Federal Register / Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations

SECURITIES AND EXCHANGECOMMISSION

17 CFR Parts 231 and 241

[Release Nos. 33-6900; 34-29314]

Limited Partnership Reorganizationsand Public Offerings of LimitedPartnership Interests

AGENCY: Securities and ExchangeCommission.ACTION: Interpretive release.

SUMMARY: The Commission today isannouncing the publication of a releasesetting forth its views concerningexisting disclosure requirementsapplicable to limited partnership roll-uptransactions and initial public offeringsof limited partnership units and othersimilar securities. These interpretationsare necessary in order to address theconcerns that have been expressedrecently by investors, Congress andother interested parties. The intendedeffect of this release is that registrantswill provide investors with clear,concise and understandable disclosureof material information about thesetransactions 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, DC20549.SUPPLEMENTARY INFORMATION: Seriousconcerns have been expressed about thecomplexity and length of prospectuses,proxy statements and other disclosuredocuments used in connection with roll-ups of limited partnerships. Thisinterpretive release addresses theapplication of current requirements toroll-ups and offerings of limited.partnership interests and the companionrelease proposes rule revisions.1

Together, these releases are intended toimprove the overall quality andreadability of disclosure documentsused in roll-up transactions. This releasealso sets forth the Commission's viewson the application of existing disclosurerequirements to initial offerings oflimited partnership interests. Thisrelease emphasizes the risks of investingin a limited partnership and therestrictions that state partnership lawsand limited partnership agreementsplace on investor rights in an effort to

' The companion release publishes for commentproposed rules applicable to limited partnershiproll-up transactions and is being issued concurrentlyby the Commission. See Securities Act Release No.33-6899 (June 17,1991).

assure that investors are apprised of therisks and limited rights often associatedwith an investment in a limitedpartnership. Finally, this release setsforth the Commission's views as to theapplication of disclosure requirementsto registration statements of real estateinvestment trusts as well as non-realestate limited partnership offerings.

I. BackgroundSince January 1, 1985, 68 roll-ups

involving two or more entities havebeen registered with the Commission.These roll-ups have involvedapproximately 1,800 entities, 1.2 millioninvestors and an aggregate exchangevalue of $7.1 billion.

In a roll-up transaction, a sponsorconsolidates two or more public orprivate limited partnerships or otherpass-through investment vehicles into asingle entity, or reorganizes a singlepartnership. In most cases, the roll-uptransaction results in a conversion of alimited partner's interest from a finite-life to an infinite-life interest.

While roll-up transactions can bestructured in different ways, thesetransactions typically are accomplishedthrough a merger of the existing entitiesinto a successor entity.I Investors in theexisting entities receive an interest,usually equity, in the successor entity.The successor generally is either anewly formed corporation or limitedpartnership. Before a sponsor mayproceed with a roll-up/merger, it mustreceive approval of the transaction froma requisite number of limited partners ineach limited partnership, most often theholders of a majority of the outstandinglimited partnership interests. Whereasthe securities of the existing entities forthe most part are thinly traded in thepink sheet secondary markets or nottraded at all, ,the securities of thesuccessor entity often are listed on theNew York Stock Exchange, theAmerican Stock Exchange or traded onthe National Association of SecuritiesDealers' ("NASD's") AutomatedQuotation system.

Roll-ups have created considerablecontroversy and have generated avariety of criticisms, many of whichwere highlighted in a series ofCongressional hearings on limitedpartnership roll-ups. Criticisms havefocused primarily on issues relating tothe fairness of the transactions and the

2 A roll-up may also be effected through anexchange offer. Unlike a merger, an exchange offerwill not compel a limited partner to give up hisoriginal investment, even if a maiority of the otherlimited partners in the partnership choose toparticipate in the roll-up. Approximately 11% of theroll-ups have been conducted as exchange offers.less so in more recent years.

general partners' conflicts of interest, aswell as the inadequacy of the disclosure.The fairness of the methods used tovalue the securities issuable in exchangefor investors' limited partnershipinterests has been questioned. Anotherarea of concern has been the significantdiscount at which the price of thesecurity received in the roll-up trades inthe secondary market.

Serious issues have been raised withrespect to general partners' fiduciaryduties to the limited partners, includingtheir potential conflicts of interest andlack of independence in structuring andnegotiating the terms of a transaction.Critics have questioned the potentialoverreaching by the general partnersinherent in the increased benefits, interms of compensation, ownershipinterests and dilution of investors'voting rights, accruing to them in mostroll-up transactions. These increasedbenefits typically include payments forgeneral partnership interests andchanges in compensation arrangements.

Additional complaints have beenraised with respect to fundamentalchanges that a roll-up may bring aboutin the future operations of the successorentity. These changes frequently relateto the entity's borrowing policies,business plan, investment objectives,intended term of existence and votingrights of investors. Limited partnersobjecting to a roll-up transaction haveespecially criticized the absence of anylegal or equitable alternative to thetransaction. The "cram down" effect onobjecting partners is perceived as unfair.

Investors may have acquired limitedpartnership interests for severalreasons. A principal reason may havebeen the expectation of the pass-throughof tax benefits, s accompanied by thesafety of limited liability. When a roll-upis proposed, investors, despite thedisclosures in the original offeringdocument, have been surprised todiscover how limited their rights areunder state laws and the partnershipagreements. Many of the state lawprotections afforded corporateshareholders are not provided to limitedpartners.

"Prior to major revisions to the federal tax codebeginning in 1984, limited partnerships affordedindividual investors the opportunity to invest and toreceive substantially the same tax treatment andcash distributions as a direct investment in theasset itself would have provided.

