taxes and, in some cases, state and local income taxes on their share of our taxable income even if they receive no cash distributions from us. Unit-holders may not receive cash distributions from us equal to their share of our taxable income or even equal to the actual tax liability that results from the taxation of their share of our taxable income.

In response to current market conditions, we may engage in transactions to delever the Partnership and manage our liquidity that may result in income and gain to our Unit-holders without a corresponding cash distribution. For example, if we sell assets and use the proceeds to repay existing debt or fund capital expenditures, you may be allocated taxable income and gain resulting from the sale without receiving a cash distribution. Further, taking advantage of opportunities to reduce our existing debt, such as debt exchanges, debt repurchases, or modifications of our existing debt could result “cancellation of indebtedness income” (also referred to as “COD income”) being allocated to our Unit-holders as taxable income. Unit-holders may be allocated COD income, and income tax liabilities arising therefrom may exceed cash distributions. The ultimate effect of any such allocations will depend on the Unit-holder’s individual tax position with respect to its units.”

– and –

Tax gain or loss on disposition of our Common Units could be more or less than expected.

“If Unit-holders sell their Common Units, they will recognize a gain or loss equal to the difference between the amount realized and the tax basis in those Common Units. Because distributions in excess of the Unit-holder’s allocable share of our net taxable income result in a decrease in the Unit-holder’s tax basis in their Common Units, the amount, if any, of such prior excess distributions with respect to the units sold will, in effect, become taxable income to the Unit-holder if they sell such units at a price greater than their tax basis in those units, even if the price received is less than their original cost. In addition, because the amount realized includes a Unit-holder’s share of our nonrecourse liabilities, if a Unit-holder sells units, the Unit-holder may incur a tax liability in excess of the amount of cash received from the sale.

A substantial portion of the amount realized from the sale of your units, whether or not representing gain, may be taxed as ordinary income to you due to potential recapture items, including depreciation recapture. Thus, you may recognize both ordinary income and capital loss from the sale of your units if the amount realized on a sale of your units is less than your adjusted basis in the units. Net capital loss may only offset capital gains and, in the case of individuals, up to $3,000 of ordinary income per year. In the taxable period in which you sell your units, you may recognize ordinary income from our allocations of income and gain to you prior to the sale and from recapture items that generally cannot be offset by any capital loss recognized upon the sale of units.”

The common sense interpretation of this complicated legalese – investors in MLPs may owe taxes, in some instances substantial taxes, on income that they never received.

If you are an individual or institutional investor who has any concerns about your investment in any Master Limited Partnership investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Energy Master Limited Partnerships – Investors May be the Ones Getting Drilled

As noted in an April 1, 2016 article in The Wall Street Journal (“MLP Investors’ Maze of Tax Trouble Keeps Getting Worse”), investors are learning the hard way that energy MLPs, set up to shield companies from Uncle Sam, could have unexpected tax consequences when times get tough.

It is yet another sign investors didn’t fully understand what they were getting into when they poured billions of dollars into master limited partnerships before the oil bust.

According to the article, “the implications are getting a test case in Linn Energy. When the Houston-based oil and gas producer announced plans to restructure its debt on March 22, it offered its 350,000 investors a deal many will likely jump to accept: swap their units in the MLP for an equal number of shares in LinnCo, the firm’s corporate parent. The swap will let those investors avoid a tax bill for their share of the forgiven debt, which counts as a gain. But there is a catch. Investors who exchange their Linn MLP units for shares could trigger another tax hit, because the swap counts as a sale.”

Investors in other energy-related MLPs could soon be facing similar choices.

“The energy partnerships are structured to avoid corporate income taxes by passing much of their tax burdens along with the bulk of their earnings through to investors. That arrangement worked well when oil and gas prices were rising. But with prices falling and some MLPs nearing a restructuring or bankruptcy, investors face the possibility of being left with units that have lost value and a tax bill as well, a double-hit that has surprised many investors.

