Interpretive Release Limited Partnership Reorganizations and Public Offerings of Limited Partnership Interests 33-6900, 34-29314

Federal Register / Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations
SECURITIES AND EXCHANGE
COMMISSION
17 CFR Parts 231 and 241
[Release Nos. 33-6900; 34-29314]
Limited Partnership Reorganizations
and Public Offerings of Limited
Partnership Interests
AGENCY: Securities and Exchange
Commission.
ACTION: Interpretive release.
SUMMARY: The Commission today is
announcing the publication of a release
setting forth its views concerning
existing disclosure requirements
applicable to limited partnership roll-up
transactions and initial public offerings
of limited partnership units and other
similar securities. These interpretations
are necessary in order to address the
concerns that have been expressed
recently by investors, Congress and
other interested parties. The intended
effect of this release is that registrants
will provide investors with clear,
concise and understandable disclosure
of material information about these
transactions and offerings.
EFFECTIVE DATE: June 17, 1991.
FOR FURTHER INFORMATION CONTACT.
Michael L. Hermsen, Amy S. Bowerman,
or Meredith B. Cross at (202) 272-2573,
Division of Corporation Finance,
Securities and Exchange Commission,
450 5th Street, NW., Washington, DC
20549.
SUPPLEMENTARY INFORMATION: Serious
concerns have been expressed about the
complexity and length of prospectuses,
proxy statements and other disclosure
documents used in connection with roll-
ups of limited partnerships. This
interpretive release addresses the
application of current requirements to
roll-ups and offerings of limited.
partnership interests and the companion
release proposes rule revisions.1
Together, these releases are intended to
improve the overall quality and
readability of disclosure documents
used in roll-up transactions. This release
also sets forth the Commission's views
on the application of existing disclosure
requirements to initial offerings of
limited partnership interests. This
release emphasizes the risks of investing
in a limited partnership and the
restrictions that state partnership laws
and limited partnership agreements
place on investor rights in an effort to
' The companion release publishes for comment
proposed rules applicable to limited partnership
roll-up transactions and is being issued concurrently
by the Commission. See Securities Act Release No.
33-6899 (June 17,1991).
assure that investors are apprised of the
risks and limited rights often associated
with an investment in a limited
partnership. Finally, this release sets
forth the Commission's views as to the
application of disclosure requirements
to registration statements of real estate
investment trusts as well as non-real
estate limited partnership offerings.
I. Background
Since January 1, 1985, 68 roll-ups
involving two or more entities have
been registered with the Commission.
These roll-ups have involved
approximately 1,800 entities, 1.2 million
investors and an aggregate exchange
value of $7.1 billion.
In a roll-up transaction, a sponsor
consolidates two or more public or
private limited partnerships or other
pass-through investment vehicles into a
single entity, or reorganizes a single
partnership. In most cases, the roll-up
transaction results in a conversion of a
limited partner's interest from a finite-
life to an infinite-life interest.
While roll-up transactions can be
structured in different ways, these
transactions typically are accomplished
through a merger of the existing entities
into a successor entity.I Investors in the
existing entities receive an interest,
usually equity, in the successor entity.
The successor generally is either a
newly formed corporation or limited
partnership. Before a sponsor may
proceed with a roll-up/merger, it must
receive approval of the transaction from
a requisite number of limited partners in
each limited partnership, most often the
holders of a majority of the outstanding
limited partnership interests. Whereas
the securities of the existing entities for
the most part are thinly traded in the
pink sheet secondary markets or not
traded at all, ,the securities of the
successor entity often are listed on the
New York Stock Exchange, the
American Stock Exchange or traded on
the National Association of Securities
Dealers' ("NASD's") Automated
Quotation system.
Roll-ups have created considerable
controversy and have generated a
variety of criticisms, many of which
were highlighted in a series of
Congressional hearings on limited
partnership roll-ups. Criticisms have
focused primarily on issues relating to
the fairness of the transactions and the
2 A roll-up may also be effected through an
exchange offer. Unlike a merger, an exchange offer
will not compel a limited partner to give up his
original investment, even if a maiority of the other
limited partners in the partnership choose to
participate in the roll-up. Approximately 11% of the
roll-ups have been conducted as exchange offers.
less so in more recent years.
general partners' conflicts of interest, as
well as the inadequacy of the disclosure.
The fairness of the methods used to
value the securities issuable in exchange
for investors' limited partnership
interests has been questioned. Another
area of concern has been the significant
discount at which the price of the
security received in the roll-up trades in
the secondary market.
Serious issues have been raised with
respect to general partners' fiduciary
duties to the limited partners, including
their potential conflicts of interest and
lack of independence in structuring and
negotiating the terms of a transaction.
Critics have questioned the potential
overreaching by the general partners
inherent in the increased benefits, in
terms of compensation, ownership
interests and dilution of investors'
voting rights, accruing to them in most
roll-up transactions. These increased
benefits typically include payments for
general partnership interests and
changes in compensation arrangements.
Additional complaints have been
raised with respect to fundamental
changes that a roll-up may bring about
in the future operations of the successor
entity. These changes frequently relate
to the entity's borrowing policies,
business plan, investment objectives,
intended term of existence and voting
rights of investors. Limited partners
objecting to a roll-up transaction have
especially criticized the absence of any
legal or equitable alternative to the
transaction. The "cram down" effect on
objecting partners is perceived as unfair.
Investors may have acquired limited
partnership interests for several
reasons. A principal reason may have
been the expectation of the pass-through
of tax benefits, s accompanied by the
safety of limited liability. When a roll-up
is proposed, investors, despite the
disclosures in the original offering
document, have been surprised to
discover how limited their rights are
under state laws and the partnership
agreements. Many of the state law
protections afforded corporate
shareholders are not provided to limited
partners.
"Prior to major revisions to the federal tax code
beginning in 1984, limited partnerships afforded
individual investors the opportunity to invest and to
receive substantially the same tax treatment and
cash distributions as a direct investment in the
asset itself would have provided.
