42 T.C. 769">*770 The Commissioner determined a deficiency in petitioner's income tax for its fiscal year ended November 30, 1955, in the amount of $ 65,827.36, part of which is no longer in controversy. The issues remaining for decision are: (1) Whether petitioner realized a short-term capital loss in the amount of $ 17,805 on February 15, 1955, on its purported sale of 3,000 shares of Chicago, Milwaukee, St. Paul & Pacific Railway Co. preferred stock, ex dividend, which it had purportedly purchased the previous day, and whether petitioner is entitled to a dividends-received deduction in the amount of $ 12,750 based upon its receipt of $ 15,000 which purported to represent a dividend on the 3,000 shares of stock; (2) whether, assuming that the foregoing matters are decided against petitioner, it is entitled to deduct its "out-of-pocket" costs in the amount of $ 2,805, 1964 U.S. Tax Ct. LEXIS 69">*72 in connection with the above transaction, either as a loss on the sale of an "option" or as an "ordinary and necessary" business expense.

FINDINGS OF FACT

The facts stipulated by the parties and exhibits introduced in evidence are incorporated herein by this reference.

Malden Knitting Mills, hereinafter referred to as Malden, a Massachusetts corporation organized on January 1, 1918, in Malden, Mass., is a manufacturer of sweaters and knitted fabrics. It timely filed its Federal income tax return for its fiscal year ended November 30, 1955, on an accrual basis, with the district director of internal revenue at Boston, Mass.

Samuel C. Feuerstein has been associated with Malden since its inception and has been its president for the past 20 or 25 years.

Gerald Glunts, hereinafter referred to as Glunts, is an attorney and a certified public accountant and a partner in an accounting partnership, James D. Glunts & Co. He has been Malden's auditor for approximately 25 years and has advised Malden in respect of accounting, financial, and tax matters.

J. Benn Keizer, hereinafter referred to as Keizer, is a member of Keizer & Co., Inc., hereinafter referred to as Keizer & Co., a corporate 1964 U.S. Tax Ct. LEXIS 69">*73 brokerage firm doing business in Boston. He has been in the securities business for approximately 25 years. Neither Keizer & Co. nor its officers and employees were, in 1955, members of a listed stock exchange. However, during 1955 Keizer & Co. was a securities dealer registered with the Securities and Exchange Commission. Keizer & Co. did not employ any salesmen, and Keizer alone handled sales on its behalf.

42 T.C. 769">*771 In 1954 Glunts brought up to Keizer a plan for tax avoidance for the benefit of corporate taxpayers, involving the purchase of stock of another corporation, "dividend on," to be followed by a sale of the same stock, "ex dividend." The purpose of this plan was to take advantage of a corporate tax reduction by utilization of the 85-percent dividend credit in the following manner: Under normal conditions the market price of stock would drop by the amount of the dividend when the stock went ex dividend, but the seller of the stock would remain entitled to receive the dividend; the anticipated tax advantage of Glunts' plan would be that the corporate taxpayer would become entitled to a short-term capital loss deduction in the amount of the loss on the sale, but the offsetting1964 U.S. Tax Ct. LEXIS 69">*74 dividend that it would receive would be exempt from tax to the extent of 85 percent thereof in accordance wih section 243 of the 1954 Code. Keizer was cognizant of the steps to be taken in order to obtain the desired tax consequences for clients of Glunts. Glunts advised some of his clients to enter into such transactions. These transactions involving Glunts' clients were discussed with Keizer, who arranged to execute them for these clients.

In 1954 or early in 1955, Glunts requested Keizer to advise him of any stocks which were about to pay substantial dividends. In February 1955, Keizer reported to Glunts that a $ 5 dividend would be paid on the 5-percent noncumulative, Series A, 100 par value preferred stock of the Chicago, Milwaukee, St. Paul & Pacific Railway Co., hereinafter referred to as Railway stock, on March 11, 1955, to stockholders of record on February 19, 1955, and that the stock would go ex dividend on February 15, 1955.

