IRS Revenue Procedure
2002-11

Code Sec. )(9))



<<FULL TEXT>>

26 CFR 601.201: Rulings and determination letters
(Also Part I, section 1256(g)(9))


REV. PROC. 2002-11

SECTION 1. PURPOSE

This Revenue Procedure contains procedures that an exchange may follow
to enable the Internal Revenue Service to determine whether certain
persons trading on that exchange qualify as "dealers" under section
1256(g)(9) of the Internal Revenue Code (the "Code"). It is expected that,
after the issuance of a letter ruling to a specific exchange determining
whether a specific category of persons trading securities futures
contracts (and options on such contracts) on that exchange qualifies for
dealer status under section 1256(g)(9), the Service will publish the same
conclusion in a revenue ruling.


SECTION 2. BACKGROUND

The Commodity Futures Modernization Act of 2000, enacted as part of the
Consolidated Appropriations Act, 2001 (Public Law 106-554, 114 Stat.
2763), authorizes the trading of securities futures contracts, a new type
of derivative financial product. In general, gain or loss is recognized on
securities futures contracts upon disposition, and the character of that
gain or loss is determined by newly enacted section 1234B of the Code.

The timing and character of gains and losses on dealer securities
futures contracts (and options on such contracts), however, is determined
under section 1256. Dealer securities futures contracts are subject to
mark-to-market treatment, and gains or losses are treated as 60 percent
long-term capital gain or loss and 40 percent short-term capital gain or
loss. Section 1256(a). For purposes of the application of section 1256 to
dealer securities futures contracts (and options on such contracts), a
person is a dealer if the Secretary of the Treasury determines that the
person performs functions with respect to such options or contracts
similar to the functions performed with respect to stock options by
persons registered with a national securities exchange as a market maker
or specialist in listed options.

In Notice 2001-27 (2001-13 I.R.B. 942), the Service and the Treasury
Department requested comments and suggestions regarding both the substance
of the required determinations and the manner in which they should be
made. Numerous comments have been received regarding criteria that could
be used to identify dealers in securities futures contracts (and options
on such contracts). In addition, staff of the Service and Treasury
initiated numerous conversations with both regulators and various
exchanges. These ongoing conversations are expected to continue unabated.

The exchanges on which securities futures contracts and options may be
traded, however, are still developing rules that will govern trading. In
addition, certain of the regulatory requirements that will be imposed by
the Securities and Exchange Commission and the Commodity Futures Trading
Commission have not yet been issued in final form, and the rules
promulgated by some exchanges may differ in important respects from those
governing the trading of any other products.

During the current period, when trading rules are being developed, it
is important for the Service and Treasury to provide certainty for
taxpayers while at the same time not constraining the development of
trading structures for the new markets. Given the likely diversity of
trading platforms and the potential for new trading models, the Service
and Treasury have determined that encouraging exchanges to apply for
case-by-case determinations while they are developing their trading rules
is preferable to either writing general rules before the trading
structures are known or waiting until the structures are finally
established and then making the exchanges wait for a general rule to be
crafted.

The issuance at this time of general guidance for determining dealer
status would risk constraining the development of the structures for the
new markets. On the other hand, if general guidance is not issued now, the
absence of an interim process for securing dealer determinations could
impair the ability of the exchanges to adapt their proposed trading
systems to the requirements for achieving dealer status for market
participants. As a result of the flexibility inherent in the process of
obtaining a letter ruling, an exchange will have an opportunity, if it so
desires, to make adjustments in its proposed trading practices should
those be needed to secure dealer status for particular groups of traders.

Under the procedures set forth below, if an exchange is one on which
securities futures contracts (or options thereon) are, or are expected to
be, traded, the exchange may request a letter ruling that, based on its
specific rules and facts and circumstances, certain persons trading such
contracts (or options thereon) on the exchange will be treated as
"dealers" under section 1256(g)(9).

The Service expects that, once it has reached a decision regarding the
request for ruling, the same conclusion will be published in a revenue
ruling, which will serve as general guidance. The Service and Treasury are
committed to expedited processing for both the letter ruling and the
revenue ruling.


SECTION 3. PROCEDURES

.01 Procedures for submitting a ruling request. An exchange desiring a
letter ruling concerning whether certain persons trading on that exchange
will qualify as dealers with respect to specific contracts traded on that
exchange is required to submit a letter ruling request under the
procedures provided in Rev. Proc. 2002-1 (2002-1 I.R.B. 1) (or successor
procedure).

