Margin Investments

[david rigby]

I'm looking for some guidance on whether there are any restrictions on buying stocks on margin,

- within a profit-sharing plan?

- within a 401(k) plan?

- within an IRA?

Specific reasoning and/or cites would be appreciated. Thanks.

[MGB]

Qualified plan and IRAs are not allowed to borrow (sorry, don't know the exact site). Buying on margin is a type of borrowing. Wouldn't that be all there is to it?

[QDROphile]

Qualified plans borrow frequently. The whole ESOP industry is based on it. I think IRAs can borrow. However, even asking the question means that you should not do whatever you are thinking of doing.

[Kirk Maldonado]

Theoretically, plans and IRAs can borrow. However, that causes the income that they recognize to be subject to income tax under the unrelated debt-financed income rules. Also, the prohibited transaction rules often come into play because of the way in which the transactions are structured.

[Jon Chambers]

ERISA prohibits transactions that can result in a loss greater than account value. This is the primary rationale most institutions use to prohibit margin trades. Furthermore, margin interest paid may constitute a PT if the margin lender is also the trustee.

[Guest reg_h2b]

There is an easy way around the margin problem at least for stock indices in IRAs.

You can get the effect of "margin" by buying a mutual fund that is "leveraged". There are some index funds that have a daily return 1.5 times or 2 times the return of the underlying stock index (eg nasdaq 100). The mutual fund creates this effect by futures, options, and swap agreements.

There is a similiar problem with shorting a stock in an IRA. But here again there are mutual funds that allow you to receive the daily% return of -2 times the underlying stock index.

[Kirk Maldonado]

I think QDROPhile's response is off-base. There is a statutory exemption from the prohibited transaction rules for ESOPs and thes IRS issued a Revenue Ruling exempting ESOPs from the unrelated business taxable income rules.

Thus, I don't think you can analogize from ESOPs.

[IRC401]

See PLR 8708031. The IRS appears to draw a distinction between borrowing money and buying on margin.

There are other rulings out there, and I do not pretend to be up to date on the issues.

My advice to pax is that if you are not willing to research the UBTI issues, don't do it.

[Kirk Maldonado]

After reading PLR 8708031, I think that IRC401 is right.

[QDROphile]

Kirk Maldonado:

Thank you for carefully characterizing my comment as "off base" rather than "wrong." You can't successfully steal unless you lead off.

[mbozek]

Jon- buying stock on margin using funds loaned by a party in interest (e.g., broker/ dealer) is permitted by DOL opinion 86-12A.

Only fiducaries are prohibited from loaning funds to the plans.

There is nothing inherently illegal in a plan entering into margin loans secured by stock or other assets - just that the gains are subject to UBIT at the rate for trusts, e.g., 40% income tax rate for gains in excess of about $9,000. However, there is a large fiduciary risk if the stocks used to secure the loan are subject to a margin call and participant's account balnace are decimated.

Also there are hidden margin risks in investments in leveraged limited partnerships. Plans that invest in such instruments will be suprised by UBIT at the end of the tax year with a 1099 form. I would review the prospectus for any of the "leveraged funds" recommended for IRAs to make sure that there is no borrowed money used to purchase the funds which will result in UBIT tax.

[Jon Chambers]

mjb--

As I noted in my earlier post, the PT becomes an issue if the loaning party is also the trustee. I concur that it's not a PT if the loan comes from a non-trustee/non-fiduciary brokersgreater than account value as the rationale why most providers don't permit this strategy, not as a legal prohibition. If the stock price declines, the broker/dealer may need to make a margin call, but there may be no way to inject funds into the account. Assuming a 50% margin, if the margined stock drops 50%, the account is wiped out; if it drops more, the account goes negative. For this reason, most brokers don't permit margin trades.