Various changes in the tax code since 1984 havereduced-or eliminated the tax shelter and other taxbenefits of an investment in a limited partnership.At the same time, industries that have principallyrelied on the partnership format for raising capital.such as oil and gas and real estate, have sufferedsubstantially. As a result, many limited partnershipinterests have lost much of their value.

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Investors also have complained aboutthe comprehensibility and sufficiency ofthe disclosure provided in connectionwith roll-ups. The Commission hasundertaken three initiatives to addressthe perceived problems. First, theDivision of Corporation Finance("Division") has incorporated into itsreview and comment process a numberof disclosure suggestions made bycommenters and participants in thesetransactions.

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Second, the Commission is, in thisrelease, setting forth its views ofexisting disclosure requirementsapplicable to limited partnership roll-uptransactions and initial public offeringsof limited partnership units. This releaseis intended to assist registrants inassuring that investors are providedclear, concise and understandabledisclosure about these transactions andofferings.

Third, the Commission is proposingamendments to its rules to enhance theclarity, as well as the substance, of thedisclosures provided to investors inconnection with roll-ups. TheCommission also is reviewing itsrequirements applicable to partnershipofferings to assess the need for anyamendments.

The NASD recently has proposed toamend its rules to prohibit memberbrokers and investment advisers fromreceiving differential compensation inconnection with roll-up transactions.5

Pending public comment on andCommission approval of the NASD'sproposed rule change, prominentdisclosure is required of sucharrangements, as well as the potentialconflicts of interest inherent in this feestructure.6

'In December 1989, one participant, LiquidityFund, provided to the staff a number of helpfulsuggestions to provide clearer disclosures about thematerial effects to investors that will result if thetransaction is approved. These suggestions focusedon the disclosure of the material differences in thelegal rights, obligations and duties of the parties tothe roll-up and the impact of the changes Ininvestment objectives on the limited partners.

'Securities Exchange Act Release No. 29228 (May23, 191), 56 FR 24436 (May 30, 1991). The commentperiod ends June 14,1991.

'Recommendations by broker-dealers to theircustomers in connection with securities to be issuedin roll-up transactions also have raised concernsinvolving customer suitability. The receipt of feestied to the number of "yes" votes obtained mayconflict with the duty of broker-dealers. inrecommending to customers the purchase, sale, orexchange of securities, to have a reasonable basisto believe that the recommendation is suitable foreach customer based on his or her security holdingsand financial situation and needs. (See NASD Rulesof Fair Practice. Art. I, Section 2, NASD Manual(CCH) 2152). Moreover, a broker-dealer's failurespecifically to disclose to customers the existence ofthis conflict may violate the general antifraudprovisions of the federal securities laws,

II. Interpretive Guidance

A. Presentation of Information

1. Readability

The primary purpose of the disclosurerequirements of the federal securitieslaws is to provide the investing publicwith clear, comprehensible andcomplete information regarding theissuer, security, offering transaction andthe risks of the investment. In view ofthe complexity of roll-up transactionsand the risks of a limited partnershipinvestment, meticulous care should betaken to assure that investors areprovided with clear, concise andunderstandable disclosure as requiredby therules of the Commission.'Legalistic, overly complex presentationand inattention to understandabilityoften make the substance of thedisclosure difficult to understand.Further, documents frequently containvague "boiler plate" explanations thatare imprecise and readily subject todiffering interpretations. Disclosure ofcomplex matters, such as compensationarrangements and partnershipdistributions, frequently is copieddirectly from the partnership and otheragreements without any clear andconcise explanation of the provisions.Disclosures are often repeated indifferent sections of the document. Suchrepetition often increases the sheer sizeof the prospectus, overwhelming thereader, without enhancing the quality ofthe information.

While these problems are troublesomein connection with any disclosuredocument, they are particularly acute inofferings directed primarily towardsretail investors. Registrants are advisedthat where partnership and roll-uptransactions are filed and they have notundertaken to present the requiredinformation in a clear, comprehensiblemanner, the staff will advise theregistrant that the document cannot beprocessed until it is so written.

To address these problems,registrants are reminded thatinformation should be presented inclear, concise paragraphs and sentences.To the extent practicable, informationshould be presented in shortexplanatory sentences and "bullet" lists.

particularly where the firm has a preexistingcustomer relationship with the investors it solicits.

'See Rule 421 of Regulation C (17 CFR 230.421).Registrants also are reminded that effectiveness ofa registration statement may be denied or a stoporder issued when there has not been a bona fideeffort to present information in a reasonably clear,concise and readable manner. See Rule 461(b)(1) ofRegulation C (17 CFR 230.461(b)(1)); see also, In theMatter of Franchard Corporation. 42 S.E.C. 163(1964).

Consistent with existing requirements,important terms should be defined in aglossary section located in the back ofthe prospectus. Frequent reliance ondefined terms as a primary means ofexplaining information in the body ofthe prospectus should be avoided.Rather, defined terms should be used inconjunction with a simple and clearlyunderstandable textual description oftheir meaning in order for the reader toeasily grasp the information beingconveyed. For example, when thedefined term Net Cash from Operationsis used in a prospectus, it should beaccompanied by a simple explanationsuch as "which is defined in thePartnership Agreement to meangenerally the partnership's cash flowfrom operations." This allows thedetailed definition to remain in theglossary but provides sufficientinformation for a reader to more easilyunderstand the disclosure beingpresented.

Legal and business terminologyshould be avoided. Registrants shouldnot presume that the investorunderstands the import of terms such as"best-efforts," "minimum-maximumoffering." "dissenters' or appraisalrights." These terms, when used, shouldbe clearly explained.

2. Captions and Headings

Caption and subheading titles shouldbe descriptive of the substance of thedisclosure included in the section.8 Forexample, the title of the risk factordiscussing the limited market for thesecurities should reflect the lack ofliquidity or the inability to resell, ratherthan simply being titled Liquidity orSecondary Market.

