* Don't allow analysts to sell if they've recommended others buy;
* Don't let investment bankers review an analyst's research;
* Don't have analysts report to investment banking;
* Bankers should not promise or propose specific ratings to clients when pursuing business; and
* Analysts should disclose if they or household members own stakes in the companies they cover.
The guidelines led some brokerage firms to make immediate changes. Merrill Lynch instituted a new policy days after the guidelines were released that prohibit its equity analysts from buying shares of stock in the companies they cover. Prudential Securities, which had already started advertising their investment banking-free research, began requiring analysts to reveal whether they or family members have $10,000 or more invested in companies they cover. Credit Suisse announced that its technology analysts would no longer report to high profile investment banker Frank Quattrone.
IV. Analysis
The blindly optimistic "research" reports emanating from Wall Street brokerage firms are well documented. According to First Call/Thomson Financial, as of July 1, 2001, 98.6 percent of the 24,000 individual stock recommendations offered by analysts were either "strong buys," "buys" or "holds" with only 1.4 percent of the recommendations being either "sells" or "strong sells." The attempts by the securities industry to resolve the problems resulting in these glowing recommendations are simply too little too late. While overwhelming evidence has existed for at least the last decade that the analysts at major brokerage firms are often nothing more than glorified salesmen for the investment banking division, it is only now after approximately $3.0 trillion has been lost from the NASDAQ and on the heels of Congressional investigations that Wall Street offers a "solution" to the problem. Representative Richard Baker, Chairman of the House Committee on Financial Services, stated at the hearings examining research analysts in June of 2001 that he was "naturally skeptical of a document that contains a disclaimer that, to me, essentially says, 'We promise to be honest--unless of course circumstances warrant that we can't be.'"13 As noted by Rep. Paul Kanjorski at the same hearings, "It's nice, but a little late."14
Unfortunately, the voluntary guidelines outlined by the brokerage firms have no enforcement powers of their own.15 While the industry groups do plan on monitoring enforcement on a continuing basis, their past efforts make these assurance dubious at best. It is highly unlikely the recommendations made by the securities trade organizations will have any real impact on the way brokerage firm analysts do business. Most of the recommendations by the securities trade organizations were already in place during the last five years when most of the problems ensued. For example, the guidelines suggest such obvious solutions as investment bankers shouldn't "promise or propose specific ratings to current or prospective clients when pursuing business," and that "management should encourage analysts to indicate both when a security should be bought and when it should be sold."
The "Chinese Wall" that is supposed to separate brokerage firm research and banking divisions has completely crumbled. The primary solution for purging these conflicts of interests is the reestablishment of the Chinese Wall between analysts and investment bankers. Nothing short of total separation between analysts and investment bankers will suffice to rebuild the Wall. Analysts' pay cannot be linked in any way to the investment banking division and the fees generated by the investment bankers, directly or indirectly, or the same problems will continue to exist.
Unfortunately, Wall Street appears unwilling to take this needed step and separate analyst pay from the investment banking business because of the lucrative fees associated with investment banking. Therefore, Congressional intervention is needed to mandate that the two divisions be separated. As noted by former SEC Chairman Arthur Levitt, the "franchise" relationship between analysts and investment bankers will be very difficult for brokerage firms to separate since they are "built into the investment banking culture."16 Brokerage firms will likely be unwilling to jeopardize these fees in order to ensure the less profitable retail investor receives unbiased information from a firm's research department. Congress needs to mandate that the two be separated through legislation in order to provide the retail investor the best chance at receiving unbiased information regarding the stocks being recommended.
IV. Conclusion
Unfortunately Wall Street has shown repeatedly throughout the years that it is unable to police itself. It was only after $3 trillion were eliminated from the NASDAQ and only days before Congressional hearings into the undisclosed conflict of interests at brokerage firm "research" departments that the securities industry provided voluntary guidelines to help eliminate the problem. Unfortunately, that is not enough thereby mandating Congressional intervention in order to ensure the reestablish of the Chinese Wall between brokerage firm research departments and investment banking divisions.
