ties, not bona fide loans); United States v. Cathcart, 104 AFTR 2d 2009-6625, 2009-2 USTC par. 50,658 (N.D. Cal. 2009) (in an action to enjoin defendants from continuing to promote Derivium's 90-percent-stock-loan program, Judge Hamilton of the U.S. District Court for the Northern District of California granted the Government's motion for partial summary judgment, holding that the 90-percent-stock-loan-program transactions offered by Derivium were sales of securities, not bona fide loans). Subsequently, the District Court for the Northern District of California permanently enjoined Charles Cathcart from, directly or indirectly, by use of any means instrumentalities:

or

1. Organizing, promoting, marketing, selling, or implementing the "90% Loan" program that is the subject of the complaint herein;

2. Organizing, promoting, marketing, selling, or implementing any program, plan or arrangement similar to the 90% Loan program that purports to enable customers to receive valuable consideration in exchange for stocks and other securities that are transferred or pledged by those customers, without the need to pay tax on any gains because the transaction is characterized as a loan rather than a sale;

[United States v. Cathcart, No. 4:07-CV-04762–PJH (N.D. Cal. Nov. 23, 2009).]

We note that Mr. Cathcart stipulated to the entry of this permanent injunction.

With respect to Derivium, a magistrate judge for the District Court for the Northern District of California recommended that "injunctive relief against Derivium is 'necessary or appropriate for the enforcement of the Internal Revenue laws.' United States v. Cathcart, 105 AFTR 2d 2010-1287, at 2010-1292 (N.D. Cal. 2010). District Court Judge Hamilton adopted the magistrate judge's recommendations, finding that the report was well reasoned and thorough in every respect. United States v. Cathcart, 105 AFTR 2d 2010-1293 (N.D. Cal. 2010). 13

13 The report and recommendation of the magistrate judge, which was adopted by the District Court judge, stated:

Section 7408 authorizes a court to enjoin persons who have engaged in any conduct subject to penalty under § 6700 if the court finds that injunctive relief is appropriate to prevent the recurrence of such conduct. * * *

To establish a violation of § 6700 warranting an injunction under § 7408, the government must prove that defendant: (1) organized or sold, or participated in the organization or sale of, an entity, plan, or arrangement; (2) made or caused to be made, false or fraudulent statements concerning the tax benefits to be derived from the entity, plan, or arrangement; (3) knew or had

reason to know that the statements were false or fraudulent; (4) the false or fraudulent statements pertained to a material matter; and (5) an injunction is necessary to prevent recurrence of this conduct. United States v. Estate Preservation Servs., 202 F.3d 1093, 1098 (9th Cir. 2000) citing I.R.C. §§ 6700(a), 7408(b). “Under § 6700, any 'plan or arrangement' having some connection to taxes can serve as a 'tax shelter' and will be an 'abusive' tax shelter if the defendant makes the requisite false or fraudulent statements concerning the tax benefits of participation.” United States v. Raymond, 228 F.3d 804, 811 (7th Cir. 2000). "Congress designed section 6700 as a 'penalty provision specifically directed toward promoters of abusive tax shelters and other abusive tax avoidance schemes."" United States v. White, 769 F.2d 511, 515 (8th Cir. 1985) (emphasis in original). * * *

In an order dated September 22, 2009, the district court granted in part and denied in part, Defendants' motions for summary judgment. The court found that the undisputed evidence revealed that: as part of the loan transaction in question, legal title of a customer's securities transfers to Derivium USA (for example) during the purported loan term in question, which vests possession of the shares in Derivium's hands for the duration of the purported loan term; that the customer must transfer 100% of all shares of securities to Derivium USA and that once transferred, Derivium USA sells those shares on the open market, and that once sold, Derivium USA transfers 90% of that sale amount to the customer as the "loan" amount, keeping 10% in Derivium USA's hands; that during the term of the loan, the Master Loan Agreement provides that Derivium USA has the right to receive all benefits that come from disposition of the customer's securities, and that the customer is not entitled to these benefits; that the customer is furthermore prohibited from repaying the loan amount prior to maturity and is not required to pay any interest before the loan maturity date; and that, at the end of the purported loan term, the customer is not required to repay the amount of the loan (but merely allowed to do so as one option at the loan's maturity date) and can exercise the option to walk away from the loan entirely at the maturity date without repaying the principle; and thus, can conceivably walk away from the transaction without paying interest at all on the loan.

