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Oil and Gas Master Limited Partnerships At Issue In FINRA Arbitration Case Won By Customer

Oil Drilling RIgsIf your financial advisor has recommended an unsuitable investment in a Master Limited Partnership (or “MLP”) without a reasonable basis for the recommendation, you may be able to recover losses through arbitration before the Financial Industry Regulatory Authority (“FINRA”).  Recently, a three-member all public FINRA arbitration panel ordered RBC Capital Markets and one of its registered representatives to pay $723,000 to a former client, an elderly customer from Norwell, MA, in connection with losses sustained on an overconcentrated portfolio of oil and gas MLPs (FINRA Case No. 17-0305 – Nourie, et al v. RBC Capital Markets).




The investments at issue before the panel in the Nourie case included the following:

  • Breitburn Energy Partners (OTC MKTS: BBEPQ);
  • Enable Midstream Partners (NYSE: ENBL);
  • Enterprise Products (NYSE: EPF);
  • Ferrellgas Partners (NYSE: FGP);
  • JP Energy Partners;
  • Mid Con Energy Partners (NASDAQ: MCEP);
  • Southcross Energy Partners (NYSE: SXE);
  • Summit Midstream Partners (NYSE: SMLP);
  • Tallgrass Energy Partners (NYSE: TEP);
  • CrossAmerica Partners (NYSE: CAPL) (former ticker – LGP);
  • Enlink Midstream Partners (NYSE: ENLK).

When a broker recommends an investment to a customer, the financial advisor must first conduct due diligence on that investment.  In addition, the broker and by extension his or her employer, must conduct a suitability analysis in order to determine if that investment is suitable in light of the customer’s stated investment objectives and associated criteria, including the investor’s age, net worth and income, risk tolerance and prior experience with investing.  Further, the broker has an affirmative duty to disclose the risks associated with an investment to their customer.

In recent years, many retail investors have been solicited to invest in MLPs.  Unfortunately, in some instances, investment recommendations were made to invest in MLPs without full disclosure of their risky nature.  The following non-exhaustive list highlights just some of the primary risks associated with investing in MLPs:

  • Energy Sector Risk: the most obvious risk associated with MLPs has to do with the underlying commodity to which the vast majority of MLPs are linked: oil. Because oil is a commodity, and as such has (and will likely continue) to experience extreme volatility through boom and bust cycles, brokers must inform investors of the considerable risk associated with large commodity price swings and the potential negative impact on the profitability and viability of a given MLP;
  • Ownership Structure Risk / Conflicts of Interest: simply put, MLPs are businesses that operate under a partnership structure rather than as a typical C-Corporation (“C-Corp”). Unlike investors in traditional C-Corp businesses that own shares of stock in the company, investors in MLPs own Units. An MLP is managed by a General Partner (“GP”) that is responsible for overseeing the business operations of the MLP on behalf of the Unitholder investors, or Limited Partners (“LPs”).  GPs typically hold a small stake in the actual partnership (generally around 2%), but also receive Incentive Distribution Rights (“IDRs”).  These IDRs present a real risk to investors, because the GP is entitled to receive a higher percentage of cash distributions over time as cash flows grow.  As a result, the GP has a conflict of interest with the Unitholder LPs.  Further exacerbating this risk, LPs have no voting rights under the MLP structure, unlike investors in a corporation who own common stock.
  • Capital Market Risk: in order to operate in the cash-intensive oil and gas sector, MLPs are extremely dependent on the deep liquidity associated with capital markets to facilitate and continue their growth. In addition, because of the high percentage of revenues that are paid to MLP Unitholders each quarter in the form of distributions, MLPs are very dependent on capital markets, often for debt issuance. While many MLP investors have enjoyed enhanced income on their tax-advantaged investment, the fact remains that any disruption to the current status quo in our capital markets could prove very troublesome.  For example, in the event that interest rates rise substantially, an MLP seeking to borrow money through the issuance of a bond will encounter difficulty as the cost of capital to fund ongoing operations and for acquisitions will surely rise.
  • Tax Treatment Risk: probably the most worrisome risk associated with MLPs involves their tax-advantaged status. Currently, MLP Unitholders are able to enjoy favorable tax treatment because they are structured as pass-through entities that are not taxed at the corporate level. However, MLPs present an extreme risk to investors in the form of a potential tax obligation.  Specifically, in the event that an MLP enters bankruptcy or needs to restructure its debt, then the Partnership may wind up forgiving a portion of its debt.  As a result, the LP Unitholder can be left a sizeable tax bill on so-called phantom income, because the “cashless income” associated with the bankruptcy or restructuring is treated as ordinary income for tax purposes.  Thus, LP Unitholders in poorly performing MLPs can theoretically lose more than 100% of their initial investment!

Brokers and brokerage firms who have steered their clients into unsuitable non-conventional investments  including oil and gas investments, may be liable for investment losses sustained, particularly where a customer’s account was allowed to become over-concentrated in non-conventional investments.  The attorneys at Law Office of Christopher J. Gray, P.C. have significant experience in representing investors in the oil and gas investments, including oil and gas private placements, drilling funds, and other energy-related investment products.  To find out more about your legal rights and options, contact a securities arbitration lawyer at Law Office of Christopher J. Gray, P.C. at (866) 966-9598 or via email at for a no-cost, confidential consultation.

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