July 15, 2002;
Following the Fees Strengthens the Case Against High Greed Partnerships
The high greed fees are among the most deceptive we have ever seen. Nor do we agree that it is all disclosed and therefore it is all right. Disclosure is much less than complete. At this time of re-examination of what went wrong in our capital markets we resonate with this approximate quote from Jim Browning of the Wall Street Journal speaking on CNBC at 7:10 am on 7/11/02, "There are things that became accepted practice in the 1990s that are clearly not acceptable." A key distinction between high greed partnerships in our coverage and Enron, Tyco and Worldcom is that the collapse and public indignation has not yet occurred. That is fortunate because investors can still take protective action.
Now we quote Joe Nocera at the same time and place, "The options mania has created an incentive for fraud." High greed partnership compensation has the complexity of options and derivatives. It is designed to look innocuous and simple, but in reality is a sophisticated stripping of assets from unsuspecting persons, in our opinion. We believe high greed compensation creates an incentive for fraud.
For another example of the dangers of the complex arrangement, let us look back to the derivative scandals of 1994. Recall that the Federal Reserve made multiple increases in short term interest rates in 1994. Those surprise moves had unexpected consequences. Orange County went bankrupt on money market investments and supposedly sophisticated Proctor and Gamble lost hundreds of millions on similar, supposedly safe, investments. We won't point any fingers because there is probably enough blame to spread among all parties. As we recall, Merrill Lynch made a settlement payment to Orange County and Bankers Trust, now Deutsche Bank, made a settlement payment to P&G.
There are many ways partnerships can be deceptive. Most make frequent acquisitions. As a result there is no consistent basis for making normal operating comparisons.
Nor do we know whether miraculous increases in cash flow for newly acquired properties reflect "good" management or clever contracting. The same companies that engaged in bogus electricity trades are active buyers of energy infrastructure services.
Cash flow is likely overstated because the amount influences the distribution that in turn influences general partner compensation. In one infrastructure partnership not in our coverage, the supposedly stable transportation fee actually depended on natural gas price. As a result surprisingly high income a year ago was accompanied by a high distribution and high general partner compensation. When that did not last, the distribution to limited partners was cut and the stock price dropped sharply. We did not notice that the general partner gave back any cash from ramping up the distribution artificially.
Another possible trick is to take advantage of current low interest rates and buy properties with debt. The determination of distribution typically makes little allowance for debt repayment. The combination allows for an artificially high distribution and accompanying general partner compensation. Nor does borrowing long term necessarily entail higher interest rates. An unscrupulous general partner can use interest rate swaps to keep the distribution and GP compensation artificially high. Yet the counter parties to swaps are not fools. The piper has to be paid when short-term rates increase as they did violently in 1994.
As in the case of Worldcom, by the time fraud is known, it is too late. Better for investors to avoid the situations where fraud is most tempting.
A critical test between now and mid August may be the new Securities and Exchange Commission requirement that top managers must attest under oath that the accounting they use is fair. In our opinion, no one directly or indirectly responsible for a high greed partnership can honestly say that is the case.