3. Format of Prospectus 9

There should be a uniform andsystematic structure to a prospectus.The headings used in the summarysection should correspond to theheadings of the various sections in thebody of the prospectus. The table ofcontents should contain these majorheadings as well as subheadings.

a. Cover Page.' 0 Prospectus coverpages now contain significant amounts

'See Rule 421(b) of Regulation C (17 CFR230.421(b)).

'See Industry Guide 5, Item 801(e) of RegulationS-K (17 CFR 220.801(e)) and Industry Guide 4, Item801(d) of Regulation S-K (17 CFR 229.801(d)).

1°See Item 501(c) of Regulation S-K (17 CFR229.501(c)), Item I to Industry Guide 5. Item 801(e) ofRegulation S-K (17 CFR 229.801(e)) and Item I toIndustry Guide 4, Item 801(d) of Regulation S-K (17CFR 229.801(d)).

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of text that result in obscuring theinformation intended to be highlightedby being placed on the cover page. As aresult, it has become difficult tounderstand at the outset what theoffering or transaction is about." Thecover page should be in plain Englishand contain a brief description of thepurpose of the offering or thetransaction. The most significantadverse effects should be highlightedthrough the use of a concise list ofbullet-type statements. For example, inthe case of an offering that presentedrisks because of a lack of control,substantial fees, leverage, limited votingrights, lack of a secondary market andlack of diversification, the cover pagecould 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 DiscountFrom the Per Unit Price

* Lack of Asset DiversificationA practice has developed in limited

partnership offerings of setting arbitraryoffering amount goals that bear norelationship to the number of securitiesthat ultimately will be sold. Specifically,an offering frequently has a very lowminimum goal to break escrow and twosignificantly higher maximum amounts.This practice may cause confusion inevaluating the current offering and thesuccess of the sponsor's prior offerings.Therefore, the offering terms shouldrefer only to the minimum amount tobreak escrow and the maximum amountto be offered.

In addition, prospective investors maynot fully appreciate the differentinvestment risks that will result from theamount actually raised. Therefore, theoffering amount set forth on the top ofthe cover page should be the minimumamount needed to break escrow. Therisk factor disclosure also should bebased on the minimum amount. If theminimum amount is met and escrow isbroken, the offering amount and otherdisclosures should be updated to reflectany material changes includinginvestment and business risks that arepresented by the offering at that point intime. This will enable an investor toappreciate fully the nature of an

I Industry Guide 4 requires specific informationto be included on the cover page of a prospectusrelating to the offering of interests in oil and gasprograms. This release is not meant to change thedisclosure requirements as they relate to theseofferings. Rather, it is intended to enhance therequirements by providing guidance concerning thepresentation of information on the cover page andin the prospectus.

investment in the particular partnershipat the time that his or her investmentdecision is made.

b. Table of Contents. A "reasonablydetailed table of contents" with specificpage references is currently required inall prospectuses.2 The headings thatappear in the table of contents should beconsistent and correspond to those usedin the body of the prospectus. The tableof contents should follow the cover pageof the prospectus.

c. Summary. 13 In light of the complexnature of disclosure documents for roll-up transactions and limited partnershipofferings, a summary is required.

The summary section should provideinvestors with a clear, concise andcoherent "snapshot" description of themost significant aspects of a roll-uptransaction or a partnership offering.However, more often than not,summaries randomly repeat the text ofprospectuses. This protracted andconfusing structure fails to provide theintended brief overview of the salientaspects of the transaction..

The information that should beincluded in the summary will vary witheach transaction or offering. Issuersshould carefully consider and identifythe aspects of an offering that are themost significant and determine how bestto highlight those points in a clear,concise and understandable manner.The summary for a roll-up transactiongenerally should include: the name anda description of the entities proposed tobe included in the roll-up transaction: abrief description of the roll-uptransaction; investor voting rights andthe most significant changes in thevoting rights, such as the addition of asupermajority provision to remove thegeneral partner; changes in the businessplan, the form of ownership interest ormanagement compensation; the generalpartner's conflicts of interest; thelikelihood that the securities received inthe roll-up transaction will trade at asubstantial discount to the exchangevalue; the material terms of the roll-uptransaction, including the valuationmethod used to allocate securities in thesuccessor; dissenters' or appraisalrights; investor rights to a limitedpartner list; any report, opinion orappraisal referred to in the prospectus;the background and reasons for thetransaction; risk factors and adverseeffects of the roll-up transaction; and,intended benefits of the roll-uptransaction. While readers should be

12 Item 502(g) of Regulation S-K (17 CFR229.502(g)).

"See Item 503(a) of Regulation S-K (17 CFR229.503(a)) and Item 3 to Industry Guide 5, Item601(e) of Regulation S-K (17 CFR 229.801(e)).

cross referenced to the more detaileddiscussion on the matters covered in thesummary, cross references without ashort descriptive discussion of thematter should be avoided.

d. Risk Factors. 14 The discussion ofinvestment and business risksassociated with the roll-up transactionor limited partnership offering should beshort and concise and organized in acareful and logical fashion. Risks of asimilar nature should be groupedtogether so they may be understood incontext. For example, risks associatedwith the business in which thepartnership intends to engage should bediscussed together. These risks wouldinclude, if applicable, risks associatedwith particular properties, the lack ofregulatory approval and the existence ofenvironmental problems. Likewise,investment risks generally should begrouped. These risks would include, ifapplicable, the lack of liquidity of aninvestment, limitations on the rights ofthe limited partners and an enumerationof the rights of the general partner. Therisks should be explained clearly, andwhere one risk is heightened by thenature of the investment, this should beclearly stated. For example, in an initialoffering of limited partnership interestswhere there is not expected to be aliquid secondary market, and where thelimited partners may be bound by a voteof a majority of other partners to asubstantially changed investment(through merger, the partnershipagreement or in other ways), that shouldbe disclosed. In the case of a roll-up thatincreases the vote necessary to removethe general partner, and therebysubstantially changes the business planof the entity or permits the generalpartner wide discretion in selectingproperties and taking on leverage, cleardisclosures should be provided of theenhanced risks introduced by thebroader discretion given to the generalpartner and the reduced ability toremove the general partner.

