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Master Limited Partnerships (MLPs) – Income Tax Liabilities Could Decimate Investors

On March 9, 2016, the Wall Street Journal reported that investors in energy-related Master Limited Partnerships (“MLP Investors Face Tax Hit on Top of Big Losses”) face the prospect of “worse things than going to zero” as a prospective “wave of expected bankruptcy filings and debt restructurings could trigger taxes for investors at a number of energy firms”

Master Limited Partnerships (MLPs) are a corporate structure that do not pay any taxes at the corporate level, but instead pass along their income – and certain tax burdens – to shareholders.

Unfortunately, the “collapse in oil and gas prices has exposed the structure’s double-sided risk: Investors with potentially worthless shares – or units, as they are known – may nonetheless owe taxes on debt that is forgiven in a bankruptcy or an out-of-court restructuring” since “debt forgiven in a restructuring counts as noncash income, or cancellation of debt income, which creates a tax liability for investors without an associated cash distribution.”

As noted by the Wall Street Journal, “the roughly 60% plunge in oil prices since the summer of 2014 already has sent a number of energy companies into bankruptcy court, and more are expected to follow.”

Clearly investors have soured on MLPs, which sometimes yielded more than 10% a year at a time when Treasury bonds were yielding pennies on the dollar, as many of them have cut or halted their distributions to investors. For example, the “Alerian MLP Index, which tracks about 50 large energy partnerships, has lost nearly half its value over the past 18 months.”

Among the energy vulnerable MLPs cited in the article, whose “debt is trading at distressed levels,” are Linn Energy LLC (NASDAQ – LINE), Breitburn Energy Partners LP (NASDAQ – BBEP) and Atlas Resource Partners LP (NYSE – ARP).

Many retail investors clearly “weren’t told they were buying a high-risk product with potential tax traps” and a number of industry professionals openly have questioned whether MLPs should ever have been recommended to investors in an account that was not tax-deferred (such as a retirement account) which would have shielded them from the negative tax implications.

As Merrill Lynch recently noted in a February 17th research report (“Master Limited Partnerships: Malaise, Loathing, Pessimism”) which accompanied the downgrading of 7 MLPs, this is a “humiliated asset class” for which “the humiliation continues.”

For many retail investors, the question remains just how expensive will their financial humiliation ultimately be.

If you are an individual or institutional investor who has any concerns about your investment in any Master Limited Partnership (MLP), 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).

Fitch Rating Downgrades Hit Business Development Companies (BDCs)

Earlier this week, Fitch Ratings announced the completion of its periodic review of Business Development Companies (BDCs) – publicly traded firms that mostly make loans to mid-sized companies.

The review, which was comprised of 10 publicly rated firms, resulted in one-half of the 10 companies being either downgraded or otherwise assigned a negative outlook.

As noted by Fitch in its announcement, “Fitch’s outlook for the BDC sector is negative and reflects competitive underwriting conditions, earnings pressure, underperforming energy investments, unsustainable asset quality metrics, increased activist pressure, and limited access to growth capital. While some firms are better positioned, given their more conservative financial profiles and portfolio characteristics, others are likely to see rating pressure over the outlook horizon.”

Among the actions that were taken as a result of this peer review were the following:

– American Capital, Ltd. (NASDAQ – ACAS): Its ratings were placed on Rating Watch Negative;

– Apollo Investment Corporation (NASDAQ – AINV): Its Long-term Issuer Default Rating (IDR) was downgraded to ‘BBB-‘ from ‘BBB’ with a Rating Outlook of Negative;

– BlackRock Capital Investment Corporation (NASDAQ – BKCC): Its Long-term Issuer Default Rating was affirmed at ‘BBB-‘ with a Rating Outlook of Negative;

– Fifth Street Finance Corp. (NASDAQ:FSC): Its Long-term Issuer Default Rating was downgraded to ‘BB’ from ‘BB+’ with a Rating Outlook of Negative; and

– PennantPark Investment Corporation (NASDAQ: PNNT): Its Rating Outlook was revised to Negative from Stable.

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).

Business Development Companies – A High Wire Balancing Act Without A Safety Net?

A March 7th article in the Sarasota Herald Tribune (“Business Development Companies: Good Income Investment or Trap”) properly noted that, “in today’s historically low interest rate environment, investors hungry for higher yields have stumbled upon a somewhat obscure class of securities called Business Development Companies (BDCs).”