Various changes in the tax code since 1984 have
reduced-or eliminated the tax shelter and other tax
benefits of an investment in a limited partnership.
At the same time, industries that have principally
relied on the partnership format for raising capital.
such as oil and gas and real estate, have suffered
substantially. As a result, many limited partnership
interests have lost much of their value.
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28980 	Federal Register / Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations
Investors also have complained about
the comprehensibility and sufficiency of
the disclosure provided in connection
with roll-ups. The Commission has
undertaken three initiatives to address
the perceived problems. First, the
Division of Corporation Finance
("Division") has incorporated into its
review and comment process a number
of disclosure suggestions made by
commenters and participants in these
transactions. 4
Second, the Commission is, in this
release, setting forth its views of
existing disclosure requirements
applicable to limited partnership roll-up
transactions and initial public offerings
of limited partnership units. This release
is intended to assist registrants in
assuring that investors are provided
clear, concise and understandable
disclosure about these transactions and
offerings.
Third, the Commission is proposing
amendments to its rules to enhance the
clarity, as well as the substance, of the
disclosures provided to investors in
connection with roll-ups. The
Commission also is reviewing its
requirements applicable to partnership
offerings to assess the need for any
amendments.
The NASD recently has proposed to
amend its rules to prohibit member
brokers and investment advisers from
receiving differential compensation in
connection with roll-up transactions. 5
Pending public comment on and
Commission approval of the NASD's
proposed rule change, prominent
disclosure is required of such
arrangements, as well as the potential
conflicts of interest inherent in this fee
structure. 6
'In December 1989, one participant, Liquidity
Fund, provided to the staff a number of helpful
suggestions to provide clearer disclosures about the
material effects to investors that will result if the
transaction is approved. These suggestions focused
on the disclosure of the material differences in the
legal rights, obligations and duties of the parties to
the roll-up and the impact of the changes In
investment objectives on the limited partners.
'Securities Exchange Act Release No. 29228 (May
23, 191), 56 FR 24436 (May 30, 1991). The comment
period ends June 14,1991.
'Recommendations by broker-dealers to their
customers in connection with securities to be issued
in roll-up transactions also have raised concerns
involving customer suitability. The receipt of fees
tied to the number of "yes" votes obtained may
conflict with the duty of broker-dealers. in
recommending to customers the purchase, sale, or
exchange of securities, to have a reasonable basis
to believe that the recommendation is suitable for
each customer based on his or her security holdings
and financial situation and needs. (See NASD Rules
of Fair Practice. Art. I, Section 2, NASD Manual
(CCH) 2152). Moreover, a broker-dealer's failure
specifically to disclose to customers the existence of
this conflict may violate the general antifraud
provisions of the federal securities laws,
II. Interpretive Guidance
A. Presentationof Information
1. Readability
The primary purpose of the disclosure
requirements of the federal securities
laws is to provide the investing public
with clear, comprehensible and
complete information regarding the
issuer, security, offering transaction and
the risks of the investment. In view of
the complexity of roll-up transactions
and the risks of a limited partnership
investment, meticulous care should be
taken to assure that investors are
provided with clear, concise and
understandable disclosure as required
by therules of the Commission.'
Legalistic, overly complex presentation
and inattention to understandability
often make the substance of the
disclosure difficult to understand.
Further, documents frequently contain
vague "boiler plate" explanations that
are imprecise and readily subject to
differing interpretations. Disclosure of
complex matters, such as compensation
arrangements and partnership
distributions, frequently is copied
directly from the partnership and other
agreements without any clear and
concise explanation of the provisions.
Disclosures are often repeated in
different sections of the document. Such
repetition often increases the sheer size
of the prospectus, overwhelming the
reader, without enhancing the quality of
the information.
While these problems are troublesome
in connection with any disclosure
document, they are particularly acute in
offerings directed primarily towards
retail investors. Registrants are advised
that where partnership and roll-up
transactions are filed and they have not
undertaken to present the required
information in a clear, comprehensible
manner, the staff will advise the
registrant that the document cannot be
processed until it is so written.
To address these problems,
registrants are reminded that
information should be presented in
clear, concise paragraphs and sentences.
To the extent practicable, information
should be presented in short
explanatory sentences and "bullet" lists.
particularly where the firm has a preexisting
customer relationship with the investors it solicits.
'See Rule 421 of Regulation C (17 CFR 230.421).
Registrants also are reminded that effectiveness of
a registration statement may be denied or a stop
order issued when there has not been a bona fide
effort to present information in a reasonably clear,
concise and readable manner. See Rule 461(b)(1) of
Regulation C (17 CFR 230.461(b)(1)); see also, In the
Matter of Franchard Corporation. 42 S.E.C. 163
(1964).
Consistent with existing requirements,
important terms should be defined in a
glossary section located in the back of
the prospectus. Frequent reliance on
defined terms as a primary means of
explaining information in the body of
the prospectus should be avoided.
Rather, defined terms should be used in
conjunction with a simple and clearly
understandable textual description of
their meaning in order for the reader to
easily grasp the information being
conveyed. For example, when the
defined term Net Cash from Operations
is used in a prospectus, it should be
accompanied by a simple explanation
such as "which is defined in the
Partnership Agreement to mean
generally the partnership's cash flow
from operations." This allows the
detailed definition to remain in the
glossary but provides sufficient
information for a reader to more easily
understand the disclosure being
presented.
Legal and business terminology
should be avoided. Registrants should
not presume that the investor
understands the import of terms such as
"best-efforts," "minimum-maximum
offering." "dissenters' or appraisal
rights." These terms, when used, should
be clearly explained.
2. Captions and Headings
Caption and subheading titles should
be descriptive of the substance of the
disclosure included in the section. 8 For
example, the title of the risk factor
discussing the limited market for the
securities should reflect the lack of
liquidity or the inability to resell, rather
than simply being titled Liquidity or
Secondary Market.
3. Format of Prospectus 9
There should be a uniform and
systematic structure to a prospectus.