_______________
1. See July 5, 2001 USA Today Editorial concluding "Until the hoodwinking ends, investors should see analysts for what they are--salesman, not researchers."
2. Analyzing the Analysts: Are Investors Getting Unbiased Research from Wall Street, David W. Tice, Congressional Testimony for the Committee on Financial Services, June 14, 2001.
3. Id.
4. Analysts Avoid Sell Ratings Out of Fear, CFO.com, April 26, 2001.
5. Analyzing the Analysts: Are Investors Getting Unbiased Research from Wall Street, David W. Tice, Congressional Testimony for the Committee on Financial Services, June 14, 2001.
6. The Pied Pipers of Wall Street, Benjamin Mark Cole, Bloomberg Press, 2001.
7. Id.
8. Id.
9. Id.
10. Analyzing the Analysts: Are Investors Getting Unbiased Research from Wall Street, David W. Tice, Congressional Testimony for the Committee on Financial Services, June 14, 2001.
11. The Pied Pipers of Wall Street, Benjamin Mark Cole, Bloomberg Press, 2001.
12. Keeping Wall Street Clean, TheStandard.com, June 12, 2001
13. Investors Cast Wary Eye on Wall Street, American City Business Journal, July 27, 2001.
14. Id.
15. SIA Sets Best Practices Ahead of Hearings, CNetnews.com, June 12, 2001
16. Levitt Expects Wall Street To Fall Short, Wall Street Journal, July 2, 2001
Beware of the "bulk sales"
provisions for business assets in the Illinois tax statutes
By James Van Vliet, Chicago
Sellers, buyers and other transferees of assets of businesses in Illinois, and their attorneys, need to be aware of the so-called "bulk sales" provisions in the Illinois tax statutes. Under these relatively obscure provisions, a buyer is required to give notice of the sale to the Illinois Department of Revenue ("Department") which in turn may require the buyer to escrow part (or in the worst case, all) of the purchase price to assure payment of the seller's state tax obligations. A buyer's failure to comply exposes it to personal liability for the seller's tax obligations. A transferee who is not a buyer has the same responsibilities under the statute as a buyer. A seller is impacted because funds belonging to it are to be escrowed to assure payment of seller's state tax obligations and termination of the escrow will be controlled by the Department in a process that can be time consuming, expensive and even misguided. That, at least, was the recent experience of one seller-taxpayer reported in the description herein of the Department's administration of the bulk sales provisions.
The statutory bulk sales provisions are badly flawed and the Department has not adopted regulations which might have cured or at least ameliorated the flaws. Further, some of the Department's practices under the bulk sales provisions are at odds not only with those provisions, but also with other parts of the Illinois tax statutes.
Flaws in the statutory provisions
The bulk sales provisions consist of matching provisions in the Illinois Retailers' Occupation Tax Act1and the state's Income Tax Act.2 The provisions in turn are incorporated by reference into other Illinois tax statutes.3 For the sake of brevity, subsequent references to the bulk sales provisions are only to those in the Income Tax Act unless otherwise specified.
Inadequacy of the bulk sale definition
Flaws in the statutory bulk sales provisions become apparent when the provisions are studied to determine their applicability and how they work. The first step in such a study is to determine what constitutes a triggering event, commonly called a "bulk sale." The statutory definition is as follows:
If any taxpayer, outside the usual course of his business, sells or transfers the major part of any one or more of (A) the stock of goods which he is engaged in the business of selling, or (B) the furniture or [sic] fixtures, or (C) the machinery and equipment, or (D) the real property, of any business that is subject to the provisions of this Act ....4 (emphasis added.)