BDCs, investment entities that were created by Congress in 1980, are traded on stock exchanges and are required to invest at least 70 percent of their assets in the non-public debt and equity of small and middle-market U.S. companies. They annually distribute at least 90 percent of their income to stockholders.

Investors may be failing to appreciate that there are a number of risks intrinsic to BDCs, however, including their: underlying company credit and investment risk; leverage risk, as BDCs borrow money to make investments; illiquidity risk, as the underlying companies may have no ready market; and capital-markets risk, as BDCs rely on being able to easily borrow money to make new investments.

The shorter-term performance of BDC’s has been disappointing with the average BDC down about 10 percent since the beginning of 2016, more than the S&P 500. The catalysts for this decline range from fears of rising interest rates to concerns about the soundness of their underlying investments.

Although, historically, BDCs have yielded over 1.5 percentage points more than high-yield bonds and 7 percent more than 10-year U.S. Treasury securities, BDCs are quite volatile investments compared with U.S. stocks in general and even more so with high-yield bonds. They have, for example, about 2.5 times the volatility of high-yield bonds.

Investors need to carefully analyze any BDC’s prospects before investing. Additionally, investors need to be confident they can deal with BDC’s high volatility. In short: BDCs are only suitable for aggressive investors.

If you are an individual or institutional investor who has any concerns about your investment in any BDC product, 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).

FBI Raids Corporate Headquarters of United Development Funding – Investors Face Devastating Losses on Their Investments

As disclosed by The Wall Street Journal on February 18, 2016 (“FBI Raids Headquarters of United Development Funding”), agents from the Federal Bureau of Investigation, armed with search warrants, raided the headquarters of this sponsor of real estate investment trusts and other investment vehicles and seized documents and other materials in what appears to be an expanding criminal investigation of UDF.

UDF, which has reportedly raised about $1 billion from retail investors for its non-traded real estate investment trusts, has been the subject of a number of criticisms and negative allegations in the past few months which have focused on the company’s concentrated lending practices (reportedly about 99% of the United Development Funding IV program’s loans have been made in Texas and, of that amount, approximately 67% of the loans have been advanced to a single borrower – Centurion American Development and its affiliates) and the contention that new money being raised has been used to repay earlier investors in its programs.

As to be expected with this latest development, shares of UDF’s largest fund, United Development Funding IV, crashed when news of the FBI’s raid hit the tape – falling 54% before trading was halted. Since December of 2015, the shares have now lost more than 80% of their value.

If you are an individual or institutional investor who has any concerns about your investment in any United Development Funding program, 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 Related Bonds & Structured Notes – A Potential Wolf in Sheep’s Clothing?

As noted in a February 5, 2016 article in The Wall Street Journal (“The Oil Rout’s Surprise Victims”), the epic collapse in the price of oil, from more than $100 per barrel less than two years ago to below $30 last week, has “crushed investors in the futures market, energy partnerships, high-yield corporate bonds and the shares of oil and gas companies.”

But there is another sector of the energy market – short term bonds and structured notes issued by major investment firms whose returns are linked to the price of oil or other energy-related assets – that could also be decimated in the coming months unless there is a significant recovery in oil prices.

These securities, which have been sold to wealthy families and individual investors who want to limit the risk or amplify the return of more-conventional investments, often carry such alluring nicknames as “Phoenix,” “Plus,” “Enhanced Return” or “Accelerated Return.” They typically mature in two years or less and pay commissions of about 2% to the brokerages that sell them which has included units of Bank of America, Citigroup, Credit Suisse, Goldman Sachs, J.P. Morgan Chase, Morgan Stanley and UBS.

Unfortunately, they use intricate combinations of options contracts to skew the payoffs from changes in energy prices: investors can make a lot of money if oil goes up a little, and they can lose much or all of their money if it goes down a lot. At current prices, most of these securities are underwater and there will have to be a significant increase in the price of oil (estimated at 50% to 100%) for them to return to their original value.

As noted by Craig McCann, principal at Securities Litigation and Consulting Group, a research firm in Fairfax, Virginia and one of the leading experts in the securities field, “this is not really an investment strategy so much as a wager on which way oil prices are going” and “some of the risks and costs of that wager are masked by the complexity of it.”

