Reaching the limit on limited partnerships

NEW YORK (Reuters) - Buyers beware: these partnerships are very limited.

Master limited partnerships have become increasingly popular with energy companies looking to spin-off assets to take advantage of tax structures that allow the companies to operate while paying virtually no corporate taxes.

Investors have the potential for much higher yields than they normally get from public company dividends -- but as ever, with the increased opportunity for return comes extra risk. And because unit holders have very little control over the entities' governance or directors, they have much less power to change the course of events.

This was illustrated starkly in the past week when the share price of pipeline MLP SemGroup Energy Partners LP SGLP.O> sank after the company that spun it off, SemGroup LP, suffered massive trading losses on oil futures and derivatives and then filed for bankruptcy.

"You've got the general partner and you've got all the rest -- the little people," said John Olson, a fund manager with Houston Energy Partners, who stays away from investing in the partnerships.

MLPs are controlled and managed by a general partner, usually owned by the parent company that created the partnership. The general partner can own as little as 2 percent of an MLP but can receive up to half of the company's cash distribution.

Shareholders in most publicly traded companies vote for the company's board of directors every year at its annual meeting. But MLP unit holders do not have a vote for either the general partner or its directors.

SemGroup Energy was spun off last July, but SemGroup LP lost control of SemGroup Energy's general partner when it defaulted on its credit agreement last week.

Two funds -- Manchester Securities Corp. and Alerian Finance Partners -- took control of the general partner without a vote by the unit holders.

The funds claim to be working to "maximize the long-term utilization of the company's assets."

But what recourse would unit holders have if that turns out to not be the case?

Not much, according to the company's registration statement.

"Our partnership agreement limits the liability and reduces the fiduciary duties of our general partner to holders of our common units and subordinated units," it reads. "Our partnership agreement also restricts the remedies available to our unit holders for actions that might otherwise constitute a breach of our general partner's fiduciary duties owed to our unit holders."

The U.S. Securities and Exchange Commission has opened an inquiry into SemGroup Energy Partners' disclosure of its parent's financial problems.

There have also been suggestions of trading irregularities at the MLP as the partnership's units fell more than 50 percent before the parent's troubles were disclosed.

Mark Easterbrook, an analyst who covers MLPs for RBC Capital Management, said that investors should stay away from MLPs unless they are well-informed of the inherent risks and difficulties.

"You have to be a very smart investor and you don't just invest in one," he said. "Because of all the issues, if you're going to do it, you're going to invest in three or five, or more, and build up a portfolio."

Besides the corporate governance risks, he said the partnerships also require a different method of tax accounting.

Furthermore, he noted that as the size of a partnership's cash distribution increases, the general partnerships cut of that cash gets proportionally larger.

He said that about 75 percent of MLP ownership is high-net-worth or retail investors and about 25 percent institutional investors.

Espen Eckbo, a professor at Dartmouth's Tuck School of Business and corporate governance expert, said the real obligation of the MLPs is to be transparent with their unit holders about the risks.

Still, he said that small-time investors should probably avoid the partnerships.

"If I was in investment management, I would advise against investing in any of these," said Eckbo.

(Editing by Gerald E. McCormick)