The rub is the exchange of units for shares counts as a sale, and the sale of partnership units is far more complex than the sale of regular stock. For example, it can trigger a ‘recapture’ of benefits that investors have already received in their annual tax-deferred payouts for things like depletion and depreciation. Investors who exit a partnership also must take into account their units’ share of its liabilities.

At worst, an investor who opts for Linn’s offer could face both ordinary taxable income due to recapture and a capital loss, because of a steep decline in the value of the units, that can’t be used to offset it.

Investors holding Linn units in an IRA or Roth IRA could also face tax bills on the exchange of units for shares. To prevent abuses, the law imposes a special levy on certain partnership income if the total in all IRAs exceeds $1,000 a year. Even if investors holding MLPs in an IRA haven’t owed this levy on their annual payouts, a sale of units could come with a tax and capital losses within an IRA aren’t deductible.”

While the majority of IRA owners are unaware of these rules, IRA custodians are charged with enforcing them and some are reportedly watching more closely than they have in the past. Last year, Pershing reportedly filed tax forms for about 5,000 investors holding Kinder Morgan Energy Partners in IRAs after its 2014 restructuring and, most recently, Fidelity Investments has announced additional oversight of partnerships in IRAs for 2016.

If you are an individual or institutional investor who has any concerns about your investment in any energy related Master Limited Partnership investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

U.S. Protection for Retirement Investors is on the Horizon

By early April, retirement investors will most likely be better protected. President Obama and his administration aim to complete a far-reaching rule holding retirement advisers to stricter standards. The proposed rules require brokers and financial advisers to act in the best interest of retirement savers, a higher standard than current regulations, which require only that advice be suitable. We will continue to update you on this developing ruling. Wall Street Journal writer Andrew Ackerman has more on the release of this news.

Business Development Companies (BDCs) – Are Astute Investors Heading for the Exits?

As reported by The Wall Street Journal on March 19, 2016 (“These High-Fee, Unlisted, Junk-Based Funds Aren’t Working Out”), investors who poured $22 billion into an obscure Wall Street investment product known as “Non-Traded Business Development Companies (BDCs)” are now pulling out record sums.

BDCs are built out of loans to small and medium-size companies with less than stellar credit, but are less transparent than regular mutual funds, typically make investors pay upfront fees of at least 10% and only accept withdrawal requests once a quarter.

According to an analysis reported by the WSJ, “the move to the exits is accelerating. Investors pulled $47.3 million out of nontraded BDC’s in the third quarter of 2015, up from $25.7 million in the second quarter” and “performance has been slipping, too. Across the industry, the value of the funds’ assets at the end of September was on average 16% lower than their initial offering price to investors.”

Non-traded BDCs were part of a fast-growing class of alternative, high-commission investments sold to individual investors in recent years. Marketing materials promised steady dividends, yields as high as 8% and a haven from volatile markets, according to fund documents and executives.

The fees, though, exceed those of most products pitched to retail investors. For example, one non-traded BDC, cited in the WSJ article, said in its disclosures that its 10% sales load and likely 2% offering expenses mean only $88 of every $100 of shares bought “will actually be invested in us…you would have to experience a total return on your investment of between 14% and 18% in order to recover these expenses.”

Meanwhile, “Wall Street continues to push the products while regulators are watching closely.” Paul Mathews, Finra’s vice president for corporate financing, was quoted in the WSJ article as having said the products are an ‘ongoing concern’ for the regulator and that ‘firms must ensure they are suitable for an investor’s risk profile and investment strategy.’

Part of what concerns regulators is that non-traded BDCs are being sold using many of the same networks of brokerage firms and typically charging the same high upfront commissions as non-traded real estate investment trusts – another product with a multitude of significant issues.

“It’s kind of like weeds,” said William Galvin, the top Massachusetts securities regulator. “You whack them in one part of the garden, but they come up in another.”

If you are an individual or institutional investor who has any concerns about your investment in any Business Development Company (BDC), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).


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