[mbozek]

Jon I concur except that not all trustees are fiducaries-- many trustees are nondiscretionary trustees, i.e., they only respond to instructions received by the employer or investment advisors. Hence they are not fiducaries under ERISA. Also HR -10 plans can use custodians to hold plan assets. Finally There are some financial entities that are affilated with broker dealers that offer margin loans for both personal assets and pension plans as part of a line of credit to a busiesss. I know of a PS plan that got a margin call from the fiancing entity which wiped its assets.

[Jon Chambers]

Respectfully, a trustee is always a fiduciary by definition, hence any loan from a trustee is potentially a PT, absent some exemption. Whether or not the trustee has discretion over investments is irrelevant. I agree that it may be possible to trade on margin, when the margin loan comes from a non-fiduciary, but I stand by my earlier comment that the vast majority of broker-dealers that I have experience with don't permit margin loans on qualified plan assets, even when they are not acting as trustee.

[mbozek]

Jon- There is a common misconception by investment advisors and attorneys that a trustee is automatically a fiduciary and therefore is the "deep pockets" in the event of the loss of assets. A trustee can only be a fiduciary to the extent the trustee agrees to excercise discretion over the assets under its control or performs an ERISA fiduciary function. A fiduciary relationship cannot arise by default or merely because the trustee is the owner of the assets. There is plenty of case law under federal and state law that absolves trustees with no discretion to act on behalf of plan assets from liability for misuse or loss of plan assets under their control if they could not act without instruction from another person. Ask Robert Metz, the former wall st. journal reporterabout that. Most investment advisors and employers pay little attention to the trust documents of directed trustees which requires that instructions be provided for any action involving investment or distribution of plan assets. The financial institutions require those provisons to limit their liability in the event of a loss of plan assets. I would be please to provide you with the Metz case upon your request . I spend a lot of time reviewing such documents and advising plan sponsors on the liability issues.

[Jon Chambers]

mjb, let's get back to first principles. Here is a direct copy from ERISA, defining party in interest:

"(14) The term ``party in interest'' means, as to an employee benefit plan--

(A) any fiduciary (including, but not limited to, any

administrator, officer, trustee, or custodian), counsel, or employee of such employee benefit plan;"

Note that the trustee is by definition, a party in interest.

Moving to the prohibited transaction issue, we find:

"Sec. 1106. Prohibited transactions

(a) Transactions between plan and party in interest

Except as provided in section 1108 of this title:

(1) A fiduciary with respect to a plan shall not cause the plan

to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect--

(A) sale or exchange, or leasing, of any property between

the plan and a party in interest;

(B) lending of money or other extension of credit between

the plan and a party in interest;"

Consequently, it's clear that the trustee, as a party in interest, cannot extend credit to the plan, unless the DOL advisory opinion you referred to above (86-12A) also applies to trustees (I don't have that opinion, and couldn't find it on the Web).

Moving to the ERISA definition of "fiduciary", we find,

"(21)(A) Except as otherwise provided in subparagraph (B), a person is a fiduciary with respect to a plan to the extent (i) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, ..."

I find it hard to believe that even a fully non-discretionary trustee could not be found to have no "authority or control respecting management or disposition of (a plan's) assets". I've never seen a trust agreement claiming a non-discretionary trustee was not a fiduciary at all, although I'm very familiar with agreements that seek to significantly limit the trustee's fiduciary liability. As an advisor to plan sponsors, you may want to review my paper on this topic, at the following link.

http://www.advisorsquare.com/advisors/schu...ns/82713136.pdf

I think your confusion may stem from the difference between an "investment fiduciary" (I agree a non-discretionary trustee is not an investment fiduciary), and a general fiduciary. I'd be interested in your rationale if you believe that it is possible to be a trustee without being a fiduciary in any sense of the term.

