Tax Switching Transactions  

Members and member organizations are reminded that "tax-switching trades," i.e., trades undertaken to take a profit or loss in a security, establish a new basis for a position, and reestablish a position, are prohibited unless such transactions are effected in accordance with applicable Exchange trading rules and in a manner that subjects them to the normal risks of the market and are reported for public dissemination. This prohibition applies to all Amex trades (including openings and closings) in all Amex securities (including bonds). In determining whether a transaction runs afoul of the above prohibition, the Exchange will consider all circumstances surrounding the transaction. These circumstances include, but are not limited to, whether the second leg of the transaction received a guarantee or assurance of a specific price, the period of time between the trades making up the transaction, the liquidity and volatility of the security, as well as the existence of common control over the trades. Members and member organizations are also cautioned that ordering or executing a transaction with knowledge that it involves no change of ownership may violate Article V, Section 4(c) of the Exchange Constitution and may be inconsistent with the Securities Exchange Act of 1934 (the "Act"). The following is an example of a prohibited transaction. Exchange member "A" wants to effect a tax switch transaction of 500 shares of XYZ. The current market in XYZ is a bid of 5.15 for 1,000 shares and an offer of 1,000 at 5.25. The bid and offer represent limit orders on the XYZ book. A approaches the XYZ specialist, who agrees to handle A's tax switch orders. Exchange member "B" subsequently enters the XYZ crowd with an order to sell 500 shares of XYZ at the market. The specialist informs B that she has sold the 500 shares at 5.15 to A (that is, to the tax-switching order). At the same time, the specialist effects a second sale of 500 shares of XYZ for A's tax-switching order to the limit order on the book. The specialist only reports one of the two 500-share XYZ transactions to the tape. This type of transaction is prohibited for a variety of reasons. First, the tax-switching trades were not effected at the risk of the market; that is, no bid or offer was made for the tax-switching orders, and other orders could not compete with them. Second, the price of each tax-switching transaction was not independently established; that is, the first execution price came from a trade where the tax-switching order did not have to compete to participate, and the second execution price was set by the first execution price rather than by competition in the crowd. Third, at the time of the first trade, the price of the second trade was guaranteed because of the arrangement that the second execution price would be set by the first, rather than having the prices determined through competition. Fourth, the period of time between the two legs of the tax-switching transaction did not bear an appropriate relationship to the market activity in the security involved; that is, the tax-switching trades were done simultaneously, rather than allowing time for market interest to appear before each trade and, through competition, establish independent prices. Fifth, while there were two trades in the tax switch, only one was reported to the tape. Finally, a specialist can not handle buy and sell orders executable at the same price for the same principal in the same security at the same time. In contrast, a transaction that appropriately addressed all of these issues would not run afoul of the above prohibition. For instance, a transaction in which a broker effected an "open outcry" cross (which could be broken up) in the crowd in which cross his or her customer sold to his or her firm (which was willing to facilitate the trade), then "walked around the post" before returning to the crowd to attempt to effect a second "open outcry" cross in which his or her firm would sell to the customer, appropriately addresses issues of market risk, independent pricing, absence of guarantee, time interval, and trade reporting and therefore would not be a prohibited tax switch trade. Please note that instructions to "cross" buy and sell orders to switch positions between accounts having the same beneficial ownership would create a "wash" transaction, which is prohibited. Further, the sending of a buy and sell order in the same security for the same beneficial owner through the Amex Order File System (AOF, also known as PER for equities and AMOS for options) to effect a tax switch transaction on the opening or at the close is prohibited. Finally, any use of the After Hours Trading Session to effect a "wash" transaction is prohibited. The purpose of this memorandum is only to describe the application of Exchange rules and procedures and should not be construed as describing the tax consequences of any transaction or furnishing interpretations of the Internal Revenue Code or state law. Please consult your tax adviser for appropriate tax advice. Please contact David J. Fisch, Managing Director, at 212-306-1450 with any questions on this topic.