00:00I want to first start with the 351 part of the tax code. It's a specific part of the tax
00:05code.
00:05Just walk us through what does that section 351 allow? What does it not allow to help us understand
00:10what's legal, what's not legal, or what might be questionably legal?
00:15Well, so the thing to understand is that section 351 is a hundred year old provision in the tax
00:20code roughly. And what it allows is for folks to contribute appreciated securities into seeding a
00:27new corporation in this case, an ETF. Now, Congress was pretty clear about what they're trying to
00:33achieve with this. They want to help bootstrap new businesses. They do not want to allow tax-free
00:39diversification. And so that's where we start to get into the difference between routine applications
00:44of section 351 versus aggressive tax planning. And that's the change that treasury was talking about
00:50at a big meeting last week in New York. How will this play out in reality? If treasury wants to
00:55do
00:55something, are they going to give guidance? And then will the ones already approved be okay,
01:01but new ones can't crop up? Like, how do you see this playing out?
01:05Well, there's three different layers to this. So we have to start with statute. So that's what the
01:08United States Congress and Senate and the president are all involved with. And as far as I can tell,
01:13there's really no momentum at that layer to make a change in the law. So now we have to move
01:18down a
01:18layer. We have to go into regulation. And so those are the rules that treasury writes and that IRS
01:24enforces. So the rules and the applications of the rules. And so it's possible that treasury could
01:29look at how the market is actually using section 351 and say, no, that's contrary to Congress's
01:35intent, which again, namely was preventing tax-free diversification and really eliminating gains or
01:41avoiding gains indefinitely for portfolio rebalancing. And so they're going to look at these
01:46three different layers. And those are the different aspects that I can see that might be impacted
01:50or that might impact the ETF markets going forward. So the thing with these 351 conversions,
01:56these new ETFs, is that they're seeded with securities rather than cash. And that in and
02:01of itself is not against the law. And if you have a diversified portfolio, that seems to be OK. But
02:05if
02:05you have a bunch of stock because your friend founded NVIDIA and you got it and now you want to
02:11put
02:12that into an ETF, does that become a problem? Yeah, definitely. That's a problem. But the code is
02:18written such that certain diversification tests have to be met. And the details here are that
02:23essentially you can't have more than 25 percent of a single name going into seed the new ETF. So
02:28that would already disallow non-recognition. In other words, you'd have to pay tax on that
02:32contribution anyway. But where this gets sort of in shenanigans territory is where we have folks
02:37doing things pre-contribution. So they'll borrow against maybe a concentrated position. They'll add
02:44some diversifying securities. And then they'll contribute that entire portfolio to meet the
02:49diversification tests on the way in. Now, that is not good. That is not what they were trying to
02:54achieve. And Brent, let me ask, given the Treasury's obvious interest in this right now, what are you
03:00seeing in the market? Are people still launching these 351s, given the fact that there's some concern
03:05that the Treasury is going to take some action? Yeah, absolutely. I don't think that that train has
03:11slowed down. What I'm seeing, though, is that maybe a little more diligence around what is a routine
03:15transaction versus what is potentially aggressive tax planning. And I think we're really going to find
03:20out who's swimming naked here when IRS does its investigations. We're going to find out who is
03:26using this to minimize transaction costs, to save investors, expense ratio, things like that,
03:32versus who is trying to achieve tax-free diversification.
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