Author Topic: Is this illegal? Trading with oneself  (Read 997 times)

ChpBstrd

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Is this illegal? Trading with oneself
« on: May 15, 2018, 10:50:41 AM »
Suppose a person was looking at their traditional IRA wishing there was a way to move funds to their Roth IRA without triggering taxes and penalties.

Suppose they find a highly illiquid investment, such as an option that is very far out-of-the-money and essentially worthless, with no buy or sell orders.

From their Roth IRA, they submit an order to sell the option. They confirm their order is the only order in the market. There exist no buy orders.

From their traditional IRA, they submit an order to buy the option.

The trade executes. Money flows from their traditional IRA to their Roth IRA. A soon-to-be-worthless option flows in the opposite direction. No taxes are triggered.

It seems almost certain this would be illegal, but can anyone point me to where it says so, or what the crime would be called? The term "self-dealing" refers to fiduciary relationships, not trading with oneself. Would it be money laundering?

For extra credit: what if spouses or friends set up such a trading structure between themselves, taking turns in the profitable role? Then it would not be trading with oneself, but it would not quite be market trades either. Either way, there is intent to avoid taxes and maybe that's illegal too?

On the other hand, it is trading in the open marketplace, and the case could be made that the direction of the cash flow is uncertain. It would be like setting up a hedge for 100 shares in account A because you have 80 shares in A and 20 shares in B.

Radagast

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Re: Is this illegal? Trading with oneself
« Reply #1 on: May 15, 2018, 11:12:51 AM »
I don't know about the details of the law, but this might be a brilliant idea and a good use of options. If Mitt Romney can do this general type of shit, we should be able to also.

Telecaster

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Re: Is this illegal? Trading with oneself
« Reply #2 on: May 15, 2018, 11:27:25 AM »
The IRS has a term for this sort of thing....which escapes me  at the moment.  Basically, even if the individual steps are technically legal, if the purpose of the scheme is to evade tax then the whole thing becomes illegal. 

Jrr85

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Re: Is this illegal? Trading with oneself
« Reply #3 on: May 15, 2018, 11:48:34 AM »
Suppose a person was looking at their traditional IRA wishing there was a way to move funds to their Roth IRA without triggering taxes and penalties.

Suppose they find a highly illiquid investment, such as an option that is very far out-of-the-money and essentially worthless, with no buy or sell orders.

From their Roth IRA, they submit an order to sell the option. They confirm their order is the only order in the market. There exist no buy orders.

From their traditional IRA, they submit an order to buy the option.

The trade executes. Money flows from their traditional IRA to their Roth IRA. A soon-to-be-worthless option flows in the opposite direction. No taxes are triggered.

It seems almost certain this would be illegal, but can anyone point me to where it says so, or what the crime would be called? The term "self-dealing" refers to fiduciary relationships, not trading with oneself. Would it be money laundering?

For extra credit: what if spouses or friends set up such a trading structure between themselves, taking turns in the profitable role? Then it would not be trading with oneself, but it would not quite be market trades either. Either way, there is intent to avoid taxes and maybe that's illegal too?

On the other hand, it is trading in the open marketplace, and the case could be made that the direction of the cash flow is uncertain. It would be like setting up a hedge for 100 shares in account A because you have 80 shares in A and 20 shares in B.

I suspect it is illegal for the same reason you can't do your own rehab and maintenance work on real estate held by your IRA.  You could have the custodian bid out the work, and you could bid ~$0, so that the IRA gets value above whatever the current year limit is.  Similarly, you can't pay yourself above market rates to do rehab work in order to take money out of the IRA without paying penalties. 

I suspect there is just a blanket prohibition on dealing with yourself from your IRA so that you can't do out of market transactions, and I doubt it's written in a way that running it through a third party broker cures it.  Could be wrong though. 