The above definition is relatively brief compared, for example, to the definition of a "bulk sale" in the Uniform Commercial Code.5 The unfortunate consequence of the brevity is vagueness. For the most common situations-- those involving the sale of substantially all of the total assets of a business to one buyer in a single transaction-- the vagueness has no consequence because the bulk sales provisions apply with a certainty. In all other situations, a buyer, to protect itself from being liable for a seller's state tax obligations, is likely to apply the broadest possible interpretation, always concluding that its purchase involves a bulk sale by the seller. At best this gives the state the broadest possible protection against sellers' non-payment of state taxes. At worst, it results in a burden and expense for sellers and buyers generally, as well as public expense for the Department's increased administrative burden, beyond what is really necessary.
Buyers and sellers who do not comply simply because they assume that a bulk sale requires a sale of the major part of the total assets of a business will be surprised. The statutory definition divides the physical assets of a business into four categories (clauses (A) through (D) in the above-quoted definition) and a sale of the major part of any category is a bulk sale. Consequently, the disposition of a single business in some circumstances can result in multiple bulk sales. For example, if a store owner sells its stock of goods to one buyer, its fixtures to another and the store building and land to still another, three separate bulk sales occur so that three separate bulk sale procedures must be carried out. (Query: Will the seller and buyer in each of the sales be aware that their transaction is a bulk sale? Query also: Is there a legitimate public need for the multiple bulk sale result?)
To be a bulk sale, the sale must involve "the major part" of the assets in any one or more of the four asset categories.6 If an owner of one business conducted through two stores closes the smaller of the two, selling the assets of the smaller store, no bulk sale in fact occurs (i.e., no "major part" of the total of any asset category of the business is sold), but how is the buyer to know this? The statute forces a buyer to make a decision about facts of which it has no direct knowledge and which are accurately known only to the seller. A buyer has to rely upon factual representations by the seller in the less than obvious situations, but why should a buyer do that and risk personal liability for seller's tax obligations in the event it turns out that seller has misrepresented the facts? No protection is built into the statute for a buyer who relies in good faith upon a seller's factual representations. This makes it more likely that a buyer will report a transaction as a bulk sale and start the Department's bulk sale process even when the seller correctly represents that no bulk sale is involved.
If the business assets are sold at an auction, with various buyers buying individual items, which of those buyers is deemed to have bought the major part of the assets when not a single item sold to any buyer is mathematically a major part of the total in any asset category? Arguably, because no sale involves "the major part" of any category of assets sold, the bulk sales provisions do not apply. However, the end result is that all of the assets are sold so a bulk sale would seem to have occurred at some point, but which (if any) of the buyers is responsible for reporting the bulk sale? The statute gives no guidance and there are no regulations to which one normally would turn next for an answer.
To be a bulk sale, a major part of the assets in any of the four categories must be sold "outside the usual course of [seller's] business."7 One might expect the quoted phrase to be placed where it would apply only to the stock of goods category in statutory clause (A). That is, a stock of goods can be sold outside the usual course of business when not sold in the usual way for the business, e.g., other than a sale at retail across the counter, customer by customer. The expectation of limiting the phrase to a sale of the stock of goods is reasonable because when would the sale of the business fixtures or the machinery and equipment or the real estate not be "outside the usual course of [seller's] business?"
Consequently, the placement in the statute of the phrase "outside the usual course of [seller's] business" so that it qualifies all four categories of assets at least suggests the possibility of a special meaning for the phrase. For example, could it mean that if the business fixtures or the machinery and equipment are sold because they are being replaced with new items, the sale should be deemed to be in the "usual course of [seller's] business" inasmuch as the sale involves a continuation, rather than a termination, of the business? So also, if all of the real estate is sold in connection with the business being moved to leased quarters, is the sale to be deemed in the "usual course of [seller's] business" because the business is not being terminated? The statute gives no indication what the answers should be and there are no regulations that might answer the questions. A buyer wanting to avoid personal liability for seller's tax obligations is not likely to give special meaning to the phrase "outside the usual course of [seller's] business" simply because of its placement in the sentence structure.
