16 T.C. 1026">*1027 Respondent has determined deficiencies in petitioners' income tax as follows:

1951 U.S. Tax Ct. LEXIS 199">*200 The deficiencies arise from respondent's determination that securities sold during the years in question by Lilley & Co., a partnership, of which the petitioners were members, were not capital assets and the gain upon their sale is taxable as ordinary income instead of as capital gain, as contended by petitioners.

FINDINGS OF FACT.

Income tax returns were filed with the collector of internal revenue for the first district of New Jersey in Camden, New Jersey, by petitioner George R. Kemon for the years 1942 through 1944, and with the collector of internal revenue for the first district of Pennsylvania in Philadelphia, Pennsylvania, by Howard J. Comber, deceased, for the years 1942 and 1943, and by the remaining petitioners for the years 1942 through 1944.

During the years 1942 through 1944, petitioners Kemon, Lilley, Jr., Welsh, Jr., and Comber, now deceased, were partners in the firm of Lilley & Co., a partnership with its principal office in Philadelphia and with a branch in New York City. Petitioners Herrman, Call, and Wells were also partners in the firm during the year 1944. Lilley & Co. is the successor of Lilley, Blizzard & Co., a firm organized in Philadelphia in 1922.

During1951 U.S. Tax Ct. LEXIS 199">*201 the taxable years in question, the principal activity of Lilley & Co. was the buying and selling of unlisted securities for its own account. During these years the firm also did a small amount of brokerage business. During each of the years 1942, 1943, and 1944, Lilley & Co. completed approximately 7,000 or 8,000 transactions per annum.

During the years in question, Lilley & Co. realized net gain from sales or exchanges of securities which had been purchased for its own account as follows: 16 T.C. 1026">*1028

Gross commissions from transactions in which the firm acted as brokers during the year totaled:

During the years 1942, 1943, and 1944, Lilley & Co. realized additional income from the following sources:

1951 U.S. Tax Ct. LEXIS 199">*202 In its partnership return for the year 1942, Lilley & Co. reported no capital gains or losses. The total income reported consisted of "Bond Trading Profit," "Stock Trading Profit," "Commissions," interest, dividends, and fees. In its partnership return for the year 1943, Lilley & Co. reported gains from the sale or exchange of capital assets.

Lilley & Co.'s activity in buying and selling securities for its own account has always been confined largely to low-priced, unmarketable securities of real estate corporations. Most of the bonds purchased were in default and most of the stocks were paying no dividends. In many cases the issuing corporation was in the hands of a creditors' committee or was involved in reorganization or receivership proceedings. Most of the securities were speculative, unrated by leading statistical services, and lacked such qualities as safety, income, and marketability.

Lilley & Co.'s activity in buying and selling securities for its own account was conducted almost exclusively by telephone, telegraph, and teletype. Some of the securities were bought from bondholders of corporations involved in reorganization or receivership proceedings and some were sold1951 U.S. Tax Ct. LEXIS 199">*203 to professional real estate operators or syndicates. Most of them, however, were bought from and sold to registered broker-dealers or security houses.

The purposes for which the firm purchased securities were usually one of the following three: First, securities were purchased for immediate or simultaneous resale at a profit. This occurred when a broker-dealer offered the firm securities at a price below that for which the firm had an offer to buy from another broker-dealer. Second, 16 T.C. 1026">*1029 securities, usually bonds, were purchased for the anticipated profit to be realized upon the liquidation of the issuing corporation. Such transactions occurred where the firm obtained information with respect to a defaulted security indicating that the actual value of the security was in excess of the prevailing market price and that a liquidation of the corporation appeared probable. Third, the firm accumulated securities of a corporation, usually one having real estate as its principal assets, in financial difficulties, in order to obtain a holding sufficiently large to enable the firm to force a reorganization of the corporation and ultimately gain control thereof. Sometimes, instead1951 U.S. Tax Ct. LEXIS 199">*204 of reorganizing the firm the partnership would sell the holdings it had accumulated to a real estate syndicate or a professional dealer in real estate.

In cases where Lilley & Co. determined to accumulate a certain security either for purposes of holding until the liquidation of the company or for the purpose of gaining control of the corporation, it normally would not sell any of the securities being accumulated even if an offer that would result in a profit was received. However, even after having embarked upon a course of accumulation, Lilley & Co. would sometimes sell the particular securities if events proved that its original analysis of their potential value was incorrect or if an opportunity to invest in a more attractive security presented itself. Lilley & Co. also occasionally sold some of the securities which it was accumulating in order to create a market. This occurred when Lilley & Co., upon inquiry from a broker, not identified as a buyer or a seller, was forced to state both bid and offering prices in order to disguise its real interest.

