January 14, 2016 Comments (0) Blog

Risks of Private Placement Investments

(Last Updated On: January 14, 2016)

The White Law Group is a national securities fraud, securities arbitration, and investor protection law firm with offices in Chicago, Illinois and Vero Beach, Florida.

Over the last few years the firm has represented numbers of investors in claims involving Reg D private placement investments sold by independent broker-dealers.  Often these investments are touted for their income potential and for being “non-correlated” to the stock market.  Too often the selling agent glosses over or completely ignores the risks involved in these investments – which are many.

The following is a transcription of the “Risk Factors” from a typical private placement memorandum (in this case an oil and gas investment) – the offering documents for a Reg D Private Placement.  This section is 6 pages long and shows that the investments are quite risky.

For more information on The White Law Group or its representation of investors, visit http://www.whitesecuritieslaw.com.

Here are the risk factors:

RISK FACTORS

                Investment in the partnership involves a high degree of risk and is suitable only for investors of substantial financial means who had no need for liquidity in their investments.  You should consider carefully the following factors, in addition to the other information in this memorandum, prior to making your investment decision. 

Particular Risks.

Your ability to resell your units is limited due to the lack of a public market and restrictions contained in the partnership agreement.

You may not be able to sell your partnership interests.  No public market for the units exists or is likely to develop.  Your ability to resell your units also is restricted by the partnership agreement.  The partnership itself may continue in existence until December 31, 2016, unless earlier terminated.  See “TRANSFERABILITY OF UNITS.”  Accordingly, you will need to bear the financial risks of your investment for an indefinite period of time.  In addition, given these restrictions on transferability, the units may not represent satisfactory collateral for a loan.

Because we have not yet identified or selected any properties, you will not be able to evaluate the partnership’s properties before making your investment decision.

We have not selected any properties for acquisition by the partnership and will not select properties for the partnership until after its formation.  You will not have an opportunity before purchasing units to evaluate geophysical, geological, economic or other information regarding the properties to be selected.  Delays are likely in the investments of proceeds from your subscription because the offering period for the partnership can extend over a number of months, and no properties will be acquired until after the formation of the partnership, which will occur once we sell ten units.

The number of producing properties we acquire in comparison to the amount of developmental properties we acquire will determine the amount of risk undertaken by the partnership.

Of the net proceeds available to the partnership from subscriptions (85% of the total subscription proceeds), we intend to devote up to 50% to the purchase of proved reserves (including proved developed producing, proved undeveloped and proved non-producing properties).  However, as of the date of this memorandum, we do not know what percentage of the partnership’s prospects will be comprised of already producing properties versus properties we will attempt to develop.  We will evaluate each prospect based on what is available in the marketplace after the partnership has been formed.  Because we cannot guarantee the types of properties that will be available at such time, we cannot state with any particularity what percentage of the partnership’s prospects will be comprised of existing producing properties as opposed to developmental properties or what percentage of the partnership’s funds will be used to develop such properties.  Investors should be aware that a majority of the partnership’s funds might be used for purposes of purchasing and developing proved undeveloped reserves and/or proved non-producing acreage.  The more partnership funds used for such purpose and development, the greater the risk to the investor.

There is no guarantee of a return of your investment or any specific rate of return on your investment in the partnership.

You may not recover all of your investment in the partnership, or if you do recover your investment in the partnership, you may not receive a rate of return on your investment that is competitive with other types of investment.  You will be able to recover your investment only through the partnership’s distribution of the sales proceeds from the production of oil and natural gas from productive wells and more fully developed properties.  The quantity of oil and natural gas in a well, which is referred to as its reserves, decreases over time as the oil and natural gas is produced until the well is no longer economical to operate.  All of these distributions to you will be considered a return of capital until you have received 100% of your investment.  This means that you are not receiving a return on your investment in a partnership, excluding tax benefits, until your total cash distributions from the partnership exceed 100% of your investment.

The partnership may become liable for joint activities of other working interest owners.

It is anticipated that the partnership will hold interests in properties in its own name and will be a joint working interest owner with other parties.  It has not been clearly established whether joint working interest owners have several liability or joint and several liability with respect to obligations relating to the working interest.  Although the operating agreements relating to properties ordinarily specify that the liabilities of joint working interest owners will be several, if the partnership and other working interest owners are determined to have joint and several liability, the partnership could be responsible for the obligations of these other parties relating to the entire working interest.

The partnership’s ability to diversify risks depends upon the number of units issued and the availability of suitable properties.