The headings used in the summary
section should correspond to the
headings of the various sections in the
body of the prospectus. The table of
contents should contain these major
headings as well as subheadings.
a. Cover Page.' 0 Prospectus cover
pages now contain significant amounts
'See Rule 421(b) of Regulation C (17 CFR
230.421(b)).
'See Industry Guide 5, Item 801(e) of Regulation
S-K (17 CFR 220.801(e)) and Industry Guide 4, Item
801(d) of Regulation S-K (17 CFR 229.801(d)).
1°See Item 501(c) of Regulation S-K (17 CFR
229.501(c)), Item I to Industry Guide 5. Item 801(e) of
Regulation S-K (17 CFR 229.801(e)) and Item I to
Industry Guide 4, Item 801(d) of Regulation S-K (17
CFR 229.801(d)).

Federal Register / Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations
of text that result in obscuring the
information intended to be highlighted
by being placed on the cover page. As a
result, it has become difficult to
understand at the outset what the
offering or transaction is about." The
cover page should be in plain English
and contain a brief description of the
purpose of the offering or the
transaction. The most significant
adverse effects should be highlighted
through the use of a concise list of
bullet-type statements. For example, in
the case of an offering that presented
risks because of a lack of control,
substantial fees, leverage, limited voting
rights, lack of a secondary market and
lack of diversification, the cover page
could include a list indicating:
" Total Reliance on General Partner
" Authorization of Substantial Fees to
the General Partner and its Affiliates
" Leverage
" Limited Voting Rights of Investors
" Inability to Resell or Dispose of the
Units Except at a Substantial Discount
From the Per Unit Price
* Lack of Asset Diversification
A practice has developed in limited
partnership offerings of setting arbitrary
offering amount goals that bear no
relationship to the number of securities
that ultimately will be sold. Specifically,
an offering frequently has a very low
minimum goal to break escrow and two
significantly higher maximum amounts.
This practice may cause confusion in
evaluating the current offering and the
success of the sponsor's prior offerings.
Therefore, the offering terms should
refer only to the minimum amount to
break escrow and the maximum amount
to be offered.
In addition, prospective investors may
not fully appreciate the different
investment risks that will result from the
amount actually raised. Therefore, the
offering amount set forth on the top of
the cover page should be the minimum
amount needed to break escrow. The
risk factor disclosure also should be
based on the minimum amount. If the
minimum amount is met and escrow is
broken, the offering amount and other
disclosures should be updated to reflect
any material changes including
investment and business risks that are
presented by the offering at that point in
time. This will enable an investor to
appreciate fully the nature of an
IIndustry Guide 4 requires specific information
to be included on the cover page of a prospectus
relating to the offering of interests in oil and gas
programs. This release is not meant to change the
disclosure requirements as they relate to these
offerings. Rather, it is intended to enhance the
requirements by providing guidance concerning the
presentation of information on the cover page and
in the prospectus.
investment in the particular partnership
at the time that his or her investment
decision is made.
b. Table of Contents. A "reasonably
detailed table of contents" with specific
page references is currently required in
all prospectuses.2 The headings that
appear in the table of contents should be
consistent and correspond to those used
in the body of the prospectus. The table
of contents should follow the cover page
of the prospectus.
c. Summary. 1
3 In light of the complex
nature of disclosure documents for roll-
up transactions and limited partnership
offerings, a summary is required.
The summary section should provide
investors with a clear, concise and
coherent "snapshot" description of the
most significant aspects of a roll-up
transaction or a partnership offering.
However, more often than not,
summaries randomly repeat the text of
prospectuses. This protracted and
confusing structure fails to provide the
intended brief overview of the salient
aspects of the transaction..
The information that should be
included in the summary will vary with
each transaction or offering. Issuers
should carefully consider and identify
the aspects of an offering that are the
most significant and determine how best
to highlight those points in a clear,
concise and understandable manner.
The summary for a roll-up transaction
generally should include: the name and
a description of the entities proposed to
be included in the roll-up transaction: a
brief description of the roll-up
transaction; investor voting rights and
the most significant changes in the
voting rights, such as the addition of a
supermajority provision to remove the
general partner; changes in the business
plan, the form of ownership interest or
management compensation; the general
partner's conflicts of interest; the
likelihood that the securities received in
the roll-up transaction will trade at a
substantial discount to the exchange
value; the material terms of the roll-up
transaction, including the valuation
method used to allocate securities in the
successor; dissenters' or appraisal
rights; investor rights to a limited
partner list; any report, opinion or
appraisal referred to in the prospectus;
the background and reasons for the
transaction; risk factors and adverse
effects of the roll-up transaction; and,
intended benefits of the roll-up
transaction. While readers should be
12Item 502(g) of Regulation S-K (17 CFR
229.502(g)).
"See Item 503(a) of Regulation S-K (17 CFR
229.503(a)) and Item 3 to Industry Guide 5, Item
601(e) of Regulation S-K (17 CFR 229.801(e)).
cross referenced to the more detailed
discussion on the matters covered in the
summary, cross references without a
short descriptive discussion of the
matter should be avoided.
d. Risk Factors.14 The discussion of
investment and business risks
associated with the roll-up transaction
or limited partnership offering should be
short and concise and organized in a
careful and logical fashion. Risks of a
similar nature should be grouped
together so they may be understood in
context. For example, risks associated
with the business in which the
partnership intends to engage should be
discussed together. These risks would
include, if applicable, risks associated
with particular properties, the lack of
regulatory approval and the existence of
environmental problems. Likewise,
investment risks generally should be
grouped. These risks would include, if
applicable, the lack of liquidity of an
investment, limitations on the rights of
the limited partners and an enumeration
of the rights of the general partner. The
risks should be explained clearly, and
where one risk is heightened by the
nature of the investment, this should be
clearly stated. For example, in an initial
offering of limited partnership interests
where there is not expected to be a
liquid secondary market, and where the
limited partners may be bound by a vote
of a majority of other partners to a
substantially changed investment
(through merger, the partnership
agreement or in other ways), that should
be disclosed. In the case of a roll-up that
increases the vote necessary to remove
the general partner, and thereby
substantially changes the business plan
of the entity or permits the general
partner wide discretion in selecting
properties and taking on leverage, clear
disclosures should be provided of the
enhanced risks introduced by the
broader discretion given to the general
partner and the reduced ability to
remove the general partner.
