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Abstract: 

Investors, large and small alike, recently dodged a bullet when Congress failed to pass the Modernization of Derivatives Act at the end of last year. Although most of the attention to this bill focused on the change in the treatment of the character and the year-end recognition of gains and losses on all derivatives, the devil here really was buried in the details. Essentially, the proposal would have forced gain recognition on anything being hedged—so much so, that it would have deterred the vast majority of hedging by individual investors. Investors would have only two choices: hold or sell. Instead of hedging, investors would resort to selling in down markets, which would increase volatility, perhaps triggering more forced selling. Although the proposal didn’t pass, this wasn’t the first incarnation of this rule. Much like Jason in the never-ending Friday the 13th movie series, this ill-conceived proposal keeps getting resurrected. By shedding light on the implications, the authors aim to put this idea to rest, once and for all.

Keywords: Modernization of Derivatives Act, IRC Sec. 1259, IRC Sec. 1092, straddle rules, investment hedges, constructive sale rules, derivative taxation, marked to market, ordinary income

Affiliations:  1: Pace University Law School; 2: Fort Point Capital Partners.