The risks should appear in order oftheir materiality to an investor. Themost significant risks may warrantbullet disclosure on the cover page ofthe prospectus. While readers should becross referenced to the more detaileddiscussion on the matters determined tobe risks, cross references without ashort description of the risks should beavoided.

"See Item 503(c) of Regulation S-K (17 CFR229.503(c)) and Item 7 to Industry Guide 5, Item801(e) of Regulation S-K (17 CFR 229.801(e)) andItem 2 to Industry Guide 4. Item 801(d) of RegulationS-K (17 CFR 229.801(d)).

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In a roll-up transaction, the risksposed by the particular transactiongenerally should be discussed before therisks that are inherent in an investmentin a partnership or other generic risks.

e. Income Tax Considerations. "Theuse of a long form tax opinion filed asan exhibit to the registration statementis encouraged. Whether a long formopinion is filed as an exhibit or isincluded as an appendix, the prospectusshould prominently set forth a brief,clear and understandable summary ofthe material income tax aspects of theroll-up transaction or partnershipoffering. This section should disclose thematerial tax aspects upon which counselis unable to opine. Where counsel isunable to opine on material tax aspects,the prospectus should include a riskfactor. If a roll-up transaction is taxableto an investor, risk factor treatmentshould be afforded.

f. Prior Performance. 16 In an initialoffering of limited partnership units, thesponsor must provide prior performanceinformation in a narrative and tabularformat. The sponsor must present thisinformation in a clear and conciseformat easily understood by theintended reader. This information mustaccurately reflect the general partner'sability to offer and manage thisprogram.

In preparing a prospectus, a sponsorshould not take line headings from theguide if they are inapplicable or do notaccurately reflect the nature of theinformation. Line entries that are notself-explanatory should be clarified. Forexample, use of the caption "other" isinappropriate if the entry consists ofonly a single category of information.When possible, the table should usemore descriptive headings (i.e., return ofcapital). Also, if the line item containsmore than one category of information,the presentation should be broken downinto various components to the extentmaterial.

B. Quality of DisclosureThe following discussion sets forth the

Commission's interpretive views ofexisting substantive disclosurerequirements. The discussion separatelypresents interpretive views that areapplicable to roll-up transactions,interpretive views applicable to bothroll-up transactions and limited

15 See Item 4(a)(6) to Form S-4 (17 CFR 239.25),Item 12 and Appendix I to Industry Guide 5, Item801(e) of Regulation S-K (17 CFR 229.801(e)) andItem 14 to Industry Guide 4, Item 801(d) ofRegulation S-K (17 CFR 229.801(d)).

"See Item 8 to Industry Guide 5, Item 601(e) ofRegulation S-K (17 CFR 229.801(e)) and Item 13 toIndustry Guide 4, Item 801(d) of Regulation S-K (17CFR 229.801(d)).

partnership offerings and interpretiveviews applicable solely to limitedpartnerships offerings. Theseinterpretations are intended to result ina clearer presentation of the benefitsand detriments of a roll-up transactionor an investment in a particular limitedpartnership. In each instance, the itemsmay be of such material significance toan investment decision as to warrantsummary treatment in the forepart of theprospectus.

1. Roll-Up Transactions

a. Effects on Different Partnerships.'7

Roll-up transactions frequently involvecombining two or more partnerships thatmay be affected quite differently by thetransaction. Investors in eachpartnership must be providedinformation from which to evaluate thepotential risks, adverse effects andmerits of the roll-up transaction for theirparticular partnership interests. Thisdisclosure should highlight thematerially different effects for theirpartnership vis-a-vis the other entitiesinvolved. Disclosure of different effectsshould not be "buried" in parentheticalreferences. For example, it would not beconsidered adequate to describe abenefit in the following format:"Investors in the partnerships (exceptPartnership A) should benefit from theability to sell their interests." Whendifferent effects are noted, the name ofeach partnership that may experiencethe effect should be Included.

b. Effects of Participation in a Roll-Upby Less Than All Partnerships. 18

Another feature of roll-up transactionsis that, even if one or more partnershipsdo not consent, the transactions oftenmay be completed with the partnershipsthat do consent. In a transaction inwhich numerous partnerships are askedto participate, it is possible that thesuccessor may be formed through manydifferent combinations of partnerships.This creates serious uncertainties aboutthe possible business prospects andfinancial condition of the successor. Inthat situation, these uncertainties aboutthe effects of the roll-up transactionshould be addressed in the disclosuredocument.

In addition, if a "fairness opinion" isobtained, the description of the opinionshould make clear what partnershipcombinations it addresses. Thedescription also should disclose whetherthe opinion addresses whether thetransaction is fair to investors in each ofthe partnerships and, if it does not, whynot. If (i) no fairness opinion is obtained,

"See Item 4 to Form S-4 117 CFR 239.25]."SSee Item 4 to Form S-4 [17 CFR 239.25].

