What if an investor in a huge, high-profile hedge fund — say, Bridgewater or Paulson & Co. — accused the manager of stealing billions of dollars from his Limited Partners? Can you imagine the public outcry and backlash?

Yesterday (2/6), Bloomberg broke the story, “Kinder Morgan Sued by Investor over Pipeline Distributions.” In a Complaint filed in a Delaware Chancery Court, a KMP investor alleges that KMI steals money from KMP (I’m putting it bluntly) by misallocating capital expenditures to “expansion” instead of “maintenance,” thus boosting distributions to KMI and diluting KMP.

A few quotes from the Complaint (our emphasis):

“KMGP [KMI] has breached its duty of good faith and fair dealing, with regard to the allocation of Maintenance Capex, to KMP, and to Plaintiff and KMP’s other Limited Partners.”

“This Complaint alleges with particularity that the Defendants breached the Partnership Agreement and their fiduciary duties to the Limited Partners by accounting for KMP’s capital expenditures in a manner designed to maximize KMI’s Distributions at the cost of KMP’s long-term financial health and not, as required by the Partnership Agreement, in “good faith.””

“The bad faith allocation of Maintenance Capex has artificially inflated KMP’s growth rate and profitability, resulting in overvalued securities that are not adequately supported by KMP’s business. Further, the bad faith allocation of Maintenance Capex leaves KMP undercapitalized, forcing the Partnership to constantly seek out new sources of financing in the capital markets, leading to the issuance of additional securities that serve to dilute the value of Plaintiff’s, and the other Limited Partners’, units.”

“Since it has become more difficult to increase KMP’s earnings as the entity has become larger and developed a broader asset and earnings base, KMI has resorted to increasing DCF by gamesmanship.”

“…KMI is also incentivized to overstate its Expansion Capex as a signal to investors that KMP — one of the most mature and largest energy MLPs in the world — continues to be a growth company.”

“By accounting for certain capital expenditures as Expansion, rather than Maintenance Capex, KMI artificially inflates KMP’s DCF and Coverage Ratio, making KMP more attractive to investors. An accurate Maintenance Capex allocation would lower DCF and KMP’s Coverage Ratio, revealing that the high level of prior Distributions has become unsustainable.”

“Such improper dilution harms KMP’s limited partners, but has very little effect on KMI’s take home as the General Partner. Moreover, going to the capital markets to fund maintenance spending but accounting for that spending as Expansion Capex allows KMI to artificially inflate DCF, triggering higher split levels and higher Distributions, with KMP’s Limited Partners left holding the bag.”

“KMP accordingly runs the risk, as in a Ponzi scheme, that it will at some point be unable to attract new investors, exposing a fundamental lack of sustainability and leaving current Limited Partners with massive losses. KMI, meanwhile, will have contributed a fraction of the capital contributed by the Limited Partners — and thus assumed a fraction of the risk — but received billions of dollar in improper Distributions.”

And what does the Plaintiff want?

“…the disgorgement of any Distributions to KMGP, KMI, and any related entities, beyond amounts that would have been distributed in accordance with a good faith allocation of KMP’s Maintenance Capex.”

“Disgorgement” seems like the appropriate word here; the number is likely in the multiple billions.

In my humble opinion, the Plaintiff has nailed it (though he did miss a big opportunity not calling out KMP’s maintenance Capex policy in its CO2 segment — that alone is a huge LP-to-GP wealth transfer). Whether or not he has a legitimate case, I don’t know — it depends on the legal intricacies of the Partnership Agreement and other disclosures. Questions like, “What constitutes acting in “good faith,”” are probably more important to his case than, “Is KMP’s maintenance CapEx misallocated to expansion CapEx?” The first question is difficult to answer; the latter is easy.

This suit will probably not be a big deal, at least not yet, for KMI/KMP or the MLP sector in general. But perhaps some grains of sand are starting to shift here? Are LP investors starting to wake up to what’s really going on? Maybe… This is the first time I’ve seen anything like this…

-Kaiser