Sinon VI: J.P. Morgan Securities Converts to LLC; Tax Benefit Gifted in Frank-Dodd

Banks being able to easily and legally convert to Limited Liability Companies (LLCs) is something for which domestic banks have pushed for years. They've wanted it because LLCs are only taxed once - if they are structured as partnerships or as "disregarded entities" - the tax "passes through" to the individual partners, or to what are essentially the dividends of each of the shareholders. Meaning only those dividends (or each stockholder's share of the company's profit or income) are taxed, versus taxing both the dividends and the corporation's overall income.

U.S. banks have had trouble converting to LLCs in the past due to federal law and IRS restrictions, which have been interpreted as making it difficult for banks to be anything other than "incorporated," or the legal "Inc." designation, under which the tax-reducing "S-Corp." election restricts the number of shareholders and types of stock the banks are allowed to issue, and also bars banks from the "check-the-box" taxation the IRS allows other non-bank LLC applicants, or those NOT insured by the Federal Deposit Insurance Corporation.

Well, the banks got what they've long pined for in Frank-Dodd, which explicitly provides the option to go LLC for banks, at least under the "Derivatives Clearing Organizations" subsection of the Act.

So if you're a bank engaged in derivatives clearing and seeking pass-through (lower) taxes without any restrictions on the amount of shareholders or class of stock you or they hold: go for it!

J.P. Morgan, for one, announced last week its investment banking division, J.P. Morgan Securities Inc., was converting to an LLC beginning Sept. 1. The division is now known as J.P. Morgan Securities LLC.

An email sent to the bank about whether Dodd-Frank emboldened it to go LLC and whether tax and liability issues were among reasons for converting, was not immediately returned. J.P. Morgan Securities is the part of the bank that provides customers underwriting, merger advisory, trade execution and clearing and settlement services in derivatives, stocks and bonds.

Note too that the Warehouse Trust Company, the derivatives database subsidiary of the Depository Trust and Clearing Corporation (DTCC), The Street's giant utility for processing and settling securities, was approved as an LLC, state-chartered bank by the Federal Reserve Board Feb. 2, a full five months before Dodd-Frank and the LLC derivatives clearing bank provision within it, became law. It did so by obtaining a state exemption from having to hold FDIC deposit insurance when forming as an LLC, as state law has required (such entities also cannot take deposits from the general public). Such exemptive approval presumably banks no longer need, as federal law - in this case, the Dodd-Frank LLC bank derivatives clearing provision - trumps that of the states. According to the Fed's order approval, DTCC also transitioned to a bank holding company, and was approved to do so by the board of the New York State Banking Department March 1, the day Warehouse Trust opened for business, and thus became a regulated entity of the Fed, as well as the SEC. Deriv/SERV, the parent of Warehouse Trust and MarkitSERV, which is DTCC's derivatives trade matching subsidiary, has operated as an LLC since launching at end of 2003.

Regardless, it's legally easier for banks to be down with LLC, now. To wit:

"(2) CONVERSION OF DEPOSITORY INSTITUTIONS.—A depository institution to which this subsection applies may, by the vote of the shareholders owning not less than 51 percent of

the voting interests of the depository institution, be converted into a State corporation, partnership, limited liability company, or similar legal form pursuant to a plan of conversion, if the conversion is not in contravention of applicable State law," says Dodd-Frank.

To be clear: We noticed the J.P. Morgan Securities conversion the same day as FT Alphaville, which provided us with the context that banks had lobbied for easier LLC tax status in the past. However, we are thus far the only publication to point out that the Dodd-Frank Act explicitly allows banks such LLC conversion when engaged in derivatives clearing. We bemoan how this world makes us toot our own horns. But: toot.

Not that we necessarily should, for we hasten to add that little in securities law possesses "bright line" clarity. However, of this we are certain: The subsection in Frank-Dodd that allows banks engaged in derivatives clearing to convert to LLCs has at least provided a bit more comfort that said conversions need not contravene federal law nor that of the IRS.

Among the "primary dealers" - the largest traders of government bonds as designated by the Federal Reserve Bank of New York - Banc of America Securities is the only other U.S. bank to have obtained LLC status; BofA converted over 10 years ago, on May 17, 1999. Swiss banks Credit Suisse Securities (USA) and UBS Securities are LLCs as well, according to the New York Fed's list.

Update: Thanks to briareus, commenting below, for pointing us to the New York Fed's Primary Dealers List Web site, which was updated June 1, 2011 to say that Morgan Stanley & Co. Incorporated converted to an LLC -- Morgan Stanley & Co. LLC -- effective May 31, 2011. And also according to the Fed, late last year, Royal Bank of Canada's investment banking subsidiary, RBC Capital Markets, converted from a corporation to an LLC, effective Nov. 1. We can only hope briareus uses his 100 hands and 50 heads for the forces of good. We also wonder why this story has our "pagevisits" spiking by 2,533.33 percent? Are banks now -- or have they ever been -- effectively using us for tax advice on this issue? That'd be inadvisable, although some would argue, could be oddly flattering. Or is this issue just plain keen?