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questionnaire indicating the participant's qualifications to
participate in the Merit markets.
The officers of Merit believed that the margin requirements
for their option trades were governed by Regulation T, Credit by
Brokers and Dealers, 12 C.F.R. pt. 220 (1998), promulgated by the
Federal Reserve Board pursuant to the Securities Exchange Act of
1934 as amended, 15 U.S.C. sec. 78g (1994). Under Regulation T,
the margin requirements for "open" T-bill options are higher than
the deposits required as margins for offsetting spread positions.
It was not feasible for Merit to offer open positions, and it
offered only spreads.
Merit provided a private placement memorandum (PPM) to each of
its T-bill option investors. This document informed potential
investors that "among other considerations, there are material
income tax considerations involved". The section "Federal Income
Tax Aspects" contained the advice that T-bills--
are expressly excluded from the definition of a capital
asset under section 1221(5) of the Code. Accordingly,
based on the provisions of Sections 1234(a) and 1221 of
the Code, gain or loss recognized by a holder of an
Option resulting from the sale or exchange (including the
expiration) of such option would be recognized as
ordinary income or loss.
The PPM further advised that "gain or loss recognized by a writer
resulting from the sale of T-Bills pursuant to the exercise of a
call by the holder would be taxable as ordinary gain or loss".
Further, it advised that--
In the event a T-Bill is determined not to constitute a
'security,' * * * gain or loss realized by a writer of a
T-Bill option, which is attributable to the lapse of the
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