The risks should appear in order of
their materiality to an investor. The
most significant risks may warrant
bullet disclosure on the cover page of
the prospectus. While readers should be
cross referenced to the more detailed
discussion on the matters determined to
be risks, cross references without a
short description of the risks should be
avoided.
"See Item 503(c) of Regulation S-K (17 CFR
229.503(c)) and Item 7 to Industry Guide 5, Item
801(e) of Regulation S-K (17 CFR 229.801(e)) and
Item 2 to Industry Guide 4. Item 801(d) of Regulation
S-K (17 CFR 229.801(d)).
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28982 	Federal Register / Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations
In a roll-up transaction, the risks
posed by the particular transaction
generally should be discussed before the
risks that are inherent in an investment
in a partnership or other generic risks.
e. Income Tax Considerations."The
use of a long form tax opinion filed as
an exhibit to the registration statement
is encouraged. Whether a long form
opinion is filed as an exhibit or is
included as an appendix, the prospectus
should prominently set forth a brief,
clear and understandable summary of
the material income tax aspects of the
roll-up transaction or partnership
offering. This section should disclose the
material tax aspects upon which counsel
is unable to opine. Where counsel is
unable to opine on material tax aspects,
the prospectus should include a risk
factor. If a roll-up transaction is taxable
to an investor, risk factor treatment
should be afforded.
f. PriorPerformance.16 In an initial
offering of limited partnership units, the
sponsor must provide prior performance
information in a narrative and tabular
format. The sponsor must present this
information in a clear and concise
format easily understood by the
intended reader. This information must
accurately reflect the general partner's
ability to offer and manage this
program.
In preparing a prospectus, a sponsor
should not take line headings from the
guide if they are inapplicable or do not
accurately reflect the nature of the
information. Line entries that are not
self-explanatory should be clarified. For
example, use of the caption "other" is
inappropriate if the entry consists of
only a single category of information.
When possible, the table should use
more descriptive headings (i.e., return of
capital). Also, if the line item contains
more than one category of information,
the presentation should be broken down
into various components to the extent
material.
B. Quality of Disclosure
The following discussion sets forth the
Commission's interpretive views of
existing substantive disclosure
requirements. The discussion separately
presents interpretive views that are
applicable to roll-up transactions,
interpretive views applicable to both
roll-up transactions and limited
15See Item 4(a)(6) to Form S-4 (17 CFR 239.25),
Item 12 and Appendix I to Industry Guide 5, Item
801(e) of Regulation S-K (17 CFR 229.801(e)) and
Item 14 to Industry Guide 4, Item 801(d) of
Regulation S-K (17 CFR 229.801(d)).
"See Item 8 to Industry Guide 5, Item 601(e) of
Regulation S-K (17 CFR 229.801(e)) and Item 13 to
Industry Guide 4, Item 801(d) of Regulation S-K (17
CFR 229.801(d)).
partnership offerings and interpretive
views applicable solely to limited
partnerships offerings. These
interpretations are intended to result in
a clearer presentation of the benefits
and detriments of a roll-up transaction
or an investment in a particular limited
partnership. In each instance, the items
may be of such material significance to
an investment decision as to warrant
summary treatment in the forepart of the
prospectus.
1. Roll-Up Transactions
a. Effects on Different Partnerships.'7
Roll-up transactions frequently involve
combining two or more partnerships that
may be affected quite differently by the
transaction. Investors in each
partnership must be provided
information from which to evaluate the
potential risks, adverse effects and
merits of the roll-up transaction for their
particular partnership interests. This
disclosure should highlight the
materially different effects for their
partnership vis-a-vis the other entities
involved. Disclosure of different effects
should not be "buried" in parenthetical
references. For example, it would not be
considered adequate to describe a
benefit in the following format:
"Investors in the partnerships (except
Partnership A) should benefit from the
ability to sell their interests." When
different effects are noted, the name of
each partnership that may experience
the effect should be Included.
b. Effects of Participationin a Roll-Up
by Less Than All Partnerships.18
Another feature of roll-up transactions
is that, even if one or more partnerships
do not consent, the transactions often
may be completed with the partnerships
that do consent. In a transaction in
which numerous partnerships are asked
to participate, it is possible that the
successor may be formed through many
different combinations of partnerships.
This creates serious uncertainties about
the possible business prospects and
financial condition of the successor. In
that situation, these uncertainties about
the effects of the roll-up transaction
should be addressed in the disclosure
document.
In addition, if a "fairness opinion" is
obtained, the description of the opinion
should make clear what partnership
combinations it addresses. The
description also should disclose whether
the opinion addresses whether the
transaction is fair to investors in each of
the partnerships and, if it does not, why
not. If (i) no fairness opinion is obtained,
"See Item 4 to Form S-4 117 CFR 239.25].
"SSee Item 4to Form S-4 [17 CFR 239.25].
(ii) the fairness opinion does not address
all possible combinations, or (iii) the
fairness opinion does not reach the
fairness of the transaction to the limited
partners of each partnership, clear and
prominent disclosure of the lack of a
fairness opinion on all, or a part, of the
transactions in question should be
made. Particularly in the case where a
fairness opinion on some part of the
transaction is obtained, the disclosure
should be clear as to those aspects of
the transaction, and those partnership
interests not covered by the fairness
opinion.
c. Allocation of Interests in the
Successor.19 A roll-up transaction
includes the issuance of interests in the
successor to the limited partners and
general partner of the partnerships.