Further, could it be that the phrase "outside the usual course of [seller's] business," by its sentence placement, was intended to exclude any sale of a major part of any of the four categories of assets of a business if the sale occurs some time after the business has been shut down? For example, if the stock of goods and the store fixtures are sold, with the business terminating at that time, might the sale one year later of the real estate not be a bulk sale because there no longer is a going business (i.e., no "usual course of ... business") at the time of sale? If so, how much time has to pass after the cessation of business before "outside the usual course of [seller's] business" becomes inapplicable? The statute gives no indication how to answer these questions and there are no interpretive regulations. Why should any buyer risk liability for seller's tax obligations by taking a chance about the meaning, even when a special meaning might seem reasonable? If the placement of the "outside the usual course" phrase in the sentence structure was intended to convey a special meaning, it simply fails to do so adequately.
Under the bulk sales provisions, any sale of a major part of the assets in any of the four categories literally qualifies as a triggering event. No exception is made for court supervised bulk sales, such as sales in a bankruptcy proceeding or a mortgage foreclosure sale. Although it seems unlikely that the Department would try to enforce the provisions against a buyer in such a sale, the statutory wording literally authorizes such action and has existed a long time without correction and with no regulations giving assurance of an exemption.
A bulk sale occurs not only when a taxpayer sells, but also when a taxpayer "transfers" the major part of any of the four asset categories.8 The statute does not limit this to transfers for value so that literally any transfer can be a bulk transfer, even when there is no consideration to be escrowed. Applying the statute literally, business assets transferred by will or the laws of descent and distribution, or by a donor's gift, can be bulk "transfers" for purposes of the bulk sales provisions and the transferee should give notice to the Department of the transfer the same as is required of a buyer in a purchase.9 Given the absence of any consideration to be escrowed, the purpose of the bulk sales provisions applying to such transfers is not readily apparent. Possibly the purpose is to assure that the Department receives prompt notice of the transfer to enable it to pursue, earlier than otherwise might be the case, the enforcement of a transferor's state tax obligations. Further, even without having consideration to be escrowed, when the bulk sales provisions apply, the failure of the transferee to give notice of the transfer within 10 days exposes the transferee under those provisions to personal liability for tax obligations owed but not paid by the transferor.10 (Query: Are transferees generally aware of the applicability of the bulk sales provisions?)11
The mandatory notice defect
A bulk sale triggers two different notice provisions. One involves a mandatory notice while under the other provision notice is optional.
Under the mandatory provision, a buyer must "file" notice of a bulk sale with the Department's Chicago office "no later than 10 days after the sale."12(Emphasis added.) The purpose of this notice is to allow the Department to respond by issuing what the statute refers to as an order to withhold, and which the Department calls a "bulk sale stop order," requiring the buyer to withhold from the purchase price a sum specified in the Department's order.
The optional notice provision operates in a different time frame and ostensibly for a different purpose. Under the optional provision, "at least 10 days before the date of the sale" either the seller or the buyer may notify the Department of the "intended sale," with the stated purpose of an optional notice being to "request the Department to make a determination as to whether the seller ... owes any tax, penalty or interest."13
In practice the Department does not distinguish between mandatory and optional notices. It uses the same form for both types of notice, being the Department's form NUC-542-A entitled "Notice of Sale or Purchase of Business Assets." The Department will respond to either a mandatory or an optional notice by issuing a bulk sale stop order. While the Department's treating mandatory and optional notices the same may technically be at odds with the statutory language, it resolves what otherwise would be an important problem. That problem is that the time periods associated with a mandatory notice simply do not work, rendering a mandatory notice incapable of achieving the withholding and escrowing of funds from the purchase price to assure payment of a seller's tax obligations.
