SECTION 2. BACKGROUND

.01 Section 1058(a) provides that in the case of a taxpayer who transfers securities (as defined in § 1236(c)) pursuant to an agreement which meets the requirements of § 1058(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.

.02 In adding § 1058 to the Code, Congress intended to provide nonrecognition treatment to securities loans in which “the contractual obligation [to return identical securities] does not differ materially either in kind or in extent from the securities exchanged . . . .” S. Rep. No. 762, 95 ^th

Cong., 2d Sess. 7 (1978); 1978–2 C.B. 357, 361 (“Senate Report”). Congress also sought to encourage securities holders to make their securities available for loans. Congress explained:

Under present law, uncertainty has developed as to the correct income tax treatment of certain securities lending transactions. As a result, some owners of securities are reluctant to enter into such transactions.

Senate Report at 3; 1978–2 C.B. 359.

Because of time delays which a broker may face in obtaining securities (from the seller or transfer agent) to deliver to a purchaser, brokers are frequently required to borrow securities from organizations and individuals with investment portfolios for use in completing these market transactions. It is generally thought to be desirable to encourage organizations and individuals with securities holdings to make the securities available for such loans since the greater the volume of securities available for loan the less frequently will brokers fail to deliver a security to a purchaser within the time required by the relevant market rules. Senate Report at 5; 1978–2 C.B. 360.

.03 Recently, a significant number of securities loans have terminated as a result of a default by the borrower of the securities. These defaults are often the direct or indirect result of the bankruptcy of the borrower (or an affiliate of the borrower). For example, the bankruptcy of the borrower might, by itself, constitute an event of default under the securities loan agreement. Likewise, the bankruptcy of an affiliate of the borrower might indirectly prevent the borrower from returning identical securities upon notice of termination by the lender, if, for example, such a bankruptcy affects the borrower’s liquidity and practical ability to acquire identical securities in the secondary market. In many of these situations, the lender thereafter purchases identical securities and applies collateral provided by the borrower pursuant to the securities loan agreement against the purchase price (and the borrower’s obligation to return identical securities is terminated).