Also, I'm not sure it would work in practice.  If you tried to go through a broker to overpay for a worthless option, what would stop the broker from supplying the worthless option from another place, so that the broker pockets the windfall and not your IRA?  If you prevent this by making the broker a fiduciary and not a true borker, then you are just using an agent to do something, and he's not going to be able to do anything you are prohibited from doing.   

bacchi

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Re: Is this illegal? Trading with oneself
« Reply #4 on: May 15, 2018, 11:49:14 AM »
It's called "painting the tape" and it's illegal because it's creating an artificial price.

Oh, sure, you can probably do it a few times without anyone noticing but if a broker or the IRS catches on, you'd be in a world of hurt. Fines, roll backs, penalties, etc., would make your life a cluster.



bacchi

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Re: Is this illegal? Trading with oneself
« Reply #5 on: May 15, 2018, 12:01:56 PM »
The relevant code is in "15 U.S. Code § 78i - Manipulation of security prices":

Quote
It shall be unlawful...

(1) For the purpose of creating a false or misleading appearance of active trading in any security other than a government security, or a false or misleading appearance with respect to the market for any such security,

(A) to effect any transaction in such security which involves no change in the beneficial ownership thereof,

or (B) to enter an order or orders for the purchase of such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the sale of any such security, has been or will be entered by or for the same or different parties

alanB

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Re: Is this illegal? Trading with oneself
« Reply #6 on: May 15, 2018, 12:12:46 PM »
Can you still deduct losses from a Roth IRA at >2% AGI?  If you have basis there why not pull your little scam in the opposite direction and take a ~100% loss from your Roth IRA for the deduction.  No penalty for early distribution on losses, right?  Next year siphon the money back and wash-rinse-repeat.  Let us know how it goes :)

ChpBstrd

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Re: Is this illegal? Trading with oneself
« Reply #7 on: May 15, 2018, 12:22:08 PM »
The relevant code is in "15 U.S. Code § 78i - Manipulation of security prices":

Quote
It shall be unlawful...

(1) For the purpose of creating a false or misleading appearance of active trading in any security other than a government security, or a false or misleading appearance with respect to the market for any such security,

(A) to effect any transaction in such security which involves no change in the beneficial ownership thereof,

or (B) to enter an order or orders for the purchase of such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the sale of any such security, has been or will be entered by or for the same or different parties

Thanks bacchi. That's a weird title for the law against trading with oneself. And part B is just bizzare in the context of markets for options, which routinely will have only a bid price or only an ask price. How could anyone not know that if you enter an order with a price better than the math calls for, that a "different party" will swoop in and buy/sell it? Oh well, A is definitive anyway.

meghan88

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Re: Is this illegal? Trading with oneself
« Reply #8 on: May 16, 2018, 10:08:10 AM »
The relevant code is in "15 U.S. Code § 78i - Manipulation of security prices":

Quote
It shall be unlawful...

(1) For the purpose of creating a false or misleading appearance of active trading in any security other than a government security, or a false or misleading appearance with respect to the market for any such security,

(A) to effect any transaction in such security which involves no change in the beneficial ownership thereof,

or (B) to enter an order or orders for the purchase of such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the sale of any such security, has been or will be entered by or for the same or different parties

Thanks bacchi. That's a weird title for the law against trading with oneself. And part B is just bizzare in the context of markets for options, which routinely will have only a bid price or only an ask price. How could anyone not know that if you enter an order with a price better than the math calls for, that a "different party" will swoop in and buy/sell it? Oh well, A is definitive anyway.

But ... the PURPOSE is not to create a false or misleading appearance of active trading in any security.  It's to move $ from one account to another.  Disclosure:  I'm not a U.S. tax lawyer, but that particular rule doesn't appear to prohibit what you're trying to do.

L.A.S.

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Re: Is this illegal? Trading with oneself
« Reply #9 on: May 16, 2018, 10:51:57 AM »
Hmm...

I don't know that there is a specific IRS rule or regulation that prohibits this on point however..