[mbozek]

Jon my analaysis is based upon the principle that to be a fiduciary a person must agree to excercise some discretion over plan assets. A party who under the terms of the opertative agreements can only act upon the instruction of another person is not a fiduciary regardless of whether they have legal title to the assets and is designated as the trustee. In the Metz case Metz deposited $400k into an IRA with a bank named as trustee. Metz later instructed the bank to transfer $360 k to another IRA operated by Metz's investment advisor. The advisor absconded with the money and Metz sued the bank for a breach of fiduciary duty in not reviewing the backound of the advisor before releasing the funds. The bank prevailed because Metz had signed an agreement that the bank would not be liable for transactions excuted by the bank based upojn directions received from Metz. This is sop for all banks that are not acting as an investment advisor. The ERISA case law is the same. All bank documents that I review have similar language that requires instruction from a representative of the plan before funds will be transferred/ invested unless the bank is being paid a fee for investment advice.

As noted in the definition of a fiduciary, the key is the word "discretionary" . Without discretion a trustee is not a fiduciary under ERISA regardless of the title under which the property is held. This is settled case law. I don't know of any financial institutions that use f word in ERISA trust documents unless they are being compensated for discretionay investment of assets because there is no reason to take such a risk.

[Jon Chambers]

I have to differ. I don't know of any institutional trustees that DON'T use the term "fiduciary", although obviously they will make it clear in what capacity they act as fiduciary, and don't take investment discretion unless they are being paid for it. Some of the trust companies my clients work with include Union Bank of California, Charles Schwab Trust Company, Wells Fargo Bank, CNA Trust, Vanguard Fiduciary Trust Company (note the name), Bank of America and Fidelity. I'd be very interested in hearing what trustees you run into that claim not to be a fiduciary.

If you go to the second part of the ERISA fiduciary definition, it continues "...or exercises any authority or control respecting management or disposition of its assets, ..." Obviously, a trustee meets this definition, since they are the only entity that can physically make a disposition.

On a separate note, the February 4th issue of Pensions & Investments has an op-ed piece on fiduciaries. They indicate that ERISA has no clear definition of fiduciary, and indicate that it is sometimes unclear as to who is a fiduciary. They cite actuaries and investment consultants as examples, but don't even touch on the issue of trustee.

[Jon Chambers]

I finally found the right cite as to whether a trustee must be a fiduciary. It's found in 29CFR Sec. 2509.75-8. Here's the relevant info.

"D-3 Q: Does a person automatically become a fiduciary with respect to a plan by reason of holding certain positions in the administration of such plan?

A: Some offices or positions of an employee benefit plan by their very nature require persons who hold them to perform one or more of the functions described in section 3(21)(A) of the Act. For example, a plan administrator or a trustee of a plan must, be the very nature of his position, have ``discretionary authority or discretionary responsibility in the administration'' of the plan within the meaning of section 3(21)(A)(iii) of the Act. Persons who hold such positions will therefore be fiduciaries."

Hope this puts to bed the question of whether you can be a trustee without being a fiduciary.

On the issue of range of trustee responsibilities, and the Metz case cited above, note the following conflicting conclusion from a Kilpatrick and Stockton article http://www.kilstock.com/site/print/detail?...rticle_Id=1031:

"In Arakelian v. National Western Life Insurance Co., [755 F. Supp. 1080 (D.D.C. 1990)], the trustees argued that they were not fiduciaries because they had never exercised their fiduciary powers and had delegated plan administration to the insurance company from which they had purchased a group annuity contract. The court held that "[t]he fact that all administrative functions of the Plan were delegated to the Plan administrator (National Western) did not and does not absolve the trustees of their duty to review and insure that the administrator was acting in the best interests of the participants." [id. at 1084]"

[Guest FredR]

I would agree with Jon. The fact that a trustee does not proactively select the investments of a plan does not absolve them of responsibility to monitor investments that might be imprudent, due to excessive risk, or illegality etc.

I do not have the cite, but I recall that a few years ago the PWBA successfully prosecuted a bank trustee for failing to use due diligence in monitoring an ESOP that used questionable valuations.