At some time prior to February 14, 1955, Glunts told Feuerstein that Malden could realize a substantial tax benefit from the purchase of Railway stock, dividend on. He explained to him that Malden would receive the dividend and thereby become 1964 U.S. Tax Ct. LEXIS 69">*75 entitled to a dividends-received deduction in the amount of 85 percent of the dividend received and that if the price of the stock, ex dividend, fell by an amount approximating the amount of dividend, as could usually be expected, Malden could sell the stock and realize a short-term capital loss which could be applied against any capital gains realized by Malden prior to the termination of its fiscal year.

Feuerstein decided that he, in behalf of Malden, would enter into the transaction suggested by Glunts. In so doing, Feuerstein relied heavily on Glunts' advice. Glunts recommended that the transaction be handled through Keizer & Co. and suggested to Feuerstein that he discuss the matter with Keizer. Prior to his entering into this transaction Feuerstein had known Keizer only casually. Glunts also suggested to Keizer that he get in touch with Feuerstein in connection with the proposed transaction.

42 T.C. 769">*772 On either February 13 or 14, 1955, Keizer telephoned Feuerstein and told him that Glunts had "asked me to tell * * * [you] * * * that * * * [you] could use 3,000 shares." Feuerstein agreed to "purchase," in behalf of Malden, the suggested number of Railway shares.

Prior to 1964 U.S. Tax Ct. LEXIS 69">*76 his purported purchase in behalf of Malden of 3,000 shares of Railway stock, Feuerstein did not make a study of the stock market in respect of the Railway stock, nor did he study the financial history of the Chicago, Milwaukee, St. Paul & Pacific Railway Co.

A confirmation slip of Keizer & Co. bearing the date February 14, 1955, and a settlement date of February 18, 1955, purports to show that Keizer & Co., as principal for its own account, had sold to Malden 3,000 shares of Railway stock, dividend on, for $ 52 per share; the total amount of the alleged sale was $ 156,000. Similarly, on February 14, 1955, Keizer & Co. purported to sell as principal to four other clients of Glunts a total of 17,370 shares of Railway stock at the same price of $ 52 a share, with a settlement date of February 18, 1955. Thus, Keizer & Co.'s purported sales of Railway stock to Malden and the other four clients of Glunts on February 14, 1955, were in the aggregate amount of 20,370 shares.

Railway stock was traded on the New York Stock Exchange in 1955. On February 14, 1955, the low price for this stock was 51 5/8 and its high was 52 5/8. Approximately 16,600 shares of this stock were traded on the New1964 U.S. Tax Ct. LEXIS 69">*77 York Stock Exchange on February 14, 1955.

At the time of its purported sale of the Railway stock to petitioner, Keizer & Co. did not have any Railway stock in its inventory and it did not thereafter acquire any such stock for delivery to petitioner.

On the next day, February 15, 1955, when the Railway stock went ex dividend, Malden and the other four clients of Glunts referred to above, each purported to sell its Railway stock, in the aggregate amount of 20,370 shares, back to Keizer & Co. at 46 1/8. On that day 42,500 shares of Railway stock were traded on the New York Stock Exchange at a price between a low of 45 5/8 and a high of 47. A confirmation slip of Keizer & Co. bearing the date February 15, 1955, and a settlement date of February 21, 1955, purports to show Malden's sale of its 3,000 shares; and the books of Keizer & Co. reflect the same settlement date for the alleged sales by the other four clients of Glunts.

Malden's purported purchase of 3,000 shares of Railway stock on February 14, 1955, was on margin, involving a loan of 40 percent of the market value of the security purchased. Accordingly, on or before February 18, 1955, the settlement date for Malden's alleged1964 U.S. Tax Ct. LEXIS 69">*78 purchase, it paid Keizer & Co. $ 93,600 (60 percent of the total alleged purchase price of $ 156,000). At approximately the same time, about February 18, 1955, Keizer & Co. sent petitioner a check in the amount 42 T.C. 769">*773 of $ 75,795. This amount represented the difference between the total net purchase price of the 3,000 shares purportedly sold on February 15, 1955 by Malden to Keizer & Co. ($ 138,195) ¹ and the debit balance in Malden's margin account.