4The following factual findings are taken directly from Judge Hamilton's Order dated September 22, 2009. Docket No. 333.

The district court concluded that analysis of these and other undisputed facts pursuant to either the benefits/burdens approach outlined in Grodt & McKay Realty, Inc. v. Commissioner of Internal Revenue, 77 T.C. 1221, 1236 (Tax Court 1981), or the approach outlined in Welch v. Comm'r, 204 F.3d 1228, 1230 (9th Cir. 2000), compelled the conclusion that the transactions in question constituted sales of securities, rather than bona fide loan transactions. See e.g., Grodt, 77 T.C. at 1236-37 (applying multi-factor test to determine point at which the burdens and benefits of ownership are transferred for purposes of qualifying a transaction as a sale); Welch, 204 F.3d at 1230 (examining factors necessary to determine whether a transaction constitutes a bona fide loan).

The district court also found that the "substance over form doctrine" further supported the conclusion that, in looking beyond the actual language of the Master Loan Agreement to the totality of the undisputed facts, the substance of the transaction between the parties constituted a sale, and not a bona fide loan. See, e.g., Harbor Bancorp and Subsidiaries v. Comm'r, 115 F.3d 722, 729 (9th Cir. 1997) (it is axiomatic that tax law follows substance and not form).

Reviewing the above evidence and legal authorities cited above, the Court concludes that the evidence against Defendant Derivium USA is strong and that the merits of the case support entry of default judgment here. The Court concludes that an injunction against Derivium is necessary or appropriate for the enforcement of the internal revenue laws. See e.g., United States v. Thompson, 395 F.Supp.2d 941, 945-46 (E.D. Cal. 2005) (“Injunctive relief is appropriate if the defendant is reasonably likely to violate the federal tax laws again.")

[United States v. Cathcart, 105 AFTR 2d 2010-1287, at 2010-1290 to 2010-1291 (N.D. Cal. 2010).]

Securities Lending Arrangement

On brief petitioners argue that the transaction was a nontaxable securities lending arrangement analogous to the following situation described in Rev. Rul. 57-451, 1957-2 C.B. 295, 296:

(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.

In Rev. Rul. 57-451, supra, the Internal Revenue Service was asked to determine whether the situation described above was a taxable disposition of stock by the stockholder. Petitioners urge this comparison because the revenue ruling concludes that there is no taxable disposition of stock unless and until the broker satisfies his obligation to the stockholder by delivering property that does not meet the requirements of section 1036. Section 1036 provides for nonrecognition if common stock in a corporation is exchanged solely for common stock in the same corporation. Id., 1957-2 C.B. at 298. By analogy, petitioner seems to argue that his IBM stock was not disposed of until 2004 when he surrendered his right to reacquire the IBM stock in satisfaction of his "debt" to Derivium.

The transaction differs significantly from that described in the revenue ruling. Derivium was not acting as a broker, and the arrangement between petitioner and Derivium was not the type of securities lending arrangement described in the revenue ruling. In the revenue ruling, the stockholder authorized his broker, subject at all times to the instructions of the stockholder, to "lend" his stock to others to satisfy obligations in a short sale transaction. The "loan" in the revenue ruling required the borrower, "on demand," to restore the lender to the same economic position that he had occupied before entering into the "loan". Rev. Rul. 57-451, 19572 C.B. at 297, described the transaction as follows:

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 * * * (1926). ***

The securities lending arrangement described in Provost was also terminable on demand by either the lender or the borrower so that the lender retained all the benefits and assumed all of the burdens incident to ownership of the stock. 14