(ii) the fairness opinion does not addressall possible combinations, or (iii) thefairness opinion does not reach thefairness of the transaction to the limitedpartners of each partnership, clear andprominent disclosure of the lack of afairness opinion on all, or a part, of thetransactions in question should bemade. Particularly in the case where afairness opinion on some part of thetransaction is obtained, the disclosureshould be clear as to those aspects ofthe transaction, and those partnershipinterests not covered by the fairnessopinion.

c. Allocation of Interests in theSuccessor. 19 A roll-up transactionincludes the issuance of interests in thesuccessor to the limited partners andgeneral partner of the partnerships.Accordingly, the method used toallocate the interests is a critical term ofthe transaction and must be thoroughlyexplained and illustrated in anunderstandable manner. This disclosureshould include the reasons why thismethod was selected, what othermethods were considered, why theywere rejected and a completedescription of how assets of thepartnerships and the interests of thegeneral partner were valued forpurposes of the allocation, including anymaterial assumptions, limitations orqualifications. For example, if thegeneral partner will receive interests inthe successor in exchange for previously"subordinated" rights to payments fromthe partnerships, the method used todetermine the value of such rightsshould be explained. If the methoddiffers among partnerships, the reasonand effects of the method used toallocate interests in the successor on thedifferent partnerships also should behighlighted and described.

d. Trading Market. In light of thehistory of a substantial differencebetween trading value of the securitiesissued in roll-up transactions and theexchange value, roll-up transactiondisclosure documents should includeprominent disclosure of the likelihoodthat the securities will trade at a pricesubstantially below the value assignedin the transaction. This informationshould be presented on the cover pageand in the risk factors section. The effecton the trading price of the payment ofpreviously subordinated fees orexpenses to the general partner shouldalso be discussed. Other factors, such asthe successor entity's cash distributionpolicy, that likely will affect the tradingprice should be discussed as well.

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e. Reports, Opinions and Appraisals. 20

If a report, opinion or appraisal isreferred to in a roll-up proxy statement/prospectus, Form S-4 requires that theinformation requested by Item 9(b) (1)through (6) of Schedule 13E-3 beprovided. Also, the complete, and notsummary, report, opinion or appraisalmust be filed as an exhibit to theregistration statement.

If a negative opinion was rendered byan investment banker or financialadvisor concerning the fairness of theroll-up, or an investment banker orfinancial advisor refused to render afavorable opinion, this must bedisclosed. Failure to provide adequatedisclosure of this information wouldconstitute a material omission under theanti-fraud provisions of the securitieslaws.

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2. Roll-Up Transactions and LimitedPartnership Offerings

a. Application of Guide 5.22 WhileIndustry Guide 5 ("Guide"] by its termsapplies only to the "Preparation ofRegistration Statements Relating toInterests in Real Estate LimitedPartnerships," the requirementscontained in the Guide should beconsidered, as appropriate, in thepreparation of registration statementsfor real estate investment trusts and forall other limited partnership offerings.The Guide addresses disclosureconcerns that are applicable to allofferings of limited partnership units,e.g., conflicts of interest, risk factors.compensation and summary of limitedpartnership agreement.

The requirements contained in theGuide that are relevant to all limitedpartnership offerings also should beconsidered, as appropriate, in thepreparation of disclosure documents forroll-up transactions. Many of thedisclosure concerns, such as conflicts ofinterest, investment objectives andfiduciary responsibilities, are pertinentto roll-up transactions.

b. Compensation to General Partnerand its Affiliates. 2The description ofcompensation and fee arrangements inprimary offerings by limitedpartnerships frequently is complicatedand obscure. The use of tables as ameans of simplifying the disclosure isencouraged. The description ofcompensation arrangements betweenthe partnership, general partner and its

"See Items 4(b) and 21(c) to Form S-4 (17 CFR239.2S).

21 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 clearunderstanding of the nature and amountof compensation that may be paid.Commonly, there are categories ofcompensation to be earned by thegeneral partner. The disclosuredocument should make clear thedistinctions among categories, includingthe level of potential compensation. Theextent to which a general partner mayaffect the nature of the compensation byundertaking different transactionsshould be made clear. For example, ageneral partner might receive a givenpercentage of operating income (i.e.,from rents, etc.) and a differentpercentage for sales of properties orrefinancings. The distinction should bemade clear, as well as the potential forthe general partner to affect thecategories of compensation. Both anarrative and tabular presentation ofthis information is recommended.

In the narrative presentation, themaximum amount that may be paid ineach category of fees or compensationshould be prominently disclosed. Thetabular numeric presentation of thisinformation should be based on thismaximum amount.

Where an issuer states that there areceilings on certain categories of fees orexpenses, the issuer should also statewhether the fees or expenses may berecovered by reclassifying them under adifferent category.

In addition, in a roll-up transaction,the issuer should compare the natureand level of compensation to be paid bythe new entity to that paid by the old.To provide for clearer disclosure,registrants should present.changes inthe structure of fees and othercompensation payable to the generalpartner in a tabular format, and shouldinclude specific quantification of suchchanges, where practicable. Further, thedi3closure documents should includetextual and numerical disclosure of thefees and other expenses payable to thegeneral partner, affiliates and otherssolely because of the roll-up transaction.

A pro forms presentation of thecompensation and fees proposed to bepaid in the new entity should bepresented using the historical pro formsfinancial statements. Where changes inthe business plan may result in highercompensation than that shown in thepro forms presentation based onhistorical activities, the disclosureshould address the potential for greaterfees than shown in the pro formas andoutline the potential differences. Wherea compensation ceiling is fixed for aspecified time period, the issuer alsoshould set forth a pro forms

presentation of the compensation andfees without giving effect to the ceiling.

c. Conflicts of Interest. 24 Many ofthese transactions or offerings arecomplicated by the number of affiliatedentities involved in the transaction or inthe business operations of the entities.Where affiliates of the general partnprmay participate in the offering or theissuer's business activities, anorganizational chart showing therelationship between the general partnerand its affiliates in the forepart of theprospectus should facilitate investorunderstanding of the relationshipsamong such entities.