Thereafter, on March 11, 1955, Keizer & Co. sent its check in the amount of $ 15,000 to Malden, purporting to represent the amount of dividends on the 3,000 shares of Railway stock allegedly purchased by Malden on February 14, 1955.

Malden's sole purpose in entering into the foregoing transaction was to obtain tax benefits.

In its income tax return for the fiscal year ended November 30, 1955, petitioner reported a short-term1964 U.S. Tax Ct. LEXIS 69">*79 capital loss in the amount of $ 17,805 in respect of its purported sale of Railway stock on February 15, 1955; it reported dividends in the amount of $ 15,000 and claimed a dividends-received deduction in the amount of $ 12,750. Petitioner applied the foregoing short-term capital loss in the amount of $ 17,805 against short-term capital gains which were in excess of its purported loss.

The purported purchase and sale of the 3,000 shares of Railway stock by Malden were parts of a sham. Keizer & Co. not only had no such stock to sell, but a reversal of the transaction was contemplated by means of a prompt offsetting "resale" of such stock by Malden to Keizer & Co. The parties did not intend to deal in real shares of Railway stock; the various confirmation slips and bookkeeping entries merely gave the appearance of purchase and sale of stock; Malden sustained no short-term capital loss upon its purported sale of such stock, nor did the $ 15,000 which it received from Keizer & Co. represent a dividend.

It is customary for securities dealers to sell securities in which they are "short," intending to make delivery to the purchaser upon demand either by borrowing or purchasing such securities1964 U.S. Tax Ct. LEXIS 69">*80 for that purpose. Prior to such delivery it is customary for dealers to make dividend payments to the purchaser from their own personal funds. It is not unusual for a customer who actually buys securities from a dealer to resell those securities to that dealer; if such resale occurs prior to delivery and while the dealer is still "short," it becomes unnecessary for the dealer to carry out his original intention of acquiring the securities for delivery. However, no such original intention existed in the present case.

OPINION

1. We have found as a fact that Malden's "purchase" and "resale" of the 3,000 shares of Railway stock were merely component parts of a sham. Although there was testimony calculated to 42 T.C. 769">*774 lead us to the conclusion that Malden made a bona fide purchase of such shares, we did not believe it. We heard and observed both Feuerstein and Keizer, and the short answer to petitioner's position is that we had no confidence in their testimony in this respect.

It must be remembered that Malden's "purchase" and "resale" of 3,000 shares of Railway stock were parts of a larger picture involving four other clients of Glunts who entered into like transactions. All five1964 U.S. Tax Ct. LEXIS 69">*81 of these clients, including Malden, purported to purchase an aggregate of 20,370 shares of Railway stock on February 14, 1955, from Keizer & Co. at the identical price of 52, and all five purported to resell their respective shares to Keizer & Co. at the identical price of 46 1/8 on the very next day when the stock went ex dividend. The 20,370 shares which Keizer & Co. purported to sell to these five clients of Glunts on February 14 were substantially in excess of the total number of shares of that stock that were traded on that day on the New York Stock Exchange, and Keizer & Co. had no such stock in its inventory. ²1964 U.S. Tax Ct. LEXIS 69">*83 We do not believe that Keizer & Co. ever intended to make delivery of the shares it purported to sell, or that it contemplated anything other than a bookkeeping reversal of these sales by means of purported repurchases when the stock went ex dividend. The fact that all five of Glunts' clients, including Malden, promptly "resold" their shares to Keizer & Co. speaks too loudly to be ignored in the context of the record before us. ³ We are satisfied that Malden did not make any bona fide purchase of Railway stock on February 14, that it did not sell any Railway stock1964 U.S. Tax Ct. LEXIS 69">*82 on February 15, that it suffered no short-term capital loss on the transaction, that it received no dividend in connection with that transaction entitling it to a deduction in the amount of 85 percent thereof, and that indeed no part of any 42 T.C. 769">*775 such alleged dividend should have been included in its gross income in the first instance.