The step transaction doctrine allows the IRS, in some cases, to disregard a series of individual steps and look at the overall economic transaction that occurred.   Here, by dis-regarding the worthless-options steps, the overall transaction begins to look like a combination of a traditional IRA distribution and a corresponding cash contribution to the Roth IRA.
I guess the IRS could take the stance that since a person engaging in both sides to the transactions that the money leaving the t-IRA should be considered a taxable distribution, and therefore subject to tax, and that the money entering the Roth should be considered a cash contribution.  The IRS could then come after the individual for the taxes, and possibly negligence penalties, interest, etc. from when the distribution should have been reported and taxes paid.  And the IRS would probably also claim that absent the filing of a proper 8606 for reporting a Roth conversion, that the contribution to the Roth IRA should be subject to ordinary income threshhold and annual contributions limits, with any amount over that being subject to the Roth IRA over-contribution excise tax.

 

bacchi

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Re: Is this illegal? Trading with oneself
« Reply #10 on: May 16, 2018, 10:52:20 AM »
The relevant code is in "15 U.S. Code § 78i - Manipulation of security prices":

Quote
It shall be unlawful...

(1) For the purpose of creating a false or misleading appearance of active trading in any security other than a government security, or a false or misleading appearance with respect to the market for any such security,

(A) to effect any transaction in such security which involves no change in the beneficial ownership thereof,

or (B) to enter an order or orders for the purchase of such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the sale of any such security, has been or will be entered by or for the same or different parties

Thanks bacchi. That's a weird title for the law against trading with oneself. And part B is just bizzare in the context of markets for options, which routinely will have only a bid price or only an ask price. How could anyone not know that if you enter an order with a price better than the math calls for, that a "different party" will swoop in and buy/sell it? Oh well, A is definitive anyway.

But ... the PURPOSE is not to create a false or misleading appearance of active trading in any security.  It's to move $ from one account to another.  Disclosure:  I'm not a U.S. tax lawyer, but that particular rule doesn't appear to prohibit what you're trying to do.

That's arguable. You're creating a false market in order to put more money into a restricted vehicle (a retirement account). It's misleading because it's not really an open market -- it's created for you alone (per (A), the ownership doesn't change).

But I'm sure high priced lawyers can make a case that it doesn't violate the code. The question then becomes: Are you moving enough money to make it worth hiring lawyers that have $100,000 retainers?

Or, to put it another way, it might be "legal" for a well connected and wealthy person, such as Romney, but not for those of us worth less than $100 million.

ChpBstrd

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Re: Is this illegal? Trading with oneself
« Reply #11 on: May 16, 2018, 01:50:46 PM »
Arguably, market makers would violate this law by setting bid and ask prices and making trades with themselves and each other. However, their purpose is something other than deceiving investors about some hypothetically true value of a security - it is to maintain constant liquidity and price discovery. I suspect the law was written more for pump-and-dump scams than self-trading. E.g. buying and selling between one's accounts to create a false market price on a penny stock so that some sucker who got your fax pays you five pennies for it.

I guess the question is, could a person be acting as a market maker? Could you sell these options to yourself for a penny and that would arguably be the lowest tradeable value so you haven't inflated the price? (And with options, there is always a chance that the option will rapidly appreciate, no matter how far out of the money, so who is to say a penny is too much to pay / a false price for a lotto ticket?)

Telecaster

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Re: Is this illegal? Trading with oneself
« Reply #12 on: May 17, 2018, 09:13:18 AM »

But ... the PURPOSE is not to create a false or misleading appearance of active trading in any security.  It's to move $ from one account to another.  Disclosure:  I'm not a U.S. tax lawyer, but that particular rule doesn't appear to prohibit what you're trying to do.

The purpose is to move money from one account to the other without paying tax.   That's the only reason you would do this transaction in this manner.  The IRS really doesn't like stuff like this. 

