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Are master limited partners unsuitable for some investors? The term master limited partnership sounds like a complicated legal transaction. In fact, master limited partnerships or MLPs are complex investments that have become hugely popular in the last few years in this low interest rate environment. MLPs are tax exempt publicly traded companies that often own infrastructure in the energy field (pipelines, tanks, etc.). Individual and small institutional investors having be loading up on MLPs because they pay a large percentage of their income out to shareholders as distributions. According to Morningstar, investors added almost $12 billion in 2014 into mutual and exchange-traded funds which invest in MLPs. That’s a huge amount of hard earned money looking for higher yields. The question is, do investors understand the real risks? We doubt it.

Brokers commonly market MLPs as low risk, higher yield securities. But that’s not the case. An MLP is a publicly traded limited partnership with two types of partners: the general partner (or GP) who is responsible for managing the MLP and is compensated for performance; and the limited partner (or LP) who is the investor who provides the capital to the MLP and receives periodic income distributions. Unlike most partnerships, shares of MLPs can be bought or sold on a stock exchange. Just like any partnership, the problem with being a limited partner is that an LP has no role in the management of MLP. That’s risk number one.

Risk number two is that most MLPs invest in the natural resources infrastructure. This is normally a risky space, especially with the swings on energy and commodity prices.

This week, the New Jersey Supreme Court denied the appeal of an arbitration award against Merrill Lynch by the Associated Humane Societies Inc. of Tinton Falls, N.J. In the original FINRA arbitration, the society alleged that certain of its investments were improper, it improperly sustained penalties and other charges when the investments were liquidated, its accounts were improperly managed and churned, and it was overcharged for management of its accounts. The society sought $10 million in punitive damages, $872,171 in compensatory damages and $544,299 in attorneys’ fees. After an 18-day hearing, the FINRA panel found in favor of the society, but awarded it only $168,103 in compensatory damages and $126,077 in punitives.

The society appealed. A 3-judge appellate division panel upheld the award in October, finding that the FINRA panel did not abuse its discretion. Associated Humane Societies, Inc. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., No. L-4376-13 (Oct. 29, 2014). The New Jersey Supreme Court denied any further appeal on Feb. 17, 2015.

Though the society was ultimately disappointed with the size of the award, the decision shows the reluctance of courts to disturb FINRA arbitration awards.

Does the conventional wisdom regarding asset allocation hold up in today’s economy? The New York Times recently featured an article suggesting that a portfolio teeming with risky stocks, derivatives, and other exotic investments may, in fact, not be suitable for even young investors. The Times points out that these young investors experience higher rates of unemployment and are more likely to cash out their 401(k)’s and other investments when they switch jobs. An appropriate suitability analysis under FINRA Rule 2111 would take these factors into account. It is highly likely that many brokers are still using a one-size-fits-all asset allocation formula for their young customers.

Investors may have a variety of claims against such brokers who fail to take into account current market conditions, including unsuitable investment advice, fraudulent misrepresentations and omissions, and failure to supervise.

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