Brill v. Commissioner

I. C. BRILL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Brill v. Commissioner Docket No. 49663. United States Board of Tax Appeals 30 B.T.A. 40; 1934 BTA LEXIS 1383; March 8, 1934, Promulgated *1383 The stock brokerage firm with which petitioner dealt on marginal account went into bankruptcy in 1928, at which time petitioner's account showed a credit balance. It was not known until 1929 that creditors of the firm would sustain any loss. The evidence fails to establish either any embezzlement of stocks purchased for petitioner's account or any ascertainment of worthlessness of petitioner's account of 1928, and it is held that petitioner is not entitled to a deduction in that year. Johnston Wilson, Esq., for the petitioner. Willis R. Lansford, Esq., for the respondent. ARUNDELL *40 The respondent disallowed a loss deduction claimed by petitioner growing out of the bankruptcy in 1928 of a brokerage firm with which petitioner had an account, and thereby determined a deficiency in the amount of $545.12. The only issue is whether petitioner is entitled to the deduction claimed in the amount of $6,665.50. FINDINGS OF FACT. The petitioner is a physician, engaged in practice at Portland, Oregon. In the computation of net income as shown by his income tax return for the year 1928 he claimed a loss of $6,665.50 as having been sustained*1384 through the bankruptcy of Overbeck & Cooke Co. It is the disallowance of this loss which forms the sole basis of the petitioner's appeal. Overbeck & Cooke Co. was a corporation organized under the laws of the State of Oregon for the purpose of engaging in the stock, bond, and brokerage business. The corporation did not have a seat on the New York Stock Exchange, but placed its orders through the partnership of Logan & Bryan, which did have a seat on the Exchange. Overbeck & Cooke Co. had a large clientele in the city of Portland and through its connection, Logan & Bryan, purchased and sold stock for its customers. Most of these transactions were handled through margin accounts, the customers paying the required margin, delivery of stock being withheld until the full price was paid. The individuals active in the control of Overbeck & Cooke Co. were "bearish" with respect to security prices for a number of years preceding 1928 and made short sales consistently in the expectation of being able to make purchases to fulfill their obligations at lower prices. As the trend of security prices was generally higher during this period, the volume of short sales resulted in large losses. *1385 On January 30, 1928, Logan & Bryan sold the securities purchased and held by it for Overbeck & Cooke Co., as the latter company *41 had been unable, by using every resource, to maintain adequate margin. As the result of this action, Overbeck & Cooke Co. was placed in receivership on January 31, 1928, and on February 2, 1928, was adjudicated a bankrupt. A trustee in bankruptcy was appointed, who was in charge of the company's affairs until they were completely wound up in 1931, when the last payment to creditors was made. In December 1928 the petitioner learned that the brokers had been charged with embezzling some of their clients' funds. On January 4, 1929, the trustee in bankruptcy informed the creditors that $1,131,030.06 was possible of recovery. Subsequently the bankrupt's assets were converted into cash and payments made to its creditors as follows: September 27, 1929 10.00% January 15, 1930 5.00% January 12, 1931 3.37% January 28, 1931 5.00% 23.37% None of these dividends were reported as taxable income by the petitioner in the years they were received. The petitioner opened his account with Overbeck & Cooke Co. on November 5, 1927, by*1386 the purchase of certain stocks on marginal transactions. During the remainder of the year 1927 the account was active and on January 1, 1928, the petitioner had to his credit the following stocks: 100 shares of Underwood, purchased December 14, 1927 200 shares of New Cornelia, purchased December 20, 1927 200 shares of Cerro de Pasco, purchased December 20, 1927 200 shares of Calumet & Arizona Mining, purchased December 24, 1927 100 shares of Freeport Texas, purchased December 31, 1927 On January 10, 1928, stocks had fallen in value and petitioner put up $4,000 cash with Overbeck & Cooke Co. On January 18, 1928, the Underwood stock was sold, giving petitioner credit for $6,666 and on the same date he drew down $2,000, leaving a balance in the hands of Overbeck & Cooke Co. to protect his margin. Upon the sale, on January 30, 1928, by Logan & Bryan of the securities held for the account of Overbeck & Cooke Co., there was entered on the books of Overbeck & Cooke Co. to the credit of the petitioner the amount of $49,659.30, which represented the closing values on the stocks on that date. After making adjustment for dividends, commissions, and other items, the petitioner's*1387 account with Overbeck & Cooke Co. showed a credit in his favor of $6,665.50, which sum represents the balance of undrawn margin deposits and profits after losses and expenses have been charged thereto. The bills and statements of Overbeck & Cooke Co. contained the following printed notice: *42 It is understood and agreed that all securities carried on this account, or deposited to secure same, may be carried in our general loans, and may be sold or bought at public or private sale, without notice, when such sale or purchase is deemed necessary by us for our protection. It is further understood and agreed that on all accounts the right is reserved * * * to settle contracts in accordance with the rules and customs of exchange where order is executed. No demand was made by petitioner on Overbeck & Cooke Co. for the