A master limited partnership, or MLP, is a limited partnership that is publicly traded.  It combines the tax benefits of a limited partnership with the liquidity of publicly traded securities.  MLPs are limited by the U.S. Tax Code to only apply to enterprises that engage in certain businesses, mostly pertaining to the use of natural resources, such as petroleum and natural gas extraction and transportation.  To qualify for MLP status, a partnership must generate at least 90 percent of its income from what the Internal Revenue Service deems "qualifying" sources.  For many MLPs, these sources include all manner of activities related to the exploration, production, processing, refining or transportation of any mineral or natural resource, such as oil, natural gas and coal.

The limited partnership interests of an MLP are typically called common units and are analogous to common stock of a corporation.  The MLP common units represent equity or ownership interests in the MLP.  MLPs also have subordinated units, which also represent equity or ownership interests in the MLP.  The MLP common and subordinated units generally provide limited voting rights and entitle the holder to a share of the company's success through distributions and capital appreciation.

MLPs are generally required by their limited partnership agreements to distribute a large percentage of their available cash.  As a matter of policy, MLPs generally distribute substantially all of their cash on hand, less reserves established by their general partners, on a periodic basis (generally quarterly).  MLPs are typically structured such that holders of comon units and general partner interests have first priority to receive quarterly cash distributions up to an established minimum amount, which is referred to as the "minimum quarterly distribution" or "MQD."  Under an MLP's partnership agreement, the MLP is obligated to distribute the available cash each quarter, but holders of common units are entitled to receive the MQD before any cash is distributed to the subordinated units.  Once common and general partner interests have been paid, holders of subordinated units receive distributions of up to the MQD.  Distributable cash in excess of the MQD paid to holders of both common and subordinated units is distributed to those holders on a pro rata basis.

When the subordination period ends, all subordinated units convert into common units on a one-for-one basis.  The subordination period ends once the MLP meets the financial tests in the MLP's partnership agreement, but it generally cannot end before a certain date specified in the partnership agreement.  The financial tests are not tied directly to the market price of the MLP's securities.

The issue distills to whether subordinated units are reportable under Section 16 of the Securities Exchange Act.

Subordinated units are "Equity Securities" by definition but are also "Derivative Securities" because of the convertible feature.

Generally, an insider's acquisition of a unit option or other derivative security is required to be reported as of the date of acquisition.  Where the option or grant is subject to a future contingency, the option or phantom grant is not deemed to have been acquired by the insider until the contingency has been satisfied (unless the contingency is solely within the control of the insider or is related to the market price of the issuer's stock).  Options or grants subject to vesting based on conditions (other than passage of time and continued employment) that are not tied to the market price of issuer securities are not subject to Section 16 until the vesting conditions have been satisfied.

The SEC staff takes the position that unvested options or grants do not constitute derivative securities for purposes of Section 16 until the applicable condition is satisfied, except where the condition is (i) the passage of time and continued employment (as with most options and restricted stock), or (ii) tied directly to the market price of issuer securities.  Thus, the acquisition of derivative security should be reported upon the satisfaction of the vesting condition.  The date of acquisition is the date on which the condition is met.

However, because subordinated units are "Equity Securities," they are reportable on Forms 3, 4 and 5, notwithstanding the fact that they are also "Derivative Securities" with a performance condition.  Derivative securities beneficially owned that are both equity securities and convertible or exchangeable for other equity securities (e.g. convertible preferred securities) should be reported only on Table II of the applicable form.

OUR TAKE:  Navigating the beneficial reporting requirements under Section 16 can be tricky and oftentimes a time consuming process.  Holders of subordinated units of an MLP should report their direct and indirect holdings under Section 16.