Under the mandatory notice provisions, a buyer must file the notice of sale "no later than 10 days after the sale."14 The Department in response may issue its stop order "within 10 days after [it] receives notification of [the] sale."15 Because the notice of sale relates to a "sale" and not an "intended sale," the statute literally does not permit the mandatory notice of sale to be given before the sale actually occurs on the closing date. Whether the maximum time period is used (notice of sale filed 10 days after the sale), or the shortest possible time (notice of sale filed on the date of sale, immediately after the closing), and no matter how quickly the Department acts in response to the notice, the stop order always will be issued after the sale is completed. The usual terms of a sale will call for buyer's payment to seller of the entire purchase price at the closing so any stop order issued under the mandatory notice procedure will be too late-- at minimum at least minutes and probably at least a day or more too late or at maximum 20 days too late. There simply will be nothing left in buyer's possession to be withheld and escrowed when the stop order issues.
The timing flaw in the mandatory notice requirement forces a buyer to make the optional notice mandatory. Buyer may do this either by giving the optional notice itself or by contractually requiring seller to give the optional notice, in either case with the notice to be given more than 10 days prior to the closing date. As a practical matter, this will result in a stop order being issued by the Department by the time of the sale, allowing the escrowing of the amount required to be withheld under the Department's order. As long as the escrow is then disbursed only in accordance with the bulk sales provisions, as a practical matter the buyer will be protected against being personally liable for seller's state tax obligations.
However, under a literal interpretation of the bulk sales provisions, an optional notice does not fully protect a buyer. The statute, without an exception for the case in which an optional notice is given, says that if the buyer "fails to file the [mandatory] notice of sale ... within [10 days after the sale]," the buyer "shall be personally liable ... for the amount owed [for tax obligations] ... by the seller ... but unpaid, up to the amount of the reasonable value of the property acquired" by the buyer.16 It is not likely that the Department would attempt to enforce such personal liability when a mandatory notice has not been given but an optional notice has been timely given. Nevertheless, it is bizarre that the statute says that it can and has said so for a long time without correction.
Errors in the Department's practices
The Department has not issued regulations with respect to the bulk sales provisions. Instead, we have only the practices of the Department in administering the bulk sales provisions. There is no notice to the general public of these practices. Consequently, the affected public learns of the practices only by individual experiences, without forewarning and without knowing if the practices are uniformly and consistently employed.
Problems with the Department's administration go beyond its election not to use regulations to explain and improve the badly flawed statutory bulk sales provisions. In one instance, the Department has failed to adopt regulations notwithstanding a statutory directive to adopt them for a specific topic. In another instance, the Department has elected not to carry out a specific and very important statutory directive. In a third instance, the Department has arrogated to itself authority to withdraw a seller's funds from a bulk sale escrow even though the Department has no statutory basis for such action and in doing so actually violates the tax assessment process clearly specified elsewhere in the Income Tax Act.
Failure to adopt required regulations
The Department has failed to adopt regulations that are required by statute. The amount the Department may order a buyer to withhold and escrow from a bulk sale purchase price is prescribed by statute to be the total of (i) "twice the average liability of preceding filings times the number of unfiled returns which were not filed [by seller] when due," plus (ii) "twice the outstanding unpaid liabilities [of seller for taxes, penalties and interest]," plus (iii) an amount "not to exceed a minimum amount varying by type of business, as determined by the Department pursuant to regulations."17 (Emphasis added.) Although the statute clearly calls for regulations to determine the amount in the preceding third category, no regulations have been adopted. Unless the amount in the third category is being excluded from the total which the Department orders buyers to withhold, the Department's bulk sale stop orders are not complying with the statute.
Failure to comply with 60 days notice requirement
The Department also has failed to carry out the statutory bulk sales provisions in another respect. This involves the following statutory requirement:
Within 60 days after issuance of the initial order to withhold, the Department shall provide written notice to the purchaser ... of the actual amount of all taxes, penalties and interest then due and whether ... additional amounts may become due as a result of unpaid taxes required to be withheld by an employer, returns which were not filed when due, pending assessments and audits not completed.18