The master agreement did not enable petitioner to retain all of the benefits and burdens of being the owner of the IBM stock. Neither petitioner nor Derivium could terminate the "loan" on demand. Petitioner could not repay the "loan" and demand return of his stock during the 3-year term of the "loan". As a result, petitioner did not retain the benefits and burdens of ownership. He did not retain the benefit of being able to sell his interest in the stock at any time during the 3-year period and, therefore, could not take advantage of any increases in the stock's value at any given time during the 3-year period. At the same time petitioner bore no risk of loss in the event that the stock's value decreased.

In 1978 Congress codified and clarified the then-existing law represented by Rev. Rul. 57-451, supra, by enacting section 1058. Section 1058(a) provides for nonrecognition of gain or loss when securities are transferred under certain agreements as follows:

In the case of a taxpayer who transfers securities * * * pursuant to an agreement which meets the requirements of subsection (b), no gain or loss shall be recognized on the exchange of such securities by the taxpayer for an obligation under such agreement, or on the exchange of rights under such agreement by that taxpayer for securities identical to the securities transferred by that taxpayer.

14 In Provost v. United States, 269 U.S. at 452, the Supreme Court described the transaction as follows:

During the continuance of the loan the borrowing broker is bound by the loan contract to give the lender all the benefits and the lender is bound to assume all the burdens incident to ownership of the stock which is the subject of the transaction, as though the lender had retained the stock. The borrower must accordingly credit the lender with the amount of any dividends paid upon the stock while the loan continues and the lender must assume or pay to the borrower the amount of any assessments upon the stock. * * *

The original short sale is thus completed and there remains only the obligation of the borrowing broker, terminable on demand, either by the borrower or the lender, to return the stock borrowed on repayment to him of his cash deposit, and the obligation of the lender to repay the deposit, with interest as agreed. * * *

Section 1058(b) requires the securities agreement to meet the following four requirements in order to qualify for nonrecognition:

SEC. 1058(b). AGREEMENT REQUIREMENTS.-In order to meet the requirements of this subsection, an agreement shall

(1) provide for the return to the transferor of securities identical to the securities transferred;

(2) require that payments shall be made to the transferor of amounts equivalent to all interest, dividends, and other distributions which the owner of the securities is entitled to receive during the period beginning with the transfer of the securities by the transferor and ending with the transfer of identical securities back to the transferor;

(3) not reduce the risk of loss or opportunity for gain of the transferor of the securities in the securities transferred; and

(4) meet such other requirements as the Secretary may by regulation prescribe.

The master agreement does not satisfy the requirements of section 1058(b)(3).

In order to meet the requirements of section 1058(b)(3), the agreement must give the person who transfers stock "all of the benefits and burdens of ownership of the transferred securities" and the right to "be able to terminate the loan agreement upon demand." Samueli v. Commissioner, 132 T.C. 37, 51 (2009). In Samueli we focused on the meaning of the requirement in section 1058(b)(3).

[W]e read the relevant requirement*** to measure a taxpayer's opportunity for gain as of each day during the loan period. A taxpayer has such an opportunity for gain as to a security only if the taxpayer is able to effect a sale of the security in the ordinary course of the relevant market (e.g., by calling a broker to place a sale) whenever the security is in-the-money. A significant impediment to the taxpayer's ability to effect such a sale * * * is a reduction in a taxpayer's opportunity for gain. [Id. at 48.]

Petitioner was bereft of any opportunity for gain during the 3-year period because he could reacquire the IBM stock only at maturity. Schedule D of the master agreement not only provides that Derivium had the “right, without notice to *** [petitioner], to transfer, pledge, repledge, hypothecate, rehypothecate, lend, short sell, and/or sell outright some or all of the securities during the period covered by the loan", but also provides that Derivium "has the right to receive and retain the benefits from any such transactions and that *** [petitioner] is not entitled to these benefits during the