.02 Time for submitting a ruling request. Ruling requests may be
submitted prior to the date on which the exchange anticipates that trading
in the securities futures contracts at issue will begin, provided the
exchange has developed a substantially definite framework and set of rules
within which these contracts are expected to trade and has undertaken
significant actions to obtain necessary regulatory approvals and to
establish requisite contractual arrangements and trading systems. The
Service will not rule on requests involving alternative plans of proposed
transactions or hypothetical situations. See section 7.02 of Rev. Proc.
2002-1 (2002-1 I.R.B. 1, 20).

.03 Information that should be included in each ruling request. In
addition to the information required by Rev. Proc. 2002-1, the exchange
must submit any relevant information that will help the Service to
determine whether or not persons trading in securities futures contracts
on that exchange qualify as dealers under section 1256(g)(9). References
to securities futures contracts include options on such contracts.
References to rules applicable to trading in securities futures contracts
include rules that are not yet adopted in final form but that are expected
to be applicable. The current status of such rules should be described.
The ruling request should also include the following:

Copies of information filed with non-tax regulatory agencies regarding
trading on that exchange in the securities futures contracts at issue.

Information regarding whether persons trading in such contracts on that
exchange are required to register with the Securities and Exchange
Commission or the Commodity Futures Trading Commission and the nature of
any required registration.

A description of any books and records requirements under federal
securities laws or commodities laws to which persons trading on that
exchange are subject.

Information regarding whether persons trading in such contracts on that
exchange will be required to be members of the exchange and, if such
persons are not required to be members of the exchange, whether such
persons are required to be lessees or delegates of other persons entitled
to trade at member rates on the exchange.

References to the exchange's rules, if any, to which such persons will be
subject when trading in such contracts.

A description of any books and records requirements the exchange will
impose on such persons and any rules granting the exchange the right to
monitor and/or examine a person's trading activities and financial
stability. Information regarding whether the exchange, the Securities and
Exchange Commission, or the Commodity Futures Trading Commission imposes
any licensing requirements on such persons, including a description of any
such requirements.

Information regarding whether the exchange imposes net capital
requirements on such persons, or imposes such requirements on a clearing
member firm that clears a person's trades; whether clearing firms impose
any capital requirements on persons clearing trades through those firms;
and, in either case, a description of any net capital requirements.

Information regarding whether the exchange requires such persons to
regularly and continuously hold themselves out as willing to buy and sell
securities futures contracts, regardless of market conditions; and, if the
exchange imposes no such affirmative obligation, whether those persons
will in fact make a two-sided market because of other factors or
obligations, including a description of any such other factors or
obligations.

Information regarding whether the exchange anticipates that those persons
expect to profit by entering into either side of a position to capture a
portion of the bid-ask spread, or whether the exchange anticipates that
those persons expect that most of their gross income from trading in these
securities futures contracts will be attributable to profits from market
price movements.

Information regarding whether the exchange anticipates that such persons
will enter into transactions to hedge their risks with respect to the
securities futures contracts traded on the exchanges and the nature of
such hedges.

An estimate of the average gross trading volume that the exchange
anticipates such persons will generate with regard to these contracts.

Information regarding whether the exchange anticipates that trading in
these securities futures contracts will be a substantial part of the
principal business activity of such persons. Such information might
include, for example, an estimate of the average percentage of gross
income that the exchange anticipates such persons will generate from
trading in these securities futures contracts.

Information regarding whether the exchange will impose a substantial
presence requirement or a trading activity requirement on such persons,
including a description of any such requirements.

An estimate of the volume of proprietary trading, compared to the volume
of trading for customers, that such persons are expected to generate on
the exchange.

A description of the exchange's trading environment (e.g., floor trading
or screen trading) and any special features of such environment that
differentiate the persons for whom dealer status is sought from other
exchange participants.

A discussion of the nature, extent, and frequency of material changes that
may occur in any of the above information after the requested ruling is
issued. The exchange is encouraged to include suggestions for procedures
to be followed by the exchange, its traders, and the Service in the event
that material changes in the information occur. See section 12.10 of Rev.
Proc. 2002-1 (2002-1 I.R.B. 1, 52); section 7.01 of Rev. Proc. 89-14
(1989-1 C.B. 814, 815).


The foregoing list of information should be provided with any ruling
request, along with any additional information that may help the Service
to make its determination. After its review of a request for ruling, the
Service may require the exchange to submit additional information needed
to make its determination. See section 10.06 and 10.07 of Rev. Proc.
2002-1 (2002-1 I.R.B. 1, 43-44).


SECTION 4. EFFECTIVE DATE

This revenue procedure is effective February 4, 2002, the date this
revenue procedure was made available to the public.


SECTION 5. DRAFTING INFORMATION

The principal drafter of this notice is Shawn Tetelman of the Office of
the Associate Chief Counsel (Financial Institutions and Products). For
further information regarding this notice, contact Shawn Tetelman at (202)
622-3930 (not a toll-free call).

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