Rose Freiler, 77, was looking for a safe haven for $125,000 she planned to leave her sons. She knew little about finance, so when a broker offered what he called a reliable venture with a modest return, she put the sum into two limited partnerships that invested primarily in real estate. After she died in 1990, the company that manages the investment notified Freiler's sons that it was lumping their partnerships with others into a single entity - a "rollup." The result? The Freilers fear their inheritance could drop by 80 percent. (The manager maintains the deal was done to offer liquidity and says the value won't fall anywhere near that amount.)
Thousands of investors say they've been hurt by rollups, which, critics charge, often turn out to be scams. Typically, management (general partners) persuades investors (limited partners) to vote for exchanging their shares in ventures like shopping complexes for a new investment. The new deal might include both the shopping center and, say, bonds in an ailing S&L. Often, the general partners take generous fees for arranging the deal and spin off their sour properties; when the share price of the rollup plummets as a result, the limited partners lose out.
Not all rollups are scams, of course. Many limited partnerships lost money as real-estate values plummeted during the late 1980s. The limited partners had surrendered almost all decision-making power to the general partners under the terms of such investments. But, too often, say critics, general partners abuse their responsibilities. Investors are often baffled by the lengthy rollup prospectuses and get pressure from brokers, some of whom get paid by the general partners for every "yes" vote. "Wall Street can spot a turkey in a second, [but] you can fool the limited partners, because they are middle-class, Main Street investors," says Rep. Edward J. Markey, who is sponsoring reforming legislation.
Anne Petrocci found out just how hard it is to fight a rollup. In 1987 the architect plugged $4,000 into Equitec Capital Appreciation Fund, one of 11 limited partnerships set up by Equitec, a real-estate investment firm. Equitec raised $565 million from 87,000 investors and put the money into 27 properties. When some began losing money, Equitec's general partners last July sought the consent of the limited partners to merge the investments. Petrocci was outraged by the proposal. The biggest problem? The general partners planned to pay themselves $6.9 million for their shares, plus a bonus of up to $9 million. An additional $10 million was to be spent on fees.
Petrocci wrote a letter alerting other investors, but was harassed, she says, when she tried passing it out at an investors' meeting. David Stone, counsel for the general partner, says, "The information that she was distributing was in violation of the rules." One week later the Securities and Exchange Commission informed Petrocci she may indeed have been breaking the law by lobbying investors without filing a detailed statement with the SEC. The limited partnership "overwhelmingly" approved the rollup, says Stone - and today Petrocci's $4,000 investment has a net value of $451.92.
Petrocci and Freiler's son have told Congress their stories and hope that pending legislation may clean up the rollup game. The Limited Partnership Rollup Reform Act of 1991 would provide limited partners who vote against rollups the right to compensation. The bill requires more concise prospectuses and relaxes SEC rules for investor lobbying. The bill could go before the House of Representatives as early as July. It comes too late for Petrocci or the Freilers, but at least it may prevent other limited partners from getting rolled.