Jrr85

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Re: Is this illegal? Trading with oneself
« Reply #13 on: May 17, 2018, 10:48:51 AM »
Arguably, market makers would violate this law by setting bid and ask prices and making trades with themselves and each other. However, their purpose is something other than deceiving investors about some hypothetically true value of a security - it is to maintain constant liquidity and price discovery. I suspect the law was written more for pump-and-dump scams than self-trading. E.g. buying and selling between one's accounts to create a false market price on a penny stock so that some sucker who got your fax pays you five pennies for it.

I guess the question is, could a person be acting as a market maker? Could you sell these options to yourself for a penny and that would arguably be the lowest tradeable value so you haven't inflated the price? (And with options, there is always a chance that the option will rapidly appreciate, no matter how far out of the money, so who is to say a penny is too much to pay / a false price for a lotto ticket?)

The answer is almost certainly no.

IRC 4975(c)(1)
(c) Prohibited transaction
(1) General rule.  For purposes of this section, the term “prohibited transaction” means any direct or indirect
(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;
(B) lending of money or other extension of credit between a plan and a disqualified person;
(C) furnishing of goods, services, or facilities between a plan and a disqualified person;
(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;
(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or
(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan

Even if you run it through a broker and the purchaser could in theory be anybody, it seems like that would be an indirect sale to yourself. 

ChpBstrd

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Re: Is this illegal? Trading with oneself
« Reply #14 on: May 17, 2018, 11:49:31 AM »
Arguably, market makers would violate this law by setting bid and ask prices and making trades with themselves and each other. However, their purpose is something other than deceiving investors about some hypothetically true value of a security - it is to maintain constant liquidity and price discovery. I suspect the law was written more for pump-and-dump scams than self-trading. E.g. buying and selling between one's accounts to create a false market price on a penny stock so that some sucker who got your fax pays you five pennies for it.

I guess the question is, could a person be acting as a market maker? Could you sell these options to yourself for a penny and that would arguably be the lowest tradeable value so you haven't inflated the price? (And with options, there is always a chance that the option will rapidly appreciate, no matter how far out of the money, so who is to say a penny is too much to pay / a false price for a lotto ticket?)

The answer is almost certainly no.

IRC 4975(c)(1)
(c) Prohibited transaction
(1) General rule.  For purposes of this section, the term “prohibited transaction” means any direct or indirect
(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;
(B) lending of money or other extension of credit between a plan and a disqualified person;
(C) furnishing of goods, services, or facilities between a plan and a disqualified person;
(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;
(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or
(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan

Even if you run it through a broker and the purchaser could in theory be anybody, it seems like that would be an indirect sale to yourself.

That section applies to "disqualified persons" such as 401k plan administrators, not individuals with IRAs. See definition below, quoted from the Cornell Law School website:https://www.law.cornell.edu/uscode/text/26/4975

Quote
(2) Disqualified person
For purposes of this section, the term “disqualified person” means a person who is—
(A) a fiduciary;
(B) a person providing services to the plan;
(C) an employer any of whose employees are covered by the plan;
(D) an employeeorganization any of whose members are covered by the plan;
(E) an owner, direct or indirect, of 50 percent or more of—
(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,
(ii) the capital interest or the profits interest of a partnership, or
(iii) the beneficial interest of a trust or unincorporated enterprise,
which is an employer or an employeeorganization described in subparagraph (C) or (D);
(F) a member of the family (as defined in paragraph (6)) of any individual described in subparagraph (A), (B), (C), or (E);
(G) a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of—
(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,
(ii) the capital interest or profits interest of such partnership, or
(iii) the beneficial interest of such trust or estate,
is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);
(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G); or
(I) a 10 percent or more (in capital or profits) partner or joint venturer of a person described in subparagraph (C), (D), (E), or (G).

trollwithamustache

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Re: Is this illegal? Trading with oneself
« Reply #15 on: May 17, 2018, 12:05:29 PM »
Ignoring the fact that as others have noted price manipulation is illegal, what stops someone with a faster computer for stepping in? sure there are a lot of illiquid options out there, but as soon as you throw out a mispriced bid or ask, the computers usually populate order right in with you or ahead of you.