[mbozek]

Jon: The regulation you cited in your last post is a 25 year old opinion of the US Labor Dept and is not the standard used by the Courts to determine fiduciary liability of a trustee under ERISA. In Beddall v. State St. Bank and Trust, 137 F3d 12 (1998), the First Circuit Court of Appeals held that a bank acting in the capacity of a trustee for assets of a qualified plan was not an ERISA fiduciary merely because the bank held legal title to the assets and perfomed certain administrative functions for the plan. The bank had been sued by the fiducaries for an Eastern Airlines pension plan because an investment manager appointed to manage the real estate portion of the plan had over valued the assets. The court stated the term fiduciary is functional and a party must have discretion over the plan assets to be fiduciary. Where a trustee acts on the instructions of a duly appointed advisor (the RE manager) or other plan representative, the trustee is performing a ministerial function, not a discretionary function and is not a fiduciary because it follows such instructions in disposing of plan assets. The Court also cited several prior cases for this principle. By the way the Beddell case did not even review the regulation you mentioned in your last post indicating that it has no weight in a judical review if the trustee has no discretion.

The case you cited is not on point either because it deals with plan fiducaries who had the obllgation under the Plan to review the acts of the administrator they hired but failed to exercise it. They are no different than the fiducaries for the Eastern Airlines pension plan who had the obligation to review the actions of the RE manager who they appointed but that does not make the bank fiduciary because it followed the manager's instructions.

[Jon Chambers]

Hey mjb--

Slow down a little here. I never said that a trustee has to have investment discretion, or needs to be responsible for a plan's investments. In fact, most trustees don't have that role or responsibility, because it is retained by the sponsor, or delegated to an investment manager. I merely said that a trustee is, by definition, a fiduciary. I then cited the ERISA reg that says that a trustee is a fiduciary. This whole conversation started because we were investigating whether or not a margin loan would be a prohibited transaction, a question that comes under the purview of the DOL. You may be right that courts don't care about DOL regs, and that they will adopt a functional definition of fiduciary status that is entirely dependent on whether or not the entity holds investment discretion. That doesn't change the fact that the DOL says a trustee is a fiduciary by definition, that just about every professional trustee will accept limited scope designation as a fiduciary, and that loans from fiduciaries may constitute a PT, absent an exemption. Are we in agreement on those points? If so, I don't think there is anything we disagree on.

[Kirk Maldonado]

I think that people are getting confused because they think that if you are a fiduciary, then your fiduciary responsibilities extends to everything that could go wrong.

A person is a fiduciary with respect to certain functions, not every conceivable function that could arise under the plan.

Also, I concur in Jon's remarks.

[mbozek]

I concur except to note that a person is only a fiduciary under ERISA to the extent that they perform a fiduciary function under Section 3(21(A). Advisors have duty to determine if a party is a fiduciary under the law and this requires a review of the operative documents and fiduciary status cannot be based on a title such as trustee.

[Kirk Maldonado]

I concur in mbozek's clarification of my prior posting.

[Guest Derelict]

See PLR 8708031. The IRS appears to draw a distinction between borrowing money and buying on margin.

There are other rulings out there, and I do not pretend to be up to date on the issues.

My advice to pax is that if you are not willing to research the UBTI issues, don't do it.

I can't seem to find this PLR 8708031 anywhere, can someone provide a link or post it?

It would be greatly appreciated. I'm looking for instances in which proves that margin in an IRA isn't prohibited by the code so any other PLR's/Court Rulings would help too.

Thanks,

-D

[Kirk Maldonado]

Here are the holdings of PLR 8708031 (this is all that I have):

In summary, based on the information submitted, we rule as follows:

1. Provided that no funds are borrowed to finance the acquisition of the index futures and index stocks as described above, the income realized from the two legs of the arbitrage transactions will be excluded from UBTI under section 512(b)(5)of the Code.

