Options Exchanges Ask for Big Changes to Proposed Dividend Equivalent Regulations

The U.S. Securities Markets Coalition (the "Coalition"), an industry group which includes all of the options exchanges in the United States as well as the Options Clearing Corporation, expressed serious concerns about the application of proposed regulations issued under Section 871(m) relating to the imposition of U.S. withholding tax on "dividend equivalents" to exchange-traded options (also referred to as "listed options") that reference dividend-paying stocks and indexes of stocks, other than certain "qualified indexes." In a March 5 letter to IRS Commissioner John Koskinen, the Coalition asserted that the proposed regulations, if adopted as final, would apply much more broadly than Congress intended and would disrupt the U.S. options market. The Coalition recommended that significant changes be made to the proposed regulations with respect to listed options. In particular, the Coalition objected to the proposal to treat all options with initial "deltas" of .70 or higher as economic substitutes for owning the underlying stock, even though, in the Coalition's view, the risks and rewards associated with such options "deviate significantly from those associated with owning the stock." Among the changes the Coalition suggested were:

• An option must have an initial delta of at least .90 or .95 to be treated as a specified equity-linked instrument subject to withholding;
• Deltas of options entered into in connection with each other should not be combined if the options replicate the same or similar risks with respect to additional shares of stock;
• Deltas of spreads and other complex strategies should be determined on a net basis;
• Expected dividends that have not yet been declared should not be treated as dividend equivalents;
• Qualified indexes should include any broad-based index (as determined under the securities laws) on which listed options and futures are traded and exchange-traded funds should be treated similarly; and
• Safe harbors and de minimis tests should be adopted to reduce the burden of complying with the regulations on brokers, withholding agents and other market participants.

See: Comments by U.S. Securities Marketing Coalition.For more information, please contact Daniel Mulcahy and Mark Howe.