Accordingly, the method used to
allocate the interests is a critical term of
the transaction and must be thoroughly
explained and illustrated in an
understandable manner. This disclosure
should include the reasons why this
method was selected, what other
methods were considered, why they
were rejected and a complete
description of how assets of the
partnerships and the interests of the
general partner were valued for
purposes of the allocation, including any
material assumptions, limitations or
qualifications. For example, if the
general partner will receive interests in
the successor inexchange for previously
"subordinated" rights to payments from
the partnerships, the method used to
determine the value of such rights
should be explained. If the method
differs among partnerships, the reason
and effects of the method used to
allocate interests in the successor on the
different partnerships also should be
highlighted and described.
d. TradingMarket. In light of the
history of a substantial difference
between trading value of the securities
issued in roll-up transactions and the
exchange value, roll-up transaction
disclosure documents should include
prominent disclosure of the likelihood
that the securities will trade at a price
substantially below the value assigned
in the transaction. This information
should be presented on the cover page
and in the risk factors section. The effect
on the trading price of the payment of
previously subordinated fees or
expenses to the general partner should
also be discussed. Other factors, such as
the successor entity's cash distribution
policy, that likely will affect the trading
price should be discussed as well.
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Federal Register / Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations
e. Reports, Opinions and Appraisals. 20
If a report, opinion or appraisal is
referred to in a roll-up proxy statement/
prospectus, Form S-4 requires that the
information requested by Item 9(b) (1)
through (6) of Schedule 13E-3 be
provided. Also, the complete, and not
summary, report, opinion or appraisal
must be filed as an exhibit to the
registration statement.
If a negative opinion was rendered by
an investment banker or financial
advisor concerning the fairness of the
roll-up, or an investment banker or
financial advisor refused to render a
favorable opinion, this must be
disclosed. Failure to provide adequate
disclosure of this information would
constitute a material omission under the
anti-fraud provisions of the securities
laws. 2
1
2. Roll-Up Transactions and Limited
Partnership Offerings
a. Application of Guide 5.22 While
Industry Guide 5 ("Guide"] by its terms
applies only to the "Preparation of
Registration Statements Relating to
Interests in Real Estate Limited
Partnerships," the requirements
contained in the Guide should be
considered, as appropriate, in the
preparation of registration statements
for real estate investment trusts and for
all other limited partnership offerings.
The Guide addresses disclosure
concerns that are applicable to all
offerings of limited partnership units,
e.g., conflicts of interest, risk factors.
compensation and summary of limited
partnership agreement.
The requirements contained in the
Guide that are relevant to all limited
partnership offerings also should be
considered, as appropriate, in the
preparation of disclosure documents for
roll-up transactions. Many of the
disclosure concerns, such as conflicts of
interest, investment objectives and
fiduciary responsibilities, are pertinent
to roll-up transactions.
b. Compensation to GeneralPartner
and its Affiliates.2The 	description of
compensation and fee arrangements in
primary offerings by limited
partnerships frequently is complicated
and obscure. The use of tables as a
means of simplifying the disclosure is
encouraged. The description of
compensation arrangements between
the partnership, general partner and its
"See Items 4(b) and 21(c) to Form S-4 (17 CFR
239.2S).	2 1 See 15 U.S.C. 77q(a); 15 U.S.C. 78j(b).
"17 CFR 229.801(e).
23 See Item 4 to Form S-4 (17 CFR 239.25), Item 4
to Industry Guide 5. Item 801(e) of Regulation S-K
(17 CFR 229.801(e)) and Item 10 to Industry Guide 4.
Item 801(d) of Regulation S-K (17 CFR 229.801(d)).
affiliates should give investors a clear
understanding of the nature and amount
of compensation that may be paid.
Commonly, there are categories of
compensation to be earned by the
general partner. The disclosure
document should make clear the
distinctions among categories, including
the level of potential compensation. The
extent to which a general partner may
affect the nature of the compensation by
undertaking different transactions
should be made clear. For example, a
general partner might receive a given
percentage of operating income (i.e.,
from rents, etc.) and a different
percentage for sales of properties or
refinancings. The distinction should be
made clear, as well as the potential for
the general partner to affect the
categories of compensation. Both a
narrative and tabular presentation of
this information is recommended.
In the narrative presentation, the
maximum amount that may be paid in
each category of fees or compensation
should be prominently disclosed. The
tabular numeric presentation of this
information should be based on this
maximum amount.
Where an issuer states that there are
ceilings on certain categories of fees or
expenses, the issuer should also state
whether the fees or expenses may be
recovered by reclassifying them under a
different category.
In addition, in a roll-up transaction,
the issuer should compare the nature
and level of compensation to be paid by
the new entity to that paid by the old.
To provide for clearer disclosure,
registrants should present.changes in
the structure of fees and other
compensation payable to the general
partner in a tabular format, and should
include specific quantification of such
changes, where practicable. Further, the
di3closure documents should include
textual and numerical disclosure of the
fees and other expenses payable to the
general partner, affiliates and others
solely because of the roll-up transaction.
A pro forms presentation of the
compensation and fees proposed to be
paid in the new entity should be
presented using the historical pro forms
financial statements. Where changes in
the business plan may result in higher
compensation than that shown in the
pro forms presentation based on
historical activities, the disclosure
should address the potential for greater
fees than shown in the pro formas and
outline the potential differences. Where
a compensation ceiling is fixed for a
specified time period, the issuer also
should set forth a pro forms
presentation of the compensation and
fees without giving effect to the ceiling.
c. Conflicts of Interest.24 Many of
these transactions or offerings are
complicated by the number of affiliated
entities involved in the transaction or in
the business operations of the entities.
Where affiliates of the general partnpr
may participate in the offering or the
issuer's business activities, an
organizational chart showing the
relationship between the general partner
and its affiliates in the forepart of the
prospectus should facilitate investor
understanding of the relationships
among such entities.