2. Amounts deposited with a broker or other similar person as "margins" to secure your performance under an index futures contract will not constitute "acquisition indebtedness" under section 514©(1) of the Code, but rather are in the nature of a security deposit.

3. Whether or not amounts are borrowed to obtain the margin deposit for index futures, the index futures contract will not constitute debt-financed property under section 514(b)(1).

4. Because the index futures contract has no basis, your potential liability with regard to the performance of the contract will not enter into the computation of average adjusted basis for purposes of section 514 of the Code and the regulations thereunder. In addition, the cost of the short term securities acquired with the proceeds of your sale of index stocks will not enter into the computation of adjusted basis under section 514. Instead, the debt/basis percentage described in section 514(a)(1) will be based solely on the ratio of your average acquisition indebtedness with respect to the debt- financed index stocks to the average adjusted basis of the stocks.

5. In a fully hedged arbitrage position beginning with an overvalued contract, if the purchase of index stocks is financed with acquisition indebtedness, and if there ia gain on the index stocks in closing out the arbitrage, in computing UBTI included under section 514(a)(1) and (2) of the Code, such gain shall be offset by the loss realized on the index futures leg of the position, even though the index futures contract is not debt-financed property. Similarly, if instead there is gain on the index futures leg of the position and lose on the index stocks leg, in computing your UBTI from the arbitrage, the loss realized on the index stocks leg of the position shall only be allowed to the extent of the gain on the index futures leg of the position. Remaining gain shall be excluded from UBTI under section 512(b)(5) of the Code.

[Jon Chambers]

I concur except to note that a person is only a fiduciary under ERISA to the extent that they perform a fiduciary function under Section 3(21(A). Advisors have duty to determine if a party is a fiduciary under the law and this requires a review of the operative documents and fiduciary status cannot be based on a title such as trustee.

You may be interested in the recent (Friday) FAB from EBSA:

Federal regulators on Friday formally declared that directed trustees under the Employee Retirement Income Security Act (ERISA) are to be considered fiduciaries and are required to act prudently. The pronouncement came from the US Department of Labor's Employee Benefits Security Administration (EBSA), which released Field Assistance Bulletin (FAB) 2004-03. As they did in a legal brief filed in the Enron case, DOL officials said in the document released Friday that a directed trustee not only must carry out its duties prudently, they also must act solely in the interest of the participants and beneficiaries of employee benefit plans. The FAB did note, however, that a directed trustee may rely on the representations of the directing fiduciary unless the directed trustee knows that the representations are false. It also said that directed trustees do not have an independent obligation to determine the prudence of every transaction, nor do they have an obligation to duplicate or second-guess the work of the plan fiduciaries that have discretionary authority over the management of plan assets - though exceptions were noted in circumstances where the directed trustee had knowledge of "material non-public information." MORE at http://newsmail.plansponsor.com/cgi-bin1/D...bU10FkB0GL2N0A7 .

[jquazza]

Mbozek,

a Trustee has control over the plan assets and that makes him a fiduciary. Whether it excercises that control at the direction of another fiduciary is irrelevant. The article from the DOL published last week makes it very clear.

[mbozek]

I dont see what is significant about this notice which does not change the liabillty of the trustee who acts at the direction of a Fid. Directed trustees can require a representation from the fiduciary that the instructions are in accordance with the plan and ERISA before taking action and be indemnified for liability in acting on the instructions. The trustee is not required to perform an independent investigation of the proposed instructions or review the decisions of the plan fids.

But what is the difference between the fiduciary responsibility of a custodian and a directed trustee under ERISA?

[Jon Chambers]

In general, a custodian is not a "fiduciary" (although they may conduct themselves in a manner that makes them a fiduciary. A directed trustee is a fiduciary (albeit, with limits on their fiduciary duties). This is one of the key reasons why we generally recommend that our retirement plan clients engage a directed trustee rather than a custodian. At least historically, the cost for directed trustee services has tended to be quite low.