We intend to spread the risk of ownership interest in oil and natural gas properties by owning a number of different properties.  The partnership subscribed at the minimum level would be able to purchase fewer properties, thereby increasing the risk to you.  As the partnership size increases, the diversification of the partnership will increase because the partnership can obtain interests in larger number of properties.  However, if we are unable to secure sufficient attractive properties for a larger partnership, it is possible that the average quality of the partnership properties could decline.  In addition, greater demands will be placed on our management capabilities in a larger partnership.

Drilling properties in one area may increase a partnership’s risk.

To the extent that prospects are drilled in one area at the same time, this may increase the partnership’s risk of loss.  For example, if multiple wells in one area are drilled at approximately the same time, then there is a greater risk of loss if the wells are marginal or nonproductive since we will not be using the drilling results of one or more of those wells to decide whether or not to continue drilling prospects in that area or to substitute other prospects in other areas.  This is compared with the situation in which we drill one well and assess the drilling results before we decide to drill a second well in the same area or to substitute a different prospect in another area.

Cash distributions are not guaranteed.

Although it is contemplated that cash distributions will begin to be made within three months after the effective date of our acquisition of the first existing producing property, and will be made monthly thereafter, there can be no assurance as to the timing and amount of partnership distributions.  Distributions will depend primarily on the partnership’s net cash receipts from oil and gas operations, if any, and will be affected, among other things, by the price of oil and natural gas and the level of production of the partnership’s properties.  Moreover, distributions could be delayed to repay the principal and interest on partnership borrowings, if any, or to fund partnership costs.

We may have conflicts of interest with you and the partnership.

We will be responsible for management of the operations of the partnership, including the selection of any properties.  There will be occasions when, in the exercise of our best judgment, we will be faced with conflicts of interest.  These conflicts may arise due to our participation in oil and gas activities on behalf of other partnerships that may be sponsored by us or for our own account or the account of an affiliate of ours, our provision of services to the partnership, the borrowing of money by the partnership from us or our affiliates, the indemnification by the partnership of us or our affiliates, or other factors.  In addition, if unaffiliated parties do not participate, or have a small interest, in properties, there will be no independent oversight with respect to the competitiveness of any operating agreements that may be entered into with us.  We will attempt, in good faith, to resolve all conflicts of interest, including conflicts that arise as a consequence of the purchase or sale of properties between the partnership and us or our affiliates, in a fair and equitable manner, consistent with our fiduciary obligations.  We urge you to review the discussion under “CONFLICTS OF INTEREST” for a more complete description of possible conflicts of interest.  There can be no assurance that any transaction with us will be on terms as favorable as could have been negotiated with unaffiliated third parties.

Compensation payable to us will effect distributions.

We will receive compensation from the partnership throughout the life of the partnership.  Our affiliates may enter into transactions with the partnership for services, supplies and equipment and will be entitled to compensation at competitive prices and terms as determined by reference to charges of unaffiliated companies providing similar services, supplies and equipment.  Compensation payments to us and our affiliates will be due regardless of the partnership’s profitability and will reduce the amount of cash available to the partnership for distribution to its partners.  See “COMPENSATION TO THE GENERAL PARTNER.”

Other partnerships we sponsor will compete with the partnership for properties and personnel.

We may offer interests in other partnerships to be formed for substantially the same purposes as the partnership.  Therefore, a number of partnerships with unexpended capital funds, including partnership funds before and after the partnership, may exist at the same time.  Due to competition among the partnerships for suitable properties and availability of our personnel, the fact that partnerships previously organized by us and our affiliates may still be purchasing properties when the partnership is attempting to purchase properties may make the completion of property acquisition activities by the partnership more difficult.

Your subscription for units is irrevocable.

Your execution of the subscription agreement is a binding offer to buy units in the partnership. Once you subscribe for units, you will not be able to revoke your subscription.

Lack of drilling rig availability may result in delays in drilling on partnership prospects.

Due to the recent increases in oil and natural gas prices in the United States, the amount of drilling activity within the United States and in U.S. waters has increased substantially.  As a result of this increase in drilling activities, there may be shortages of drilling rigs available to drill on prospects we acquire.  Such shortages could result in delays in the drilling of wells on such prospects and delay your ability to deduct tangible drilling costs beyond the year of their investment.

Our past experience is no indicative of the results of these partnerships.

Information concerning the prior drilling experience of previous partnerships sponsored by our affiliates and us, presented under the caption, “PRIOR ACTIVITIES,” does not indicate the results to be expected by these partnerships.

The partnership agreement limits our liability to you and the partnership and requires the partnership to indemnify us against certain losses.