Lilley & Co. as a general rule always bought securities in small lots. With the exception of sales of securities which had been1951 U.S. Tax Ct. LEXIS 199">*205 purchased with a view to immediate resale at a profit, the securities which the company bought and sold for its own account were always sold in a large lot, frequently in one transaction.

Of the sales of securities purchased by Lilley & Co. for its own account and held for 6 months or less, 44.93 per cent of the sales in 1943 and 41.65 per cent of the sales in 1944 were made on the same day on which the securities were purchased. Of such sales, 61.63 per cent in 1943 and 65.98 per cent in 1944 were made within the first 7 days after the securities were purchased.

In 1942 and 1943, Lilley & Co. disposed of the following securities to the partners of the firm pro rata at market price:

16 T.C. 1026">*1030 This transaction was recorded by Lilley & Co. on its books and reported in its partnership returns for the years 1942 and 1943 as a transaction resulting in gain equal to the difference between the cost of the securities disposed1951 U.S. Tax Ct. LEXIS 199">*206 of and the price received for them by the partnership. The gains so reported were as follows:

During the years 1942 to 1944, Lilley & Co. engaged in no underwriting of securities nor did it participate in any securities syndicate operations.

During the years 1942 to 1944, Lilley & Co. did not maintain a board room, employ any salesmen, solicitors or customers' men, or carry any margin accounts.

All securities purchased and sold by Lilley & Co. for its own account are recorded in a ledger entitled "Investments and Trading Accounts -- Lilley and Company." There is no other ledger in which security transactions are recorded. The general ledger contains an account for the recording of commissions.

Lilley & Co. has always maintained its books of account and prepared its income tax returns on a cash receipts and disbursements basis. In its books of account and on its income tax returns, Lilley & Co.1951 U.S. Tax Ct. LEXIS 199">*207 has always computed its gain or loss on the sale of a security by determining the difference between the cost and the sale price. Lilley & Co. never used inventories in determining its net income for income tax purposes, and the value of its securities on hand at the close of any year has never entered into the determination of it taxable net income.

Lilley & Co. was, and still is, a subscriber to the National Daily Quotation Service, a daily publication containing listings by brokers, dealers, traders and security houses throughout the United States of bid and offering prices of unlisted securities. Lilley & Co. used this service principally as a means of obtaining securities which it desired to purchase. Its own listings of bids on the average outnumbered its own listings of offerings by about 12 to 1.

Lilley & Co. was listed in a directory known as "The Security Dealers of North America," which contains the name, address, and nature of 16 T.C. 1026">*1031 the business of approximately 2,500 firms in North America. Lilley & Co. was described in this directory as "Brokers & Traders for Own Account in Public Utility, Industrial & Real Estate Securities."

Lilley & Co. seldom advertised 1951 U.S. Tax Ct. LEXIS 199">*208 in newspapers. During the years 1942 to 1944, it ran advertisements on approximately six occasions in local Philadelphia newspapers. Lilley & Co. also carried an advertisement in the "Commercial and Financial Chronicle" to which the firm was a subscriber. The purport of all of these advertisements was that Lilley & Co. could furnish accurate market information on unlisted securities, particularly real estate bonds. In none of the advertisements did Lilley & Co. offer any stock for sale or represent itself as holding a stock of securities on hand for sale.

Lilley & Co. occasionally mailed to brokers and dealers or to lists of bondholders or stockholders postal cards stating that a particular security would be "bought, sold, quoted." The purpose of the mailings was to obtain offers of the securities, but at the same time disguise the firm's real interest.

Lilley & Co. also occasionally sent out to brokers, dealers, and security houses circulars containing a description of certain securities in which Lilley & Co. desired to stimulate trading in the hope of being able to acquire certain securities in which it had an interest. Frequently, Lilley & Co. did not own any securities of 1951 U.S. Tax Ct. LEXIS 199">*209 the issues referred to in the circular. On one occasion during the years in issue, Lilley & Co. sent out to security brokers and dealers a brochure describing 30 large apartment houses and hotels in New York City. At the time this was mailed, Lilley & Co. owned some of the securities of only three of the properties described in the brochure.