Registrants should describe conciselythe potential conflicts of interest thatare present and should identify clearlythe transactions and relationships thatgive rise to such conflicts. Thedescription should address the benefitsand detriments that may be realized bythe limited partners, the general partnerand its affiliates, and any other partiesthat are subject to a conflict. Adescription of the procedures used or tobe used to minimize the potentialconflicts should be provided.

d. Fiduciary Responsibility of theGeneral Partner. 2 Prospectuses arerequired to identify and explain thenature of the general partner's fiduciaryduties to the limited partners. Where thepartnership agreement modifies thestate-law fiduciary duty standards, theregistration statement should comparethe state-law fiduciary duty standardswith the standards as modified by thepartnership agreement. The disclosurealso should address the reasons formodifying the duties and the specificbenefits and detriments to both thegeneral partner and limited partnersfrom each modification. A tabularpresentation of this information shouldfacilitate investor understanding.

A clear description of the limitedpartners' legal rights and remediesshould be provided. Similarly, a clearexplanation of defenses available to thegeneral partner, such as the businessjudgment rule, also should be set forth.

In a roll-up transaction, the issuer alsoshould provide a comparison of thegeneral partner's fiduciary dutystandards in the new entity to those inthe existing entities. This comparisonwould describe the fiduciary dutystandards in the existing entities, thenew entity and, where the new entity is

14See Items 4 and i8ta) to Form S-4 (17 CFR239.25), Item 5 to Industry Guide 5, Item 801(e) ofRegulation S-K (17 CFR 229.801(e)) and Item 12 toIndustry Guide 4, Item 801(d) of Regulation S-K (17CFR 229.801(d)).

23 See Item 6 to Industry Guide 5, Item 801(e) ofRegulation S-K (17 CFR 229.801(e)).

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formed under a different jurisdiction, thematerial differences between thefiduciary duty standards in the old andnew jurisdictions.

e. Management. 26 Information aboutmanagement's business experience ismaterial to an investor's evaluation ofan offering and determination ofwhether to invest in the issuer. Whilethis is true in any offering, it isespecially significant when investorsmust rely largely on the individualexpertise and business acumen of thegeneral partner or other adviser to selectand operate the properties to beacquired, and realize the statedinvestment objectives. Where thehistory of the officers and directorseither individually or as a whole isinconsistent with the express or impliedassertion that the partnership willbenefit from their management,additional disclosure in support of thisassertion should be provided. In thediscussion of the business experience ofofficers and directors, where job titlesdo not indicate clearly the nature of theperson's former duties or where jobtitles may give a misleading impressionof the individual's experience,additional disclosure should beprovided in order to clarify the nature ofthe individual's duties.

f Investment Objectives andPolicies.21 The investment objective ofan offering should be clearly andconcisely set forth. This discussion mustbe consistent with other disclosures. Forexample, where a document describesthe possible use of high leverage and anincome investment objective, thedisclosure would have to address howthe business plan relying on highleverage would still permit an incomeobjective.

Further, there must be a reasonablebasis to support a stated objective. Inthis regard, consideration must be givento the effect that conditions or trends inthe economy, such as the recentconditions in the real estate industry,may have on the likelihood that a statedinvestment objective will be realizedwithin the stated anticipated term of thepartnership.

Where a general partner may amendthe investment objectives of thepartnership without the vote of thelimited partners, the disclosuredocument should make clear that, in

2See Item 401 of Regulation S-K (17 CFR229.401), Item 9 of Industry Guide 5, Item 801(e) ofRegulation S-K (17 CFR 229.801(e)) and Item 11 toIndustry Guide 4, Item 801(d) of Regulation S-K (17CFR 229.801(d)).

'See Item 4 to Form S-4 (17 CFR 239.25), Item 10to 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 arethose defined by the general partnerfrom time to time. In such cases, lengthydescriptions of a partnership'sinvestment objectives may obscure thefact that the investor is, in essence,buying an interest in an entity withunlimited investment objectives. Thedocument should disclose the generalpartner's present plans while makingclear that these may be totally recast.The document should set forth adescription of the factors to beconsidered by the general partner inmaking such a change.

Where a partnership agreementpermits the partnership to engage injoint ventures, disclosure should bemade of those activities that thepartnership may engage in through ajoint venture that it could not otherwiseundertake. For example, where thepartnership agreement precludes thepurchase of properties underconstruction, the ability of thepartnership to purchase such propertiesthrough a joint venture should bedisclosed. In such case, the risks andbusiness implications of such activitiesshould be clearly stated.

Recently, several issuers havedisclosed in their prospectuses that the "general partner, as part of its analysis ofprospective property acquisitions, "willretain a national accounting firm toperform certain agreed-upon proceduresrelated to the general partner's financialforecast with respect to each propertyacquisition" and that "[sluch procedureswill not constitute an examination of theforecast in accordance with standardsestablished by the American Institute ofCertified Public Accountants."Disclosure of an independentaccountant's involvement withprospective financial statements orforecasts should be limited tocircumstances in which the accountanthas performed, in accordance withstandards issued by the AmericanInstitute of Certified Public Accountants,an "examination" of prospectivestatements that are presented in theprospectus. Disclosure of "agreed-uponprocedures" performed or to beperformed by an accountant isinappropriate under all circumstances. 28

In a roll-up transaction, the materialeffects flowing from the changedinvestment objectives and policiesshould be disclosed clearly. Forexample, most limited partnerships,before a roll-up, are expected to have afinite life, at the end of which they willdissolve and distribute their assets.