The situation before us is somewhat comparable to Empire Press, Inc., 35 T.C. 136">35 T.C. 136, which involved1964 U.S. Tax Ct. LEXIS 69">*84 another variation of Glunts' basic device and which was similarly executed for the taxpayer therein by Keizer & Co. The result that we reach here is in accord with what we recently referred to in J. George Gold, 41 T.C. 419">41 T.C. 419, 41 T.C. 419">427, and Sammy Cahn, 41 T.C. 858">41 T.C. 858, 41 T.C. 858">874, as "an ever lengthening line of decisions reaching like results in a variety of situations comparable to the one before us." Eli D. Goodstein, 30 T.C. 1178">30 T.C. 1178, affirmed 267 F.2d 127">267 F.2d 127 (C.A. 1); Broome v. United States, 170 F. Supp. 613">170 F. Supp. 613 (Ct. Cl.); Sonnabend v. Commissioner, 267 F.2d 319 (C.A. 1), affirming per curiam a Memorandum Opinion of this Court; Lynch v. Commissioner, 273 F.2d 867 (C.A. 2), affirming 31 T.C. 990">31 T.C. 990 and Leslie Julian, 31 T.C. 998">31 T.C. 998; Egbert J. Miles, 31 T.C. 1001">31 T.C. 1001; Jockmus v. United States, 335 F.2d 23 (C.A. 2); Becker v. Commissioner, 227 F.2d 1461964 U.S. Tax Ct. LEXIS 69">*85 (C.A. 2), affirming a Memorandum Opinion of this Court; Gheen v. Commissioner, 331 F.2d 470 (C.A. 6); Rubin v. United States, 304 F.2d 766 (C.A.7); Lewis v. Commissioner, 328 F.2d 634 (C.A. 7), affirming a Memorandum Opinion of this Court; Morris R. DeWoskin, 35 T.C. 356">35 T.C. 356, appeal dismissed (C.A. 7); Perry A. Nichols, 37 T.C. 772">37 T.C. 772, affirmed 314 F.2d 337 (C.A. 5); MacRae v. Commissioner, 294 F.2d 56 (C.A. 9), affirming in part and remanding in part 34 T.C. 20">34 T.C. 20, certiorari denied 368 U.S. 955">368 U.S. 955; Kaye v. Commissioner, 287 F.2d 40 (C.A. 9), affirming per curiam 33 T.C. 511">33 T.C. 511; Milton Hart, 41 T.C. 131">41 T.C. 131; Carl Shapiro, 40 T.C. 34">40 T.C. 34; cf. Knetsch v. United States, 364 U.S. 361">364 U.S. 361; Amor F. Pierce, 37 T.C. 1039">37 T.C. 1039, affirmed 311 F.2d 8941964 U.S. Tax Ct. LEXIS 69">*86 (C.A. 9); A. A. Helwig, 37 T.C. 1046">37 T.C. 1046; United States v. Roderick, 290 F.2d 823 (C.A. 5); Bridges v. Commissioner, 325 F.2d 180 (C.A. 4), affirming 39 T.C. 1064">39 T.C. 1064; Weller v. Commissioner, 270 F.2d 294 (C.A. 3), affirming 31 T.C. 33">31 T.C. 33 and W. Stuart Emmons, 31 T.C. 26">31 T.C. 26, certiorari denied 364 U.S. 908">364 U.S. 908; William R. Lovett, 37 T.C. 317">37 T.C. 317.

