Direct Participation Programs (DPPs) aren’t well known by that acronym, but “limited partnerships” are much better known. The difference in terminology doesn’t matter, except that you need to know what DPPs are and how they function for the Series 7 and know what FINRA means by them. The rule covering DPPs is FINRA Rule 2310.
In all honesty, DPPs aren’t tested too heavily on the Series 7, and they aren’t really complicated things either. However, DPPs are particularly important for young people entering finance, because they’re most likely to come to the industry from an interest in stocks (or, more recently, in cryptocurrencies). DPPs are very far from what many young people expect in capital markets.
One particularly striking thing about DPPs is the actual personal liability of general partners. GPs construct DPPs to attract capital from limited partners, who are the investors in the project and, as the name suggests, have limited liability from the project. If there’s, for instance, an oil and gas exploratory DPP and the program illegally siphons off oil from someone else’s land, the limited partners’ liability extends only to how much they invest in the program. GPs, on the other hand, can lose everything they own and even go to jail.
Theoretically that applies to CEOs and everyone in the C-suite at conventional companies, and DPPs look very similar to conventional companies on the surface. That’s why FINRA tests on what makes DPPs unique: their limited life (unlike companies, which are designed theoretically to operate forever) and the ability for outside investors to be much more active in the operations of the company. These two defining features show up often on the SIE exam.
Those unique features don’t exist just to make an exam question! They cut to the core of the unique benefits and risks of DPPs The benefit is largely tax benefits—tax losses can flow to LPs in a pass-through taxation structure that allows investors to deduct passive losses against passive gains elsewhere. Other tax credits and tax benefits on capital gains also benefit investors, and of course depreciation and amortization on real estate partnerships are another big benefit.
Note how these benefits are largely tax related. For very wealthy investors facing large tax bills, DPPs function within a broader portfolio, lowering investors’ tax burdens, providing income for exploratory or high risk short-term ventures that would otherwise go unfunded, and ideally providing value to the world by building houses, producing energy, or some similar tangible production. It’s a complex structure that, from the outside, looks unnecessarily complicated but, for those inside it, there are significant benefits.
Recommending DPPs to clients, therefore, is a complicated business, and this is why FINRA has a higher cap on commissions firms can earn selling DPPs to clients: a broker-dealer can charge as much as 10% when selling interests in a DPP, while overall services including the formation, underwriting, etc. of a DPP can incur 15% chargers.
With such high rates, you would expect a lot of underhand dealing, corruption, and fraud in the DPP space. You wouldn’t necessarily be wrong. However, the regulations on DPPs are very strict and rules aggressively enforced, and clients often complain about DPPs, so it’s no surprise that advisors aren’t as aggressive with these as you would expect. Of course, there are bad actors, so many will flaunt the rules anyway, and it is particularly noteworthy that there is a large industry of due diligence services for DPPs to help investors navigate these complex investment vehicles.
Note what we aren’t talking about here: outperformance, large profits, or even dividends. DPPs demonstrate that financial needs in investing aren’t just about maximizing returns, and savvy pros who find a niche can end up helping investors tremendously navigate these troubled waters. If nothing else, DPPs show that there is much, much more opportunity in the investment world than many outside of it realize.