Registrants should describe concisely
the potential conflicts of interest that
are present and should identify clearly
the transactions and relationships that
give rise to such conflicts. The
description should address the benefits
and detriments that may be realized by
the limited partners, the general partner
and its affiliates, and any other parties
that are subject to a conflict. A
description of the procedures used or to
be used to minimize the potential
conflicts should be provided.
d. FiduciaryResponsibilityof the
GeneralPartner.2 Prospectuses are
required to identify and explain the
nature of the general partner's fiduciary
duties to the limited partners. Where the
partnership agreement modifies the
state-law fiduciary duty standards, the
registration statement should compare
the state-law fiduciary duty standards
with the standards as modified by the
partnership agreement. The disclosure
also should address the reasons for
modifying the duties and the specific
benefits and detriments to both the
general partner and limited partners
from each modification. A tabular
presentation of this information should
facilitate investor understanding.
A clear description of the limited
partners' legal rights and remedies
should be provided. Similarly, a clear
explanation of defenses available to the
general partner, such as the business
judgment rule, also should be set forth.
In a roll-up transaction, the issuer also
should provide a comparison of the
general partner's fiduciary duty
standards in the new entity to those in
the existing entities. This comparison
would describe the fiduciary duty
standards in the existing entities, the
new entity and, where the new entity is
14 See Items 4 and i8ta) to Form S-4 (17 CFR
239.25), Item 5 to Industry Guide 5, Item 801(e) of
Regulation S-K (17 CFR 229.801(e)) and Item 12 to
Industry Guide 4, Item 801(d) of Regulation S-K (17
CFR 229.801(d)).
23See Item 6 to Industry Guide 5, Item 801(e) of
Regulation S-K (17 CFR 229.801(e)).
28983

28984 	Federal Register / Vol. 56, No. 122 / Tuesday, June: 25, 1991 / Rules and Regulations
formed under a different jurisdiction, the
material differences between the
fiduciary duty standards in the old and
new jurisdictions.
e. Management.26 Information about
management's business experience is
material to an investor's evaluation of
an offering and determination of
whether to invest in the issuer. While
this is true in any offering, it is
especially significant when investors
must rely largely on the individual
expertise and business acumen of the
general partner or other adviser to select
and operate the properties to be
acquired, and realize the stated
investment objectives. Where the
history of the officers and directors
either individually or as a whole is
inconsistent with the express or implied
assertion that the partnership will
benefit from their management,
additional disclosure in support of this
assertion should be provided. In the
discussion of the business experience of
officers and directors, where job titles
do not indicate clearly the nature of the
person's former duties or where job
titles may give a misleading impression
of the individual's experience,
additional disclosure should be
provided in order to clarify the nature of
the individual's duties.
f Investment Objectives and
Policies.21 The investment objective of
an offering should be clearly and
concisely set forth. This discussion must
be consistent with other disclosures. For
example, where a document describes
the possible use of high leverage and an
income investment objective, the
disclosure would have to address how
the business plan relying on high
leverage would still permit an income
objective.
Further, there must be a reasonable
basis to support a stated objective. In
this regard, consideration must be given
to the effect that conditions or trends in
the economy, such as the recent
conditions in the real estate industry,
may have on the likelihood that a stated
investment objective will be realized
within the stated anticipated term of the
partnership.
Where a general partner may amend
the investment objectives of the
partnership without the vote of the
limited partners, the disclosure
document should make clear that, in
2See Item 401 of Regulation S-K (17 CFR
229.401), Item 9 of Industry Guide 5, Item 801(e) of
Regulation S-K (17 CFR 229.801(e)) and Item 11 to
Industry Guide 4, Item 801(d) of Regulation S-K (17
CFR 229.801(d)).
'See Item 4 to Form S-4 (17 CFR 239.25), Item 10
to Industry Guide 5, Item 801(e) of Regulation S-K
(17 CFR 229.801(e)) and Item 7 to Industry Guide 4,
Item 801(d) of Regulation S-K (17 CFR 229.801(d)).
essence, the investment objectives are
those defined by the general partner
from time to time. In such cases, lengthy
descriptions of a partnership's
investment objectives may obscure the
fact that the investor is, in essence,
buying an interest in an entity with
unlimited investment objectives. The
document should disclose the general
partner's present plans while making
clear that these may be totally recast.
The document should set forth a
description of the factors to be
considered by the general partner in
making such a change.
Where a partnership agreement
permits the partnership to engage in
joint ventures, disclosure should be
made of those activities that the
partnership may engage in through a
joint venture that it could not otherwise
undertake. For example, where the
partnership agreement precludes the
purchase of properties under
construction, the ability of the
partnership to purchase such properties
through a joint venture should be
disclosed. In such case, the risks and
business implications of such activities
should be clearly stated.
Recently, several issuers have
disclosed in their prospectuses that the 	"
general partner, as part of its analysis of
prospective property acquisitions, "will
retain a national accounting firm to
perform certain agreed-upon procedures
related to the general partner's financial
forecast with respect to each property
acquisition" and that "[sluch procedures
will not constitute an examination of the
forecast in accordance with standards
established by the American Institute of
Certified Public Accountants."
Disclosure of an independent
accountant's involvement with
prospective financial statements or
forecasts should be limited to
circumstances in which the accountant
has performed, in accordance with
standards issued by the American
Institute of Certified Public Accountants,
an "examination" of prospective
statements that are presented in the
prospectus. Disclosure of "agreed-upon
procedures" performed or to be
performed by an accountant is
inappropriate under all circumstances. 28
In a roll-up transaction, the material
effects flowing from the changed
investment objectives and policies
should be disclosed clearly. For
example, most limited partnerships,
before a roll-up, are expected to have a
finite life, at the end of which they will
dissolve and distribute their assets.
0 See AICPA. Guide For Prospective Financial
Statements (1986).
After a roll-up, the surviving entity will
be operated as an ongoing business with
no obligation to make distributions or to
dissolve. Therefore, while an investor
was expecting annual cash distributions
and proceeds from the sale of assets and
the dissolution of the partnership after a
seven to ten year period, the investor
will receive dividends when declared by
the successor and will be dependent
upon the securities markets in order to
liquidate his investment.