Furthermore, there isn’t any secondary trading in most of these securities, meaning that the issuing bank may often be the only buyer which, more often than not, does not benefit the investors who own them.

If you are an individual or institutional investor who has any concerns about your investment in any energy related bonds or structured notes, 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).

Breaking Bad, the Junk Bond Edition

Junk bonds, better known as high-yeild debt have seen much better days and strategists say that investors may be focusing too much on the role energy has played in the decline while underestimating other risks.

According to Matthew Mish, global credit strategist at UBS “Energy, bond valuations are pricing in an uplift in underlying commodities, so there’s more downside risk if prices hold at these levels for a long time or go lower,” And elsewhere, he added, “we do not see a marginal buyer for lower-quality credit.”

David Kotok, chairman and chief executive of Cumberland Advisors, worries more about the currency risk. “Foreign currencies — even those in developed markets such as Canada — have been crushed under a strong United States dollar. Over the past year, the Canadian loonie has fallen 17 percent against the American currency; the Brazilian real has plummeted 34 percent”, says Kotok.

Joseph F. Kalish, chief global macro strategist at Ned Davis Research concern is for the market damage seems to be spreading beyond commodities. Kalish says, “That’s what has gotten me more concerned this time around, compared to the generalized, risk-off sell-off we had in the middle of last year,”.

SEC Releases Examination Priorities for 2016

Released by the Office of Compliance Inspections and Examinations of the Securities and Exchange Commission, Examination Priorities for 2016.

Goldman Sachs to Pay $5B To End MBS Probes

CEO Lloyd Blankfien of Goldman Sachs plans on paying $5.06B to end federal and state investigations of its underwriting and sale of mortgage-backed securities from 2005 to 2007. The investment banking giant will pay $2.3B in civil penalties, $875M in cash payments, and $1.8B in consumer relief to settle all claims. The payout will lop off $1.5B from Goldman Sachs’ after-tax earnings, according to Law 360.

2016 FINRA Regulatory and Examination Priorities Letter Released

Each year, FINRA publishes its Annual Regulatory and Examination Priorities Letter to highlight issues of importance to FINRA’s regulatory programs, Regulatory and Examination Priorities Letter.

Many of the concerns in last year’s letter remain priority again for 2016. With the recent increase in interest rates, FINRA reiterates the worries mentioned in last year’s letter regarding interest rate-sensitive products. Firms are urged to evaluate their product offerings to determine where heightened concerns about interest rate sensitivity are relevant.

FINRA Chairman & CEO Richard Ketchum says, “Firm culture, ethics and conflicts of interest also remain a top priority for FINRA. A firm’s culture contributes to, and is also a product of, a firm’s supervision and its approaches to identifying and managing conflicts of interest and the ethical treatment of customers. Given the significant role culture plays in how a firm conducts its business, this year the letter addresses how we will formalize our assessment of firm culture to better understand how culture affects a firm’s compliance and risk management practices.”

Liquid Alternative Funds – Market Volatility Exposes Hidden Risks

As noted in a December 31, 2015 article in The Wall Street Journal (“The Year the Hedge-Fund Model Stalled on Main Street”), more “liquid alternative” mutual funds closed in 2015 than in any year on record, according to research firm Morningstar Inc., due, in significant part, to increased market volatility.

In all, according to Morningstar, 31 liquid-alternative funds closed in 2015, up from 22 a year earlier, as inflows dwindled and performance weakened.

The results show that enthusiasm is fading for what had emerged in recent years as one of the hottest products in asset management – funds that combine hedge-fund strategies like shorting stock with the daily liquidity of mutual funds.

Assets in liquid-alternative funds grew to $310.33 billion at the end of 2014 from $124.44 billion at the end of 2010. But the inflows have slowed as performance faltered in 2015 – in fact, it is estimated, according to the WSJ article, that just $85.1 million flowed into liquid-alternative funds in 2015.

The host of funds liquidated this past year included strategies run by J.P. Morgan Asset Management, Guggenheim Partners LLC and Whitebox Advisors LLC. The closed funds were a range of unconstrained bond funds; managed future funds, which bet on futures contracts in a number of markets; and equity funds that bet on stocks rising and falling – are of which tend to have highly concentrated bets that expose investors to riskier assets than typical mutual funds do.

If you are an individual or institutional investor who has any concerns about your investment in any liquid alternative fund, 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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