Rev. Rul. 57-451

The Internal Revenue Service has been requested to determine whether the situations described below involve the `disposition' of stock acquired pursuant to a restricted stock option within the meaning of section 421(d)(4) of the Internal Revenue Code of 1954.

(1) The stockholder deposits his stock with a bank or trust company in an `agency' account and authorizes such company to collect the dividends thereon. Although the stock certificate remains in the stockholder's name, for convenience the stockholder signs a stock assignment form in blank, enabling the bank or trust company to dispose of the shares upon subsequent order of the stockholder.

(2) The stockholder deposits his stock with his broker in a `safekeeping' account and, at the time of deposit, endorses the stock certificates and then authorizes the broker to `lend' such certificates in the ordinary course of the broker's business to other customers of the broker. The broker has the certificates cancelled and new ones reissued in his own name.

(3) Same as (2) above, except that the stockholder does not authorize the broker to `lend' the securities to other customers and the certificates remain in the stockholder's name.

Section 421 of the Internal Revenue Code of 1954 provides for the Federal income tax treatment of restricted stock options. In addition to defining a restricted stock option, section 421 sets forth the tax consequences of the receipt and subsequent exercise or disposition of the stock option and the tax consequences of the sale or other disposition of the stock obtained by exercise of the option. Subsection (d)(4) defines the term `disposition' as a sale, exchange, gift, or transfer of legal title but not, among other things, an exchange to which section 1036 of the Code applies.

The phrase `transfer of legal title' is defined neither in section 421 nor in the proposed regulations under that section. However, the phrase has been frequently considered in connection with Federal and State stock transfer taxation; and, in the absence of a definition of `transfer of legal title' in section 421, the construction placed upon the phrase by courts in the area of stock transfer taxes will be relied upon.

Courts, in cases concerning stock transfer taxes, have observed that the expression `legal title' is frequently used in stock transactions to describe a naked appearance of title, or a limited title appearing complete on its face. See William P. Bonbright & Co. v. New York , 165 App.Div. 640, 151 N.Y.Supp. 35 (1915); and Travis v. Ann Arbor Co. , 180 App.Div. 799, 168 N.Y.Supp. 53 (1917), affirmed without opinion, 227 N.Y. 640, 126 N.E. 925 (1919). On this basis, it has been held, in cases constructing the Federal stock transfer tax provisions of the Code, that a nominee in whose name stock is registered on the books of the corporation holds legal title to such stocks. See Founders General Corp. v. Hoey , 300 U.S. 268, Ct. D. 1209, C.B. 1937-1, 344; and Nee v. United Funds, Inc. , 169 Fed. (2) 33. However, in Selected American Shares, Inc. v. United States , 196 Fed. (2) 473, the court viewed a mere custodian of stock as the alter ego of the true owner and as taking no legal title to stock deposited with it for safe-keeping where the stock, accompanied by a blank assignment, was not reissued in the custodian's name so as to necessitate a retransfer by the custodian in the event of a subsequent sale by the true owner.

From the foregoing, it is held in the first and third situations described above, that where certificates representing shares of stock received by an optionee under a restricted stock option are endorsed or assigned in blank by such optionee and are deposited with a custodian, such as a bank or trust company or a broker, under a written agreement between the parties providing that such stock is to be held or disposed of by such custodian for, and subject at all times to the instructions of, the optionee, who remains the registered owner of such certificates on the books of the corporation, such deposit does not constitute a `disposition' of the stock within the meaning of section 421(d)(4) of the Internal Revenue Code of 1954.

The second situation described above, wherein the optionee authorizes the broker to `lend' his stock certificates to other customers in the ordinary course of business, presumably anticipates the `loan' of the stock to others for use in satisfying obligations incurred in short sale transactions. In such a case, all of the incidents of ownership in the stock and not mere legal title, pass to the `borrowing' customer from the `lending' broker. For such incidents of ownership, the `lending' broker has substituted the personal obligation, wholly contractual, of the `borrowing' customer to restore him, on demand, to the economic position in which he would have been as owner of the stock, had the `loan' transaction not been entered into. See Provost v. United States , 269, U.S. 443, T.D. 3811, C.B. V-1, 417 (1926). Since the `lending' broker is not acting as the agent of the optionee in such a transaction, he must have necessarily obtained from the optionee all of the incidents of ownership in the stock which he passes to his `borrowing' customer.

Section 1036 of the Code, which relates to the exchange of stock for stock, provides as follows:

(a) GENERAL RULE.-No gain or loss shall be recognizes if common stock in a corporation is exchanged solely for common stock in the same corporation, or if preferred stock in a corporation is exchanged solely for preferred stock in the same corporation.

Section 1.1036-1(a) of the Income Tax Regulations provides that the exchange referred to in section 1036 is not limited to a transaction between a stockholder and a corporation but also includes an exchange between two individual stockholders.

If this transaction, when completed, amounts to an exchange between two stockholders of common stock for other common stock (or preferred stock for preferred stock) in the same corporation, there would be no `disposition' of the optionee's stock within section 421. If, for example, by exercise of a restricted stock option, an optionee obtains a certificate for 100 shares of common stock in M Corporation, and if he then endorses the certificate, deposits it with his broker, and authorizes the broker to `lend' the stock to other customers, there would be no `disposition' of the stock for purposes of section 421 if the broker satisfies his resulting obligation to the optionee by transferring to him 100 shares of common stock in M Corporation. If the broker, on the other hand, satisfies his obligation by delivering to the optionee stock or other property which does not bring the transaction within the scope of section 1036, the optionee makes a `disposition' of his stock for purposes of section 421 as of that time.

That the delivery of shares of stock by the optionee to his broker and the satisfaction by the latter of the resulting obligation to replace them may constitute an exchange is supported by authority. A simultaneous delivery of property is not essential to an exchange. If the parties so intend, title to property delivered on one side may pass even though the contract remains executory on the other side.

Accordingly, it is concluded that the delivery of endorsed certificates of stock by the optionee to a broker, the latter being authorized to `lend' the certificates to his customers in the ordinary course of trade or business and having such certificates cancelled and new ones reissued in his own name, and the satisfaction by the broker of the resulting obligation to replace such certificates, will not constitute a `disposition' if the broker satisfies such obligation with certificates representing shares of stock of such kind and amount as to bring the then-completed exchange within the scope of section 1036 of the Code.