Jrr85

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Re: Is this illegal? Trading with oneself
« Reply #16 on: May 17, 2018, 12:12:50 PM »
Arguably, market makers would violate this law by setting bid and ask prices and making trades with themselves and each other. However, their purpose is something other than deceiving investors about some hypothetically true value of a security - it is to maintain constant liquidity and price discovery. I suspect the law was written more for pump-and-dump scams than self-trading. E.g. buying and selling between one's accounts to create a false market price on a penny stock so that some sucker who got your fax pays you five pennies for it.

I guess the question is, could a person be acting as a market maker? Could you sell these options to yourself for a penny and that would arguably be the lowest tradeable value so you haven't inflated the price? (And with options, there is always a chance that the option will rapidly appreciate, no matter how far out of the money, so who is to say a penny is too much to pay / a false price for a lotto ticket?)

The answer is almost certainly no.

IRC 4975(c)(1)
(c) Prohibited transaction
(1) General rule.  For purposes of this section, the term “prohibited transaction” means any direct or indirect
(A) sale or exchange, or leasing, of any property between a plan and a disqualified person;
(B) lending of money or other extension of credit between a plan and a disqualified person;
(C) furnishing of goods, services, or facilities between a plan and a disqualified person;
(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;
(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or
(F) receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan

Even if you run it through a broker and the purchaser could in theory be anybody, it seems like that would be an indirect sale to yourself.

That section applies to "disqualified persons" such as 401k plan administrators, not individuals with IRAs. See definition below, quoted from the Cornell Law School website:https://www.law.cornell.edu/uscode/text/26/4975

Quote
(2) Disqualified person
For purposes of this section, the term “disqualified person” means a person who is—
(A) a fiduciary;
(B) a person providing services to the plan;
(C) an employer any of whose employees are covered by the plan;
(D) an employeeorganization any of whose members are covered by the plan;
(E) an owner, direct or indirect, of 50 percent or more of—
(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation,
(ii) the capital interest or the profits interest of a partnership, or
(iii) the beneficial interest of a trust or unincorporated enterprise,
which is an employer or an employeeorganization described in subparagraph (C) or (D);
(F) a member of the family (as defined in paragraph (6)) of any individual described in subparagraph (A), (B), (C), or (E);
(G) a corporation, partnership, or trust or estate of which (or in which) 50 percent or more of—
(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of such corporation,
(ii) the capital interest or profits interest of such partnership, or
(iii) the beneficial interest of such trust or estate,
is owned directly or indirectly, or held by persons described in subparagraph (A), (B), (C), (D), or (E);
(H) an officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder, or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G); or
(I) a 10 percent or more (in capital or profits) partner or joint venturer of a person described in subparagraph (C), (D), (E), or (G).

Yea, I'm not sure which one of those applies to the plan beneficiary, but all of the IRS publications are clear that prohibited transactions include the owner, the owner's fiduciaries, spouses, children, etc.

Prohibited Transactions
Generally, a prohibited transaction is any improper use of your traditional IRA account or annuity by you, your beneficiary, or any disqualified person.

Disqualified persons include your fiduciary and members of your family (spouse, ancestor, lineal descendant, and any spouse of a lineal descendant).

"The following are some examples of prohibited transactions with a traditional IRA.

Borrowing money from it.
Selling property to it.
Using it as security for a loan.
Buying property for personal use (present or future) with IRA funds."
https://www.irs.gov/publications/p590a#en_US_2013_publink1000230855

SeattleCPA

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Re: Is this illegal? Trading with oneself
« Reply #17 on: May 17, 2018, 02:33:02 PM »
The IRS has a term for this sort of thing....which escapes me  at the moment.  Basically, even if the individual steps are technically legal, if the purpose of the scheme is to evade tax then the whole thing becomes illegal.

sham transaction... if they catch it, they can basically ignore it based on its artificiality.
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