0 See AICPA. Guide For Prospective FinancialStatements (1986).

After a roll-up, the surviving entity willbe operated as an ongoing business withno obligation to make distributions or todissolve. Therefore, while an investorwas expecting annual cash distributionsand proceeds from the sale of assets andthe dissolution of the partnership after aseven to ten year period, the investorwill receive dividends when declared bythe successor and will be dependentupon the securities markets in order toliquidate his investment.

In addition, most limited partnershipsbefore a roll-up are not publicly traded,so the value of the investment isextremely difficult to determine. After aroll-up, the value of the investment isbased on the market for securities ofentities operating in a specific industry.This value generally is based on amultiple of operating cash flow and afactor for the market's expectation ofthe likelihood of the continuation of thatcash flow, rather than the appraisedvalue of the underlying assets.

g. Summary of PartnershipAgreement. 9 The issuer should identifyand discuss the voting and othermaterial rights of the linited partnersunder the partnership agreement. Thisdiscussion should include, but not belimited to, the right to call meetings, voteupon extraordinary transactions such asmergers and consolidations, obtain acopy of the list of partners, receiveappraisal or dissenter's rights, inspectpartnership books and records, removeand replace the general partner, compeldissolution or liquidation or amend thepartnership agreement.

The voting rights of limited partnersshould be specifically set forth in thissection. Such description should includethe rights limited partners have to voteon any matter, the vote of limitedpartners necessary to approve anyproposal and the rights of limitedpartners to submit a proposal to the voteof limited partners.

Any limitations or conditions(including those under state law) thatthe general partner may place on theexercise of these rights should beexplained. If limited partners are notafforded the foregoing rights or if thepartnership agreement restricts therights that limited partners otherwisewould have enjoyed under state law,this information should be disclosed. Inaddition, the issuer should characterizethe 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) ofRegulation S-K (17 CFR 229.801(e)) and Item 15 toIndustry Guide 4,ltem 801(d) of Regulation S-IK (17CFR 229.801(d)).

Federal Register / Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations

general partner with regard to theoperations of the partnership.

In addition to the foregoing, the issuerin a roll-up transaction should clearlycompare the rights of the limitedpartners under the new partnershipagreement or governing instrumentswith the rights of the limited partnersunder the existing partnershipagreements. If limited partners will beaffected differently depending on thepartnership entity in which they haveinvested in, a partnership by partnershipcomparison must be made. If the newentity will be formed in a differentjurisdiction, the differences in the rightsunder the respective state laws shouldalso be described. A similar comparisonof the actions that the general partnermay take under the new partnershipagreement with the actions that thegeneral partner may take under theexisting partnership agreements shouldalso be provided.

h. Distributions and Allocations. 30

This section is often too complex for theinvestor to understand. In order toenhance investor understanding of thissection. the narrative text shouldinclude shortened definitions of termsthat are fully defined in the glossary.This will enable readers to gain ageneral understanding of the nature ofthe distributions and allocations withouthaving to refer constantly to theglossary.

It is often unclear whether thedistributions represent a return ofinvestors' capital or a return oninvestors' capital. Whenever cashdistributions are discussed on ahistorical basis, the disclosure shouldmake clear the nature of thedistribution. When distributions arediscussed on a prospective basis, thedisclosure also should make clear, to theextent known, the nature of thedistribution.

Limited partnership prospectusesoften disclose that limited partners willhave a "priority" or "preferred" returnon distributions made by thepartnership. These descriptive termsshould not be used if the right of limitedpartners to receive their distributions isin any way contingent. More often thannot, even though limited partners arepurportedly given a "preferred right" toa specified percentage of cashdistributions, this right may only beinvoked after substantial operating feesand expenses have been paid to thegeneral partner. The disclosure shouldmake clear that, if true, the "priority" or"preferred" distribution follows anddoes not preclude payments to the

'See Item 9 to Industry Guide 4, Item 801(d) ofPegulation S-K (17 CFR Z29.801(d) I

general partner. The disclosure shouldgive a sense of the size of suchpayments to the general partner as well.In the rare circumstance where the rightis not contingent and limited partnersare guaranteed a priority return,consideration should be given as towhether a separate security exists. 31

i. Sales Literature. 3 2 Registrants arereminded of the obligation, in Item 19Dof the Guide, to submit all salesliterature to the staff of the Commissionsupplementally prior to its use. Thisobligation is not extinguished once aregistration statement is declaredeffective. Registrants must continue tosubmit all sales literature to the staff.Sales literature includes all materialused in connection with the sale of theunits, whether or not it is prepared bythe general partner or its affiliates.

Registrants are also reminded thatsales material should present abalanced discussion of both risk andreward and the contents of the literatureshould be consistent with theprospectus.

3. Limited Partnership Offerings

a. Estimated Use of Proceeds. 3 Aprincipal problem with the presentationof the issuer's estimated use of proceedsin a limited partnership offering is thelack of prominent disclosure concerningthe amount that will actually beinvested in the business of thepartnership. It is often the case inlimited partnership offerings that asubstantial percentage of the originalinvestment will pay the expenses of theoffering and fees to the general partnerand its affiliates. The differencebetween the amounts provided byinvestors and the amounts expected tobe actually invested in assets is ofobvious significance to potentialinvestors.

Accordingly, prominent disclosureshould be made of the percentage of aninvestment that will actually beavailable for investment after thededuction of all front-end fees,commissions, expenses andcompensation. This information shouldbe presented in the narrative disclosurebefore the estimated use of proceedstable. Additionally, it is suggested thatthe bottom line of the use of proceedstable should reflect this amount. Cover

11 A guaranty may be a separate security undersection 2(1) of the Securities Act of 1933 ("SecuritiesAct") (15 U.S.C. 77b(1); 15 U.S.C. 77a et seq.).