We will have no liability to the partnership or to any partner for any loss suffered by the partnership, and will be indemnified by the partnership against loss sustained by us in connection with the partnership if:

  1. We determine in good faith that our action was in the best interest of the partnership;
  2. We were acting on behalf of or performing services for the partnership; and
  3. Our action did not constitute negligence or misconduct by us.

The effect of borrowing and other financing may negatively impact partnership distributions.

We anticipate that the net proceeds from the sale of units in the partnership will be sufficient to finance the partnership’s share of the costs of acquiring interests in certain initial properties, operating existing wells, developing non-producing acreage and providing necessary production equipment and facilities to service such oil and gas wells.  Certain costs of operations may also be financed through partnership borrowings and through utilization of partnership revenues obtained from production, the sale of net profits interests or other non-operating interest in properties, or other methods of financing.  See “SOURCES OF FUNDS AND USE OF PROCEEDS – Subsequent Sources of Funds; Borrowings.” If these methods of financing should prove to be unavailable or insufficient to maintain the desired level of operations for the partnership, operations could be continued through farmout arrangements with third parties (including affiliated partnerships) or the sale of net profits interests or other non-operating interests in properties.  This could result in the partnership giving up a substantial interest in oil and gas reserves.  If the partnership sells net profits interests in properties, the partnership will incur costs that it cannot recover from the holders of the net profits interests, except in certain cases from future revenues, if any, relating to such properties.  The effect of borrowing or other financing could be to increase funds available to the partnership, but also could be to reduce cash available for distributions to the extent cash is used to repay borrowings, or to reduce reserves if properties are farmed out or interests in the properties are sold.

Any payment pursuant to these indemnity provisions would reduce the capital and/or cash otherwise available for distributions.

Your ability to remove us as general partner is limited.

The limited partners will have the right to remove us as general partner of the partnership only upon an affirmative vote of limited partners who own 70% of the units held by limited partners.  In such event, the limited partners must either select a substitute general partner or risk dissolution of the partnership.

Our withdrawal as general partner could result in dissolution of the partnership.

We have the power to withdraw from the partnership as general partner in the event of insolvency or bankruptcy or with the approval of a majority in interest of the limited partners.  A withdrawal by us as general partners will effect a dissolution and termination of the partnership, unless the remaining partners elect to continue the partnership’s business and vote to substitute a new general partner in our place.  There can be no assurance that any other person would be willing to serve as general partner of the partnership.  In that event, the partnership would be dissolved and its business wound up.

We are dependent upon Michael Mauceli to operate.

Our ability to managed the partnership is predominately dependent upon our manager and principal executive officer, Michael J. Mauceli.  See “MANAGEMENT.”

We will manage and control the partnership’s business.  Third parties may manage and control the properties.

We will exclusively manage and control all aspects of the business of the partnership and will make all decisions concerning the business of the partnership.  You will not be permitted to take part in the management or in the decision making of the partnership.  Third parties may act as the operator of partnership properties, and in many cases, the partnership may acquire a less than 50% working interest in various oil and natural gas properties.  Accordingly, third parties may manage and control production operations on the properties.

Purchase of units by our affiliates or us may assure the minimum aggregate subscription in the partnership is obtained.

We will purchase 1% of the total units issued by the partnership at the offering price of $100,000 per unit, net of the management fee.  We and our affiliates also may, but are not required to, purchase additional units in the partnership, the effect of which may be to assure that the minimum aggregate subscription amount is obtained.

The partnership agreement prohibits your participation in the partnership’s business decisions.

You may not participate in the management of the partnership business.  The partnership agreement forbids you from acting in a manner harmful to the business of the partnership.  If you violate the terms of the partnership agreement, you may have to pay the partnership or other partners for all damages resulting from your breach of the partnership agreement.

Because we will act as general partner of several partnerships, other commitments may adversely affect our financial condition.

As a result of our commitments as general partner of several partnerships and because of the unlimited liability of a general partner to third parties, our net worth is at risk of reduction.  Because we are primarily responsible for the conduct of the partnership’s affairs, a significant adverse financial reversal for us could have an adverse effect on the partnership and the value of the partnership’s units.

Our insurance coverage may be inadequate.

The partnership’s operations will be subject to all of the operating risks normally associated with producing oil and gas, such as blow-outs and pollution, which could result in the partnership incurring substantial liabilities or losses.  Although the partnership agreement provides for the securing of such insurance as we deem necessary and appropriate, certain risks are uninsurable and others may be either uninsured or only partially insured because of high premium costs or other reasons.  In the event the partnership incurs uninsured losses or liabilities, the partnership’s funds available for partnership purposes may be substantially reduced or lost completely.