stocks purchased for his margin account by the firm, either prior to bankruptcy or thereafter. The insolvency of Overbeck & Cooke Co. was caused by reason of their trading in the market and taking heavy losses. In their operations they used in part funds that came into their possession from the customers who dealt through them. Trading for their own account*1388 was traced back to as far as 1924, 1925, and 1926. The customers' relations with Overbeck & Cooke Co. were that margins of from $10 to $25 were required per share. The arrangement between Overbeck & Cooke Co. and Logan & Bryan was that Overbeck & Cooke Co. would maintain a margin of around nine points. Every order given Overbeck & Cooke Co. was found to have been placed with Logan & Bryan. The balance due petitioner in his account with Overbeck & Cooke Co. represented his equity in shares of stock previously ordered. It was ruled by the court handling the bankruptcy proceedings that accounts such as petitioner's were classed as general claims. Customers who made demands for the stock purchased for their accounts were given a preferred status. On or about January 8, 1929, suit was brought against Logan & Bryan by the trustee in bankruptcy in connection with the operations of Overbeck & Cooke Co. for $2,275,887. Thereafter a compromise settlement was reached, whereby Logan & Bryan paid $250,000, provided each creditor signed a release of all claims and demands of every nature and kind, known and unknown. In September 1929 a dividend of 10 percent was paid by the trustee*1389 an by accepting this amount the creditors, including petitioner, released Logan & Bryan from all claims. It was not until this time that the creditors of Overbeck & Cooke Co. knew definitely that they would suffer a loss in the amounts due them. OPINION. ARUNDELL: Petitioner bases his claim for a deduction in 1928 on the theory that the sale of his stock in January 1928 was an embezzlement thereof. "Embezzlement may be defined broadly as the fraudulent appropriation of another's property by a person to whom it has been intrusted or into whose hands it has lawfully *43 come." ; . In the cited case the Supreme Court of Oregon sustained the conviction of the president of Overbeck & Cooke Co. for embezzlement where the firm had received securities on an order to sell and deliver the proceeds to the owner and, after making the sale, refused to pay over the money. The court there points out that the customer had no general account with the firm, that his relation with the firm was that of principal and agent rather than debtor and creditor, and that a very different relation would have occurred had*1390 the customer merely directed the sale of securities and the credit of the proceeds to his account. The evidence here, in our opinion, does not establish an embezzlement of the stock. The brokerage firm acted within is rights in repledging the stock with Logan & Bryan as security for its marginal account with the latter. . The established rules in such cases are set forth in ; ; affd., , as follows: * * * The relation which is established between the broker and a customer who buys stocks upon margin is that of pledgor and pledgee. The legal title to the stocks is in the purchaser, and the brokers are the pledgees of the same for the repayment of all advances made by them in connection with the transaction. ; ; . Under such relation the broker has the right to pledge the stocks and obtain from the pledgee advances of money thereon, and*1391 the latter, by such transaction, obtains a good lien thereon which he may enforce by a sale of the pledge without notice to the owner of the legal title, and without incurring any liability to him therefor, or to the broker making the pledge. * * * The duty of Overbeck & Cooke Co. was not to deliver the specific securities purchased for petitioner, but to keep on hand or under their control either those securities or a like kind and amount so as to be able to make delivery when petitioner paid up his account and made demand for the stock. The act of the firm in placing itself in the position of being unable to deliver, by failure to meet its obligation to Logan & Bryan, perhaps constituted a conversion for which it would be liable to petitioner in a civil suit had he made demand for his stock. But it is stipulated that petitioner made no demand; hence, it is at least doubtful whether he could maintain an action in trover for conversion. ; *1392 ; ; ; . Thus, as we view the case, petitioner has failed to establish that his relation to the firm in 1928 was other than that of a creditor. According to the testimony the claim of petitioner against Overbeck & Cooke Co. was treated by the bankruptcy court as only a general *44 claim, and he shared in the distribution as a general creditor. Those customers who made demand for stock purchased for their accounts by the bankrupt were accorded a preferred status in the distribution of the estate. In view of the above, petitioner's right to a deduction, if any, must be under the bad debt provisions of the taxing statute. He must fail under these provisions because he has established neither an ascertainment of worthlessness nor a charge-off within the year. Throughout the entire year 1928 the trustee in bankruptcy was of the opinion that there would be sufficient recoveries so that there would be no loss to creditors. There is no evidence that petitioner had any information different from that of the trustee upon which*1393 he could predicate a claim of ascertainment of worthlessness. On brief counsel for respondent states that, by reason of discovery of an error, a deficiency of $450.55 is now claimed. Decision will be entered for the respondent in the amount of $450.55.