[mbozek]

I think that your definiton of a directed trustee and custodian is useless and confusing since it bases the difference on a conclusion, not on an analysis of the duties assumed. Under ERISA a fiducary is any person who performs a fiduciary function e.g., administers the plan, regardless of the designation. As I see it neither a custodian or a directed trustee has discretion to act without instructions from a fiduciary.

[Jon Chambers]

I guess I don't see this as all that confusing. If you are a fiduciary, you are subject to fiduciary standards. The ERISA fiduciary responsibility legal standard has been described as "the highest known to the law." [Donovan v. Bierwirth, 680 F.2d 263, 272 (2d Cit. 1982)] . If you are not a fiduciary (i.e., if you are a custodian), you are not subject to fiduciary standards. If you are a fiduciary, you can have co-fiduciary duties. If you are not a fiduciary, you don't generally have co-fiduciary duties.

Certainly a directed trustee, like a custodian, needs to take proper direction from another plan fiduciary. But since a directed trustee is a fiduciary, the directed trustee must take reasonable steps to ensure that the direction is proper (i.e., in accordance with the terms of the Plan, does not contravene ERISA, is not a prohibited transaction, etc.) If the directed trustee merely rubber stamps and executes the fiduciary's direction, they may be breaching their fiduciary duty to the Plan.

As you note, directed trustees can require a representation from the directing fiduciary that the directive is proper, and can seek indemnification from the directing fiduciary. These are reasonable steps. However, they don't eliminate the directed trustee's fiduciary liability, they merely manage it. I've been involved in litigation where a directed trustee took no steps to ensure a directive was proper, and consequently, faced liability for executing an imprudent directive. I doubt that they would have faced liability had they been serving in merely a custodial capacity.

Finally, in my opinion, it is "useful" to the plan sponsor to have a directed trustee serving in a fiduciary capacity, vs. a custodian in a non-fiduciary capacity. Of course, this is a judgment call on which reasonable people can disagree.

[mbozek]

Where does ERISA make a directed trustee a fiduicary by accepting the appointment to be subject to the direction of a fid? Under the DOL notice if the directed trustee relies on the reps of the fid that the direction is in accordance with plan terms and has no knowlegde that the reps are false then the DT has no fid liability which makes the DT's position no different than a custodian. I dont understand the relevance of the case you refer to since the DOL notice you cite states that a directed trustee has no independent duty to determine the prudence of transactions or duplicate or second guess the work of plan fids who have discretonary authority over plan assets. If the DT gets reps from the fid that the direction is in accordance with plan terms and not contrary to ERISA and has no duty to look behind the transaction how is there fid liability to the DT for following the direction of the fid? If as you claim, the DT is a fid in following the directions of a fiduciary then why be a DT because you have the same liability as the fid even though you are following the direction of a fid under ERISA and relying on their judgment?

[Jon Chambers]

ERISA makes ALL trustees fiduciaries by definition. We already established that (see 29CFR Sec. 2509.75-8). As Kirk and others noted, being a fiduciary does not mean that you have fiduciary responsibility for all plan functions, although you may have co-fiduciary duties, depending on the terms of your contract, etc.

We agree on the ability of the DT to reasonably rely on a representation from the fiduciary prior to executing a trade. The point that you didn't address was DT liability when the directing fiduciary has not made a representation. Further, under certain circumstances, the FAB notes that it may not be acceptable for the DT to rely on the fiduciary's representation. For example, the FAB provides that a directed trustee may have to question directions involving the purchase or holding of a security where there are "clear and compelling public indicators" that call into question the issuer’s viability as a going concern.

Which is exactly my point. A DT has different duties from a custodian, because a DT is a fiduciary (albeit, a limited fiduciary) while a custodian is not. Your question "Why be a DT?" is a good one. But since there are DT's in the market, I believe that my advice to clients ("Hire a DT, not a custodian") continues to be good advice.