The legend on the door of Lilley & Co.'s office in the Packard Building, Philadelphia, Pennsylvania, states: "Lilley & Co., Members of the Philadelphia Stock Exchange."

Lilley & Co. is a member of the Philadelphia Stock Exchange and is registered with and licensed by the Pennsylvania Securities Commission. The registration certificate states that Lilley & Co. has been registered as a "Dealer in Securities."

In partnership returns of income for years prior to 1943, the partnership inserted the words "Dealers in Stocks and Bonds" next to the printed phrase "Business or Profession." In 1943 and 1944, upon advice of counsel, the words "investment securities" were inserted instead.

Voting trust certificates of the Crestshire Corporation which were sold by Lilley & Co. on June 20, 1944, for $ 11,516.72 were acquired on December 13, 1943, at a cost1951 U.S. Tax Ct. LEXIS 199">*210 of $ 8,931.33. Lilley & Co. erroneously reported the long term capital gain on this sale as a short term capital gain in its 1944 Federal income tax return.

16 T.C. 1026">*1032 During the years 1942 through 1944, Lilley & Co. was a trader as to those securities which it bought for its own account and sold after having held them for more than 6 months. These securities were held for speculation or investment; they were not held primarily for sale to customers in the ordinary course of the firm's business. These securities were capital assets.

OPINION.

The respondent has determined that securities disposed of by Lilley & Co. during the years in question were not capital assets within the definition of section 117 (a) (1) of the Internal Revenue Code and, therefore, the gain upon their sale or exchange is taxable as ordinary income pursuant to section 22 of the Code. The relevant portion of section 117 (a) (1) defines "capital assets" as "property held by the taxpayer (whether or not connected with his trade or business), but does not include * * * property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business * * *." In support of his determination, 1951 U.S. Tax Ct. LEXIS 199">*211 the respondent argues that Lilley & Co. was a "dealer" holding the securities primarily for sale to customers in the ordinary course of business.

Whether or not securities are held primarily for sale to customers in the ordinary course of business is a question of fact, Stern Brothers & Co., 16 T.C. 295, in which the crucial phrase is "to customers." This phrase and the word "ordinary" were added to the definition of capital assets by Senate Amendment No. 66 in the Revenue Act of 1934 so that a speculator trading on his own account could not claim the securities he sold were other than capital assets. The theory of the amendment was that those who sell securities on an exchange have no "customers" and for that reason the property held by such taxpayers is not within the above quoted exclusionary clause. O. L. Burnett, 40 B. T. A. 605, 118 F.2d 659; Thomas E. Wood, 16 T.C. 213.

In determining whether a seller of securities sells to "customers," the merchant analogy has been employed. Schafer v. Helvering, 299 U.S. 171">299 U.S. 171; Van Suetendael v. Commissioner, 152 F.2d 654,1951 U.S. Tax Ct. LEXIS 199">*212 affirming a Memorandum Opinion of this Court (Sept. 25, 1944); Leach Corp. v. Blacklidge, 23 F. Supp. 622">23 F. Supp. 622; Warren Co. v. United States, 53 F. Supp. 578">53 F. Supp. 578; Regulations 111, sec. 29.22 (c)-5. Those who sell "to customers" are comparable to a merchant in that they purchase their stock in trade, in this case securities, with the expectation of reselling at a profit, not because of a rise in value during the interval of time between purchase and resale, but merely because they have or hope to find a market of buyers who will purchase from them at a price in excess of their cost. This excess 16 T.C. 1026">*1033 or mark-up represents remuneration for their labors as a middle man bringing together buyer and seller, and performing the usual services of retailer or wholesaler of goods. Cf. 299 U.S. 171">Schafer v. Helvering, supra;Securities-Allied Corp. v. Commissioner, 95 F.2d 384, certiorari denied, 305 U.S. 617">305 U.S. 617, affirming 36 B. T. A. 168; Commissioner v. Charavay, 79 F.2d 406, affirming1951 U.S. Tax Ct. LEXIS 199">*213 29 B. T. A. 1255. Such sellers are known as "dealers."

Contrasted to "dealers" are those sellers of securities who perform no such merchandising functions and whose status as to the source of supply is not significantly different from that of those to whom they sell. That is, the securities are as easily accessible to one as the other and the seller performs no services that need be compensated for by a mark-up of the price of the securities he sells. The sellers depend upon such circumstances as a rise in value or an advantageous purchase to enable them to sell at a price in excess of cost. Such sellers are known as "traders."