In addition, most limited partnerships
before a roll-up are not publicly traded,
so the value of the investment is
extremely difficult to determine. After a
roll-up, the value of the investment is
based on the market for securities of
entities operating in a specific industry.
This value generally is based on a
multiple of operating cash flow and a
factor for the market's expectation of
the likelihood of the continuation of that
cash flow, rather than the appraised
value of the underlying assets.
g. Summary of Partnership
Agreement. 9 The issuer should identify
and discuss the voting and other
material rights of the linited partners
under the partnership agreement. This
discussion should include, but not be
limited to, the right to call meetings, vote
upon extraordinary transactions such as
mergers and consolidations, obtain a
copy of the list of partners, receive
appraisal or dissenter's rights, inspect
partnership books and records, remove
and replace the general partner, compel
dissolution or liquidation or amend the
partnership agreement.
The voting rights of limited partners
should be specifically set forth in this
section. Such description should include
the rights limited partners have to vote
on any matter, the vote of limited
partners necessary to approve any
proposal and the rights of limited
partners to submit a proposal to the vote
of limited partners.
Any limitations or conditions
(including those under state law) that
the general partner may place on the
exercise of these rights should be
explained. If limited partners are not
afforded the foregoing rights or if the
partnership agreement restricts the
rights that limited partners otherwise
would have enjoyed under state law,
this information should be disclosed. In
addition, the issuer should characterize
the extent of discretion retained by the
2See Item 4(a)(4) to Form S-4 (17 CFR 239.25),
Item 14 to Industry Guide 5, Item 801(e) of
Regulation S-K (17 CFR 229.801(e)) and Item 15 to
Industry Guide 4,ltem 801(d) of Regulation S-IK (17
CFR 229.801(d)).

Federal Register / Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations
general partner with regard to the
operations of the partnership.
In addition to the foregoing, the issuer
in a roll-up transaction should clearly
compare the rights of the limited
partners under the new partnership
agreement or governing instruments
with the rights of the limited partners
under the existing partnership
agreements. If limited partners will be
affected differently depending on the
partnership entity in which they have
invested in, a partnership by partnership
comparison must be made. If the new
entity will be formed in a different
jurisdiction, the differences in the rights
under the respective state laws should
also be described. A similar comparison
of the actions that the general partner
may take under the new partnership
agreement with the actions that the
general partner may take under the
existing partnership agreements should
also be provided.
h. Distributionsand Allocations.30
This section is often too complex for the
investor to understand. In order to
enhance investor understanding of this
section. the narrative text should
include shortened definitions of terms
that are fully defined in the glossary.
This will enable readers to gain a
general understanding of the nature of
the distributions and allocations without
having to refer constantly to the
glossary.
It is often unclear whether the
distributions represent a return of
investors' capital or a return on
investors' capital. Whenever cash
distributions are discussed on a
historical basis, the disclosure should
make clear the nature of the
distribution. When distributions are
discussed on a prospective basis, the
disclosure also should make clear, to the
extent known, the nature of the
distribution.
Limited partnership prospectuses
often disclose that limited partners will
have a "priority" or "preferred" return
on distributions made by the
partnership. These descriptive terms
should not be used if the right of limited
partners to receive their distributions is
in any way contingent. More often than
not, even though limited partners are
purportedly given a "preferred right" to
a specified percentage of cash
distributions, this right may only be
invoked after substantial operating fees
and expenses have been paid to the
general partner. The disclosure should
make clear that, if true, the "priority" or
"preferred" distribution follows and
does not preclude payments to the
'See Item 9 to Industry Guide 4, Item 801(d) of
Pegulation S-K (17 CFR Z29.801(d) 	I
general partner. The disclosure should
give a sense of the size of such
payments to the general partner as well.
In the rare circumstance where the right
is not contingent and limited partners
are guaranteed a priority return,
consideration should be given as to
whether a separate security exists. 31
i. Sales Literature.3 2 Registrants are
reminded of the obligation, in Item 19D
of the Guide, to submit all sales
literature to the staff of the Commission
supplementally prior to its use. This
obligation is not extinguished once a
registration statement is declared
effective. Registrants must continue to
submit all sales literature to the staff.
Sales literature includes all material
used in connection with the sale of the
units, whether or not it is prepared by
the general partner or its affiliates.
Registrants are also reminded that
sales material should present a
balanced discussion of both risk and
reward and the contents of the literature
should be consistent with the
prospectus.
3. Limited Partnership Offerings
a. Estimated Use of Proceeds. 3 A
principal problem with the presentation
of the issuer's estimated use of proceeds
in a limited partnership offering is the
lack of prominent disclosure concerning
the amount that will actually be
invested in the business of the
partnership. It is often the case in
limited partnership offerings that a
substantial percentage of the original
investment will pay the expenses of the
offering and fees to the general partner
and its affiliates. The difference
between the amounts provided by
investors and the amounts expected to
be actually invested in assets is of
obvious significance to potential
investors.
Accordingly, prominent disclosure
should be made of the percentage of an
investment that will actually be
available for investment after the
deduction of all front-end fees,
commissions, expenses and
compensation. This information should
be presented in the narrative disclosure
before the estimated use of proceeds
table. Additionally, it is suggested that
the bottom line of the use of proceeds
table should reflect this amount. Cover
11A guaranty may be a separate security under
section 2(1) of the Securities Act of 1933 ("Securities
Act") (15 U.S.C. 77b(1); 15 U.S.C. 77a et seq.).
"
2 See Item 19 to Industry Guide 5, Item 801(e) of
Regulation S-K (17 CFR 229.801(e)).