[Kirk Maldonado]

I agree with Jon's remarks.

I think that because of their increased exposure to liability, the disparity between the fees charged by a discretionary trustee and those charged by a directed trustee will dimish. However, directed trustees don't have unlimited ability to raise their fees, because if the difference isn't that much, clients will choose a discretionary trustee to be able to shift more responsibility and potential liability to the trustee.

[BeckyMiller]

I am not entering into this fiduciary discussion. That is just too scary for a lowly little accountant like me.

I just wanted to note that if you have the CCH tax service on-line. You can get the letter ruling at http://tax.cchgroup.com/network&JA=LK&fNoS...=L&fNoLFN=TRUE&.

If you really want it and can't get it from CCH or a comparable service, e-mail me.

[mbozek]

On Feb 1, a federal judge granted summary judgment dismissing the fiduciary claims against Merrill Lynch, the directed trustee of the WorldCom 401k plan which invested in world com stock. The ct held that ML was not the fiduciary who made investment decisions regarding company stock. The ct's dismissal relied on the recent DOL bulletin on directed trustees obligations under ERISA. The World Com case was the first case to be decided in which employees tried to hold a directed trustee liable for investing in employer stock.

[CaptainObvious]

Disclaimers: I am not a lawyer, or any kind of financial expert. I am just sharing my possibly incorrect layman's understanding in the hopes that it will give others ideas to research from more authorative sources.

In a minor update to this decade old threat, I'd like a mention a more recent possibly relevant Internal Revenue Service private letter ruling, 201434024, dated May 29, 2014, released August 22, 2014, at http://www.irs.gov/pub/irs-wd/201434024.pdf, that seems to indicate that short selling stock in a trust's margin account does not itself generate UDFI tax, even if the temporarily increased cash position created from initiating the short is used to buy more stock.

One warning to keep in mind is that this private letter ruling was issued about a charitable remainder trust rather than a qualified retirement plan.

Anyhow, it seems to me that this is an example of use of a legiatimate use margin in a trust account that apparently would not generate UDFI tax.

Excerpts from pages 5-6:

"In Rev. Rul. 95-8, supra, we ruled that a short sale does not create an indebtedness for purposes of § 514 because it constitutes the borrowing of property rather than money. Rev. Rul. 95-8, supra, relies on Deputy v. duPont, 308 U.S. 488, in which the Supreme Court held that a borrowing of property does not give rise to "indebtedness." The taxpayer borrowed stock and argued that payments made to the lender constituted interest. The court held that although the taxpayer had an obligation to the lender, such obligation was not an "indebtedness," because an indebtedness arises only with respect to the borrowing of money, not the borrowing of property."

[...]

"Rulings:
1. The borrowing of stocks by a fund in entering into short positions will not result in "acquisition indebtedness" as defined in§ 514( c) so that none of the distributive share of a fund's income or gain which is derived from the fund's trading activities, to the extent attributable to the foregoing transactions, will be treated as "debt-financed property" as defined in§ 514(b).
2. The purchase of long positions in stocks in accounts at one or more affiliates of a broker using, in whole or in part, cash proceeds from short sales made through a fund's accounts at one or more affiliates of that same broker will not result in "acquisition indebtedness" as defined in § 514© so that none of the distributive share of a fund's income or gain which is derived from the fund's trading activities, to the extent attributable to the foregoing transactions, will be treated as "debt-financed property" as defined in § 514(b).
3. The use of long positions in stocks, including some or all of those purchased with short sale proceeds, as collateral to secure the performance by a fund of its obligations to deliver stock to the broker to cover its open short positions will not result in "acquisition indebtedness" as defined in§ 514© so that none of the distributive share of a fund's income or gain which is derived from the fund's trading activities, to the extent attributable to the foregoing transactions, will be treated as "debt-financed property" as defined in § 514(b).
"