The securities sold by Lilley & Co. were held for widely varying lengths of time. Some were sold on the day of purchase; others were held for periods in excess of 3 years. We need not determine whether those held for not more than 6 months were capital assets. It may well be that as to them, the firm's status was that of a dealer holding securities primarily for sale to customers, but since the gains on their sale were reported in full and the losses were not in excess of these gains, the correctness of the asserted deficiency1951 U.S. Tax Ct. LEXIS 199">*214 in nowise depends upon whether or not the securities were capital assets. Furthermore, the fact that the firm's status as to these securities was that of either a dealer or trader does not require a determination that the firm occupied the same status as to the remaining securities. Carl Marks & Co., 12 T.C. 1196. See I. T. 3891, 1948-1 C. B. 69.

But whatever the firm's status may be as to the securities held for not more than 6 months, the evidence taken as a whole clearly establishes that as to the remaining securities the firm was a trader holding them primarily for speculation or investment. Specific evidence has been submitted to show that a considerable number of the securities held for more than 6 months were accumulated as part of a program to force a reorganization and gain control of the issuing corporation, or for the realization of a gain when the issuing company redeemed them or issued liquidating dividends. Furthermore, as to these securities, it was the firm's practice to buy in small lots and dispose of them in large blocks. It did not acquire them "to create a stock of securities to take care of future1951 U.S. Tax Ct. LEXIS 199">*215 buying orders in excess of selling orders," 299 U.S. 171">Schafer v. Helvering, supra, or always sell to a class of persons different than those from whom it bought. Cf. Van Suetendael v. Commissioner, supra.It frequently refused to sell these securities which it was accumulating despite the fact that the bid price would have 16 T.C. 1026">*1034 resulted in a profit. The activity of Lilley & Co. with regard to the securities in question conformed to the customary activity of a trader in securities rather than that of a dealer holding securities primarily for sale to customers.

Respondent has stressed other phases of the firm's activity in support of his argument that the firm is a dealer in securities. He points out that the firm has two regular places of business, is licensed by the State of Pennsylvania as a "dealer," advertises itself as a "dealer," transacts a large volume of business, and subscribes to certain services commonly used by brokers and dealers. These are all significant facts which weigh against petitioners' contention that the firm was a trader. But they are no more conclusive than are other facts which weigh just1951 U.S. Tax Ct. LEXIS 199">*216 as heavily in favor of petitioners' contention, such as the fact that the firm had no salesmen, no "customers' men," no customers' accounts, no board room, and has never advertised itself or held itself out to the public as having on hand securities for sale.

After weighing all such factors and analyzing the activity previously referred to, we are of the opinion that Lilley & Co.'s status as to those securities held for more than 6 months was that of a trader holding them for speculation or investment. Therefore, those securities are capital assets and the gain upon their sale or exchange is taxable at capital gains rates.

Respondent relies on such cases as Edmund S. Twining, 32 B. T. A. 600, affd. on other points, 83 F.2d 954, certiorari denied, 299 U.S. 578">299 U.S. 578; Stokes v. Rothensies, 61 F. Supp. 444">61 F. Supp. 444, affd., 154 F.2d 1022, and Helvering v. Fried, 299 U.S. 175">299 U.S. 175. These cases, as well as United States v. Chinook Investment Co., 136 F.2d 984, held that the taxpayer in question1951 U.S. Tax Ct. LEXIS 199">*217 was a dealer in securities. But since they resolved merely a question of fact, and contained significant evidence that is not present in the instant case, they do not support the conclusion respondent seeks here.

On brief the petitioners argued that no income was realized either by Lilley & Co. or the individual partners upon the disposition of securities to the partners in the years 1942 and 1943. The partnership disposed of these securities pro rata to the partners at market price. This issue was not raised by the pleadings, nor suggested by anything contained therein or in the opening statement of counsel. Under these circumstances, the issue is not before us and may not be considered. Jamieson Associates, Inc., 37 B. T. A. 92.

In the partnership income tax return for 1944, Lilley & Co. erroneously included the long term capital gain of $ 2,585.39 on the sale of 470 7/100ths voting trust certificates of Crestshire Corporation as a short term capital gain. The parties may make proper adjustment of this error in the computation under Rule 50.

Decisions will be entered under Rule 50.