Petitioner's "purchase" and "resale" of 3,000 phantom shares of Railway stock consisted in substance of nothing more than a bucket-shop-type transaction. ⁴ Although it argues earnestly that, whatever 42 T.C. 769">*776 may have been Keizer's intentions, Feuerstein intended to make a bona fide purchase in its behalf, we do not take so generous a view of Feuerstein's intentions. We think that he fully understood that he was entering into a transaction that was to be promptly reversed without any delivery of securities. Moreover, even if his testimony were to be accepted at face, a taxpayer's1964 U.S. Tax Ct. LEXIS 69">*87 possible good faith cannot change the nature of what is otherwise a sham transaction. See Bornstein v. Commissioner, 334 F.2d 779 (C.A. 1), affirming a Memorandum Opinion of this Court; Jockmus v. United States, supra;Lynch v. Commissioner, 273 F.2d 867, 872 (C.A. 2); Gheen v. Commissioner, supra;Perry A. Nichols, 37 T.C. 772">37 T.C. 772, 37 T.C. 772">788-789, affirmed 314 F.2d 337, 338 (C.A. 5); MacRae v. Commissioner, 294 F.2d 56, 59 (C.A. 9), certiorari denied 368 U.S. 955">368 U.S. 955. Cf. Sammy Cahn, 41 T.C. 858">41 T.C. 858, 41 T.C. 858">875, fn. 4.

1964 U.S. Tax Ct. LEXIS 69">*88 We do not express any opinion as to whether petitioner would have become entitled to the tax benefits it seeks if it had actually purchased Railway stock dividend on and then sold it ex dividend, all in accord with a preexisting plan. ⁵1964 U.S. Tax Ct. LEXIS 69">*89 We cannot find on the record before us that it ever purchased any Railway stock, or that Keizer & Co. ever made a bona fide short sale of such stock to petitioner. ⁶It is one thing to make a genuine short sale, intending to effect delivery thereafter; it is quite another thing to go through the form of executing a short sale without intending to make delivery. The burden of proof was upon the petitioner, and the testimony offered by it to carry that burden did not ring true.

2. Petitioner contends alternatively that if the first issue should be decided against it, as was done above, it is nevertheless entitled to deduct its "out-of-pocket expenses" in the amount of $ 2,805. Actually, 42 T.C. 769">*777 petitioner did not make any specific expenditure in that amount. That figure reflects its net loss on the transaction and represents the difference between the $ 93,600 which petitioner paid Keizer & Co. as part of the purported purchase price for the 3,000 shares of Railway stock and the sum of the two amounts which it received from Keizer & Co., namely, $ 75,795 as the balance in its account upon the alleged resale of those shares and $ 15,000 as a "dividend" thereon.

Petitioner seeks the $ 2,805 deduction on either of two grounds: (i) As a short-term capital loss upon the sale of an "option" under sections 1234(a)⁷ and 1651964 U.S. Tax Ct. LEXIS 69">*90 ⁸ of the 1954 Code, or (ii) as an "ordinary and necessary" business expense under section 162(a). ⁹ We hold that the claimed deduction is not allowable under any of those provisions.

1964 U.S. Tax Ct. LEXIS 69">*91 (i) Petitioner argues that it could have demanded delivery from Keizer & Co. of 3,000 shares of Railway stock "upon payment of $ 62,400, the 'exercise price,'" that on February 15, 1955, it "sold the option to Keizer & Co. * * * and suffered a loss," and that such loss upon the "sale of the option" was deductible under sections 1234(a) and 165. Its position in this respect rests upon pure fiction and a strained interpretation of the term "option."

