Congressional and Securities and Exchange Commission investigators are probing what some critics say is a new systematic abuse of millions of investors in real estate limited partnerships nationwide.
Critics are charging that the small-scale investors who bought into the deals in the 1980s are again being taken advantage of -- and in growing numbers -- through a process known as a "roll-up." Congressional staffers have been investigating the complaints, and hearings on the issue have been scheduled for mid-September.
Roll-ups are the mergers of numerous existing limited partnerships into larger, publicly traded partnerships or real estate investment trusts. While a handful have done well for their investors, many have done poorly: In some cases, investors have watched the share values plummet by as much as 90 percent after the securities appeared on the market, according to industry analysts.
The roll-up plans generally look attractive to investors at the time they are proposed because they appear to offer economies of scale and the opportunity to cash out of long-held investments.
What the investors often don't know and aren't told, however, is that the stock brokers they use as financial advisors to help them decide whether to consent to the roll-up are paid commissions -- usually 2 percent of the transaction value -- but only for "yes" votes, industry experts said.
Not surprisingly, roll-ups are particularly attractive to those who sponsor the deals, who can earn millions in fees and commissions on a successfully completed roll-up, even where the partnerships are otherwise financially faltering and strapped for cash.
"It's an increasing phenomenon, and we feel that if it is not stopped it will grow like wildfire and affect millions of investors," said Richard G. Wollack, chairman of the Liquidity Financial Group L.P., which is the nation's largest investor in real estate limited partnerships. "It's a mini savings-and-loan scandal, driven by the same thing -- the fees."
Wollack and other opponents of roll-ups have captured the attention of several Capitol Hill lawmakers. In mid-September, the House subcommittee on telecommunications and finance will hold hearings on roll-ups, and whether investors are being given adequate disclosure on the issue and the chance to opt out if they wish.
"The subcommittee is generally concerned that individual investors have not been well-served by such reorganizations in the past and that regulatory or legislative changes may be necessary to assure that limited partners are treated fairly in future roll-ups," Rep. Edward J. Markey (D-Mass.), the subcommittee chairman, and Rep. Mike Synar (D-Okla.) wrote in a letter to the Securities and Exchange Commission.
The SEC is looking into the complaints, sources said.
Meanwhile, in April, Rep. Fortney "Pete" Stark (D-Calif.) proposed that an excise tax be imposed on roll-ups if dissenting groups are not given a fair escape clause and the ability to cash out of a deal.
Many roll-up offers pose new risks for investors who already have been burned by real estate limited partnerships. Lured in the 1980s by glossy marketing brochures that offered tax benefits and the chance to participate in the purchase of high-profile properties, millions of investors rushed to buy shares in private and public partnerships. The syndication industry raised about $68 billion from 1979 to 1988, and put the money into apartment buildings, office towers and shopping centers nationwide.
Washington area investors were attracted in large numbers. About 340,000 people in the metropolitan area invested in real estate limited partnerships, according to estimates compiled by the Liquidity Financial Group.
For the most part, the bright promises have not translated into reality. According to real estate syndication industry analysts, about half of all limited partnerships are now troubled, saddled with highly leveraged properties purchased at inflated prices in what have become increasingly overbuilt markets. In other words, many investors will earn no profits and may not be able to recoup their money.
Jud Steen, an Alexandria retiree, for example, has watched his original $19,000 investment shrink to about one-fifth what he was told it would be worth. He had bought shares in a California-based public real estate limited partnership called McNeil VIII, which was sponsored by Robert A. McNeil, one of the pioneers in the syndication industry.
Over the years, the partnership performed sluggishly, Steen said, and he was encouraged to learn that McNeil had been bought by Dallas-based Southmark Corp. in 1986.
The next year, Steen was contacted for his consent to the conversion of his shares to a new publicly traded partnership called National Realty Limited Partnership. The letter was accompanied by a weighty and confusing 273-page proxy statement. As his own financial advisor, Steen found himself at a loss for what to do, and he took what appeared to be the best course.
"I voted for it," he said. "I didn't have much information, but I thought anything was better than McNeil."
Since then, however, things have gotten much worse, he said. Units for which he paid $20 a share are now trading for $4 to $5, and Steen is still not sure what went wrong.
"I'm sure it wasn't managed well," he said. "You don't lose that much money without something being wrong ... . Somebody must have gotten some money out of this."
But while Steen watched his investment go sour, the sponsors of the National Realty partnership and their associates have profited from their efforts: They earned about $12 million, according to Wollack's group and the Wall Street Journal.
Spokesmen for the partnership industry, however, say that investors have seen the share values decline because so many of them put their shares up for sale immediately following the offering -- leading to a glut in the market. In addition, they said, the appraised values given for the properties have sometimes been imprecise, leading to a correction by the market after the shares began trading.
They also said that the newly emerging roll-ups are more fair than some of the first of them. A roll-up created last year by Rockville-based CRI Inc., for example, has left its investors smiling, they said.
"Clearly they have evolved," said Christopher L. Davis, president of the D.C.-based Investment Partnership Association. "The ones they are offering now are better than the ones offered earlier ... . The market is a wonderfully self-correcting entity."
Davis and others say the bigger questions are not specifically roll-up problems, but issues that are troubling the entire securities industry. They said that disclosure is a key issue in an era when securities documents have become virtually indecipherable except by financial planners, accountants and lawyers.
"These are questions that go to the heart of our nation's securities laws," Davis said.
Davis conceded, however, that investors have encountered roll-up problems that need to be resolved. In particular, he noted that disclosure procedures could be improved, and that the system of compensating brokers only for "yes" votes may call for some scrutiny.
But if improperly performed roll-ups are questionable, the motives of some of the critics may warrant examination as well, said Ross Keeler, president of Boston-based Krupp Securities Corp..
Keeler said that companies like Wollack's are leading the campaign against roll-ups are merely guarding their own interests. Wollack's company buys partnership shares at deeply discounted prices, Keeler said, noting that roll-ups reduce the market of desperate investors eager to sell at any price to Wollack and his group.
Wollack, for his part, acknowledges that he mounted his campaign in an effort to protect the people who have invested money in limited partnership interests purchased by his group.
"Our opponents have branded it self-interest legislation," Wollack said. "There is no question it is self-interest legislation. If we protect our investors, we protect our interests."
Industry observers said there are few unscarred reputations in the real estate limited partnership industry after a decade in which large profits were made by putting investors into what became poorly performing limited partnerships.
Wollack, for example, was formerly an officer of Consolidated Capital Equities Corp., once one of the nation's largest real estate syndicators, but which ultimately filed for Chapter 11 bankruptcy protection in late 1988.
Davis and Keeler said the roll-up hearing may provide the opportunity for many related issues to be discussed.
"We're not opposed to the hearings at all," Davis said. "I think sunshine is a great antiseptic."