"2See 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 CFR229.504), Item 3B to Industry Guide 5, Item 801(e) ,ofRegulation S-K (17 CFR 229.801(e)) and Item 8 toIndustry Guide 4, Item 801(d) of Regulation S-K (17CFR 229.801(d)).

page disclosure of this percentageshould also be made in order to placethe amount offered in its proper context.

b. Prior Performance. 34 In partnership

offerings, the general partner is requiredto discuss the "track record" or priorperformance of other programssponsored by the general partner. Aproblem arising with greater frequencyis what information is necessary when ageneral partner was a sponsor of a priorprogram, but has been removed fromthat program. Prior performanceinformation should be provided for theperiod during which that person was thegeneral partner. If the results (i.e. finalsales of properties) for such a programdid not meet expectations or the originalinvestment objectives of the program, aperson who was a general partner forany part of the operating period shouldprovide information concerning theadverse developments experienced bythat prior program.

The prior performance tabularinformation should reflect whether priorprograms have been able to achievetheir stated objectives. Adversedevelopments contained in the tablesshould be addressed in detail in thenarrative section. The narrative sectionshould be updated whenever the tabularinformation is updated.

Tabular information should beprovided for all programs which havehad a closing or have closed within thetime period specified by the applicabletable. If a program has had a closing andhas begun operations, prior performanceinformation should be provided for thatprogram.

With regard to Table III of the Guide,the amount of cash generated fromoperations should be calculated basedon the definition of operating cash flowfrom the Statement of Cash Flowsprepared in accordance with FinancialAccounting Standard ("FAS") 95. If theamount in the table differs from theamount that would be reflected in theStatement of Cash Flows, a footnoteshould be included reconciling thedifference. Also with regard to Table III,a footnote should be included thatexplains how those programsexperiencing operating deficiencies arebeing funded. Typically suchdeficiencies are built into the programduring its first years of operations.However, continuing deficiencies canrepresent an adverse development thatrequires additional disclosure. Finally, ifa program was designed to provide taxcredits to investors, specific line itemsshould be included in both parts of thetable that disclose the amount of tax

3, See supr note 16.

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28986 Federal Register /-Vol. 56, No. 122 / Tuesday, June 25, 1991 / Rules and Regulations

credits that have been provided toinvestors.

III. UPDATING OF INFORMATION 3s

Issuers engaged in real estateofferings traditionally have updatedprospectuses by means of supplementsattached to the basic prospectus. Thispractice may result in a confusing,disjointed and lengthy disclosuredocument. In these circumstances, itoften is left to the investor to discern'notonly which information has or has notbeen modified or superceded, but thesubstance of the change as well.Material information that ordinarilywould appear in the forepart of aprospectus may be spread out indifferent documents. Moreover, otherinformation in the initial prospectus,such a risk factors or investmentobjectives, may not be updated in aclear and concise manner. Therefore,just as in the case of non-real estateoffering documents, when the documentbecomes confusing, a post-effectiveamendment containing a reprintedprospectus will be required. Where asupplement is used, considerationshould be given to including an updatedsummary section as part of thesupplement.

IV. MATCHING SERVICES ANDCROSSING ARRANGEMENTS

There appears'to have been a recentincrease in the number of limitedpartnerships or real estate investmenttrusts attempting to create an alternativesecondary market for their security

s See Item 20 to, Industry Guide 5, Item 801(e) ofRegulation S-K (17 CFR 229.801(e)). "

interests. The most common methodused has been a form of matchingservice, crossing arrangement or someother such liquidity enhancement planthrough which a person wishing to sellan equity interest will be matched withsomeone who is seeking to buy anequity interest. This service often iscreated to supplement or work inconjunction with a dividendreinvestment plan. Usually, the generalpartner, advisor or one of their affiliatesstructures the arrangement andfacilitates the matching of potentialbuyers and sellers. In certaincircumstances, services provided byaffiliated entities or their associatedpersons pursuant to a matching serviceor crossing arrangement could subjectsuch persons to the broker-dealerregistration requirement of Section 15(b)of the Securities Exchange Act of 1934("Exchange Act"). 3'

If the general partner, advisor or oneof their affiliates is involved in thecrossing arrangement, the sale ofsecurities through the arrangement is anoffer or sale by the issuer for purposesof section 2(3) 37 and section 5 38 of theSecurities Act. Therefore, the issuermust register under section 5 of thatActa good faith estimate of the number ofshares expected to be purchasedthrough the arrangement. The issuer alsomust undertake to keep the registration

"15 U.S.C. 78o(b); see Rule 3a4-1 under theExchange Act (17 CFR 240.3a4-11 and SecuritiesExchange Act Release No. 22172 (June 27, 1985); seealso Tri-State Livestock Credit Corporation, letterissued October 18, 1989 and CNB Corporation, letterissued June 9, 1989.

"7 See 15 U.S.C. 77b(3).

-"See 15 U.S.C. 77e.

statement "evergreen" during theexistence of the arrangement. Thistreatment is similar to that accordedemployee stock purchase plans anddividend reinvestment plans fordetermining whether registration isrequired under the Securities Act. 31

List of Subjects in 17 CFR Parts 231 and241

Reporting and recordkeepingrequirements, Securities.

PART 231-INTERPRETATIVERELEASES RELATING TO THESECURITIES ACT OF 1933 ANDGENERAL RULES AND REGULATIONSTHEREUNDER

PART 241-INTERPRETATIVERELEASES RELATING TO THESECURITIES EXCHANGE ACT OF 1934AND GENERAL RULES ANDREGULATIONS THEREUNDER

Parts 231 and 241 of title 17, chapter IIof the Code of Federal Regulations areamended by adding each of thefollowing Release Nos. and the releasedate of June 17, 1991, to the list ofinterpretive 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 amlBILLING 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 issuedJuly 5. 199.