Petitioner did not hold any "option" as that term is ordinarily understood, and it confuses the difference between an option and what purports to be an executed contract of sale. See Lawler v. Commissioner, 78 F.2d 567, 568 (C.A. 9). Pursuant to its arrangement with Keizer & Co., petitioner purported to make an outright purchase of 3,000 shares of Railway stock and then purported to make an outright resale of these shares on the following day. No "option" of any kind was involved, and it would require a judicial tour de force to press this case into the mold of section 1234. The inapplicability of the option loss provisions in situations of this kind was fully spelled out in Morris R. DeWoskin, 35 T.C. 356">35 T.C. 356,1964 U.S. Tax Ct. LEXIS 69">*92 appeal dismissed (C.A. 7), dealing with the corresponding provisions in section 117(g)(2) of the 42 T.C. 769">*778 1939 Code. And the Court of Appeals for the Seventh Circuit recently reached the same result in Lewis v. Commissioner, 328 F.2d 634. We follow DeWoskin and Lewis here.

The dictum in Goodstein v. Commissioner, 267 F.2d 127">267 F.2d 127, 267 F.2d 127">132 (C.A. 1), relied upon by petitioner, was plainly not concerned with the foregoing considerations. Moreover, Goodstein and the two other cases relied upon by petitioner in respect of this issue ( Becker v. Commissioner, 277 F.2d 146 (C.A. 2); MacRae v. Commissioner, 294 F.2d 56 (C.A. 9)) are distinguishable here. In Goodstein (pp. 131, 132), the court found that the taxpayer promised to pay Seaboard $ 9,929,212.71 at any time he might select and that Seaboard promised to acquire and deliver to the taxpayer, on the date he selects, certain Treasury notes in the face amount of $ 10 million. Both Becker (p. 148) and McRae (p. 60) found similar promises on the part of the taxpayer and the purported1964 U.S. Tax Ct. LEXIS 69">*93 lender, respectively. There is thus a crucial distinction between the instant case and the three cases relied on by petitioner. ¹⁰ Here we have found that it was the understanding and intention of the parties that Keizer & Co. was not to deliver any Railway stock. Petitioner promised to pay $ 156,000 to Keizer & Co. and Keizer & Co. promised to pay to petitioner $ 15,000 (the purported dividends on the Railway stock) plus $ 138,195, which amount represented the selling price of the stock ex dividend, namely, $ 138,375, less a charge in the amount of $ 180 for tax on the purported sale. Keizer & Co.'s promise was to pay money in a bucket-shop-type transaction and not to deliver stock. Simply stated, petitioner incurred a loss because it received less money than it paid out, and the money it received in no way related to any right to require delivery of Railway stock. There was no option to purchase "property" within the meaning of section 1234.

1964 U.S. Tax Ct. LEXIS 69">*94 (ii) Nor is the claimed deduction of $ 2,805 allowable under section 162(a) as an ordinary and necessary business expense. Petitioner contends, and it is supported by evidence, that it from time to time made short-term investments in securities with funds temporarily not needed in its manufacturing business, that such investment activities were part of its business, and that therefore investment expenses thus incurred are deductible as business expenses. The difficulty with that contention here is that petitioner did not in fact make any bona fide investment in securities in respect of the alleged purchase of 3,000 shares of Railway stock, short term or otherwise, and that in accordance with our finding this transaction was a sham. Any loss which it sustained in connection therewith was not an "ordinary and 42 T.C. 769">*779 necessary" expense incurred "in carrying on * * * [its] trade or business." Cf. Carl Shapiro, 40 T.C. 34">40 T.C. 34, 40 T.C. 34">39-40; MacRae v. Commissioner, 294 F.2d 56, 59 (C.A. 9).

Furthermore, in view of the intention of the parties not to make delivery of the securities in which they purportedly dealt, there appears1964 U.S. Tax Ct. LEXIS 69">*95 to have been a violation of the Massachusetts law against bucket-shop transactions. See fn. 4, supra. Accordingly, there may be serious doubt whether losses incurred in any such transaction, in contravention of the clearly defined public policy of the State, are in any event deductible by reason of that circumstance alone. Cf. Tank Truck Rentals v. Commissioner, 356 U.S. 30">356 U.S. 30; Lilly v. Commissioner, 343 U.S. 90">343 U.S. 90, 343 U.S. 90">97.

Decision will be entered under Rule 50.