	3 See Item 504 of Regulation S-K (17 CFR
229.504), Item 3B to Industry Guide 5, Item 801(e) ,of
Regulation S-K (17 CFR 229.801(e)) and Item 8 to
Industry Guide 4, Item 801(d) of Regulation S-K (17
CFR 229.801(d)).
page disclosure of this percentage
should also be made in order to place
the amount offered in its proper context.
b. PriorPerformance.3 4 In partnership
offerings, the general partner is required
to discuss the "track record" or prior
performance of other programs
sponsored by the general partner. A
problem arising with greater frequency
is what information is necessary when a
general partner was a sponsor of a prior
program, but has been removed from
that program. Prior performance
information should be provided for the
period during which that person was the
general partner. If the results (i.e. final
sales of properties) for such a program
did not meet expectations or the original
investment objectives of the program, a
person who was a general partner for
any part of the operating period should
provide information concerning the
adverse developments experienced by
that prior program.
The prior performance tabular
information should reflect whether prior
programs have been able to achieve
their stated objectives. Adverse
developments contained in the tables
should be addressed in detail in the
narrative section. The narrative section
should be updated whenever the tabular
information is updated.
Tabular information should be
provided for all programs which have
had a closing or have closed within the
time period specified by the applicable
table. If a program has had a closing and
has begun operations, prior performance
information should be provided for that
program.
With regard to Table III of the Guide,
the amount of cash generated from
operations should be calculated based
on the definition of operating cash flow
from the Statement of Cash Flows
prepared in accordance with Financial
Accounting Standard ("FAS") 95. If the
amount in the table differs from the
amount that would be reflected in the
Statement of Cash Flows, a footnote
should be included reconciling the
difference. Also with regard to Table III,
a footnote should be included that
explains how those programs
experiencing operating deficiencies are
being funded. Typically such
deficiencies are built into the program
during its first years of operations.
However, continuing deficiencies can
represent an adverse development that
requires additional disclosure. Finally, if
a program was designed to provide tax
credits to investors, specific line items
should be included in both parts of the
table that disclose the amount of tax
3,See supr note 16.
28985	lUm

28986 	Federal Register /-Vol. 	56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations
credits that have been provided to
investors.
III. UPDATING OF INFORMATION 3 s
Issuers engaged in real estate
offerings traditionally have updated
prospectuses by means of supplements
attached to the basic prospectus. This
practice may result in a confusing,
disjointed and lengthy disclosure
document. In these circumstances, it
often is left to the investor to discern'not
only which information has or has not
been modified or superceded, but the
substance of the change as well.
Material information that ordinarily
would appear in the forepart of a
prospectus may be spread out in
different documents. Moreover, other
information in the initial prospectus,
such a risk factors or investment
objectives, may not be updated in a
clear and concise manner. Therefore,
just as in the case of non-real estate
offering documents, when the document
becomes confusing, a post-effective
amendment containing a reprinted
prospectus will be required. Where a
supplement is used, consideration
should be given to including an updated
summary section as part of the
supplement.
IV. MATCHING SERVICES AND
CROSSING ARRANGEMENTS
There appears'to have been a recent
increase in the number of limited
partnerships or real estate investment
trusts attempting to create an alternative
secondary market for their security
s See Item 20 to,Industry Guide 5, Item 801(e) of
Regulation S-K (17 CFR 229.801(e)). 	"
interests. The most common method
used has been a form of matching
service, crossing arrangement or some
other such liquidity enhancement plan
through which a person wishing to sell
an equity interest will be matched with
someone who is seeking to buy an
equity interest. This service often is
created to supplement or work in
conjunction with a dividend
reinvestment plan. Usually, the general
partner, advisor or one of their affiliates
structures the arrangement and
facilitates the matching of potential
buyers and sellers. In certain
circumstances, services provided by
affiliated entities or their associated
persons pursuant to a matching service
or crossing arrangement could subject
such persons to the broker-dealer
registration requirement of Section 15(b)
of the Securities Exchange Act of 1934
("Exchange Act"). 3'
If the general partner, advisor or one
of their affiliates is involved in the
crossing arrangement, the sale of
securities through the arrangement is an
offer or sale by the issuer for purposes
of section 2(3) 37 and section 5 38 of the
Securities Act. Therefore, the issuer
must register under section 5 of thatAct
a good faith estimate of the number of
shares expected to be purchased
through the arrangement. The issuer also
must undertake to keep the registration
"15 U.S.C. 78o(b); see Rule 3a4-1 under the
Exchange Act (17 CFR 240.3a4-11 and Securities
Exchange Act Release No. 22172 (June 27, 1985); see
also Tri-State Livestock Credit Corporation, letter
issued October 18, 1989 and CNB Corporation, letter
issued June 9, 1989.
"
7 See 15 U.S.C. 77b(3).
-"See 15 U.S.C. 77e.
statement "evergreen" during the
existence of the arrangement. This
treatment is similar to that accorded
employee stock purchase plans and
dividend reinvestment plans for
determining whether registration is
required under the Securities Act. 31
List of Subjects in 17 CFR Parts 231 and
241
Reporting and recordkeeping
requirements, Securities.
PART 231-INTERPRETATIVE
RELEASES RELATING TO THE
SECURITIES ACT OF 1933 AND
GENERAL RULES AND REGULATIONS
THEREUNDER
PART 241-INTERPRETATIVE
RELEASES RELATING TO THE
SECURITIES EXCHANGE ACT OF 1934
AND GENERAL RULES AND
REGULATIONS THEREUNDER
Parts 231 and 241 of title 17, chapter II
of the Code of Federal Regulations are
amended by adding each of the
following Release Nos. and the release
date of June 17, 1991, to the list of
interpretive releases in each part: 33-
6900,34-29314.
By the Commission.
Dated: June 17, 1991
Margaret H. McFarland,
Deputy Secretdry
[FR Doc. 91-14770 Filed 6-24-91; 8:45 aml
BILLING CODE 8010-01-M
19See Securities Act Release Nos. 4790 (July 13,
1965). 5515 (August 8. 1974) and 6188 (February 1,
1980); see also Sierra Capital Realty Trust VI Co.
and Sierra Capital Realty Trust VII Co., letter issued
July 5. 199.