Ps were general partners in Goodbody, a stock brokerage firm. Due to the failure of record-keeping technology to keep up with trading volume, Goodbody incurred large, anticipated "back office" liabilities to its customers and other stock brokerage firms, precipitating withdrawals of firm capital and violation of New York Stock Exchange rules. In order to prevent the financial collapse of Goodbody, M Corp. agreed to assume Goodbody's business, all its assets and liabilities, subject to an obligation by Ps to pay to M any deficit in Goodbody's net worth. Held, liabilities attributable to an accrual basis partnership's deductible expenses must meet the "all events" test before they may be included in the bases of Ps' partnership interests. Held, further, reserves representing "back-office" liabilities are not includable in the bases of Ps' partnership interests in determining the amount

of their loss. Held, further, Ps realized an amount equal to
Goodbody's liabilities upon the transfer of its business to M.
Held, further, the transfer of Goodbody's business to M
resulted in a sale or exchange of Ps' partnership interests.

James E. Tyrrell, Jr., Hunter L. Prillaman, Kenneth M. Hart, William O'C. Harnisch, and Joseph E. Boury, for the petitioners.

Laurence D. Ziegler and Theodore R. Leighton, for the respondent.

GERBER, Judge: This is a consolidated action involving seven former general partners of Goodbody & Co., a broker-dealer in securities and commodities. This action is for redetermination of deficiencies arising out of the financial collapse of the Goodbody partnership and the accession to its assets and liabilities by Merrill, Lynch, Pierce, Fenner & Smith, Inc. (Merrill Lynch). The issues for decision are: (1) Whether reserves reflecting "back office" errors are liabilities that may be included in the bases of petitioners' partnership interests; (2) whether and to what extent the transfer of petitioners' business resulted in relief from partnership liabilities, causing constructive distributions and reducing petitioners' bases in their partnership interests; and (3) whether petitioners should be allowed a deduction for the worthlessness of their partnership interests or abandonment of partnership assets, or whether the transaction constituted a sale, exchange or liquidation of petitioners' partnership interests.

FINDINGS OF FACT

Many of the facts and exhibits are stipulated and are incorporated herein by this reference. Petitioners in this action are seven individuals who were formerly general partners of Goodbody & Co. (Goodbody), which was, until 1970, a partnership acting as a broker-dealer in securities and commodities. As of November 5, 1970, Goodbody, the nation's fifth largest stock brokerage firm, was a limited partnership organized under the laws of the State of New York, with 130 partners, 63 general partners, and 67 limited partners. Goodbody conducted a securities and commodities

business from approximately 100 domestic offices, serving approximately 225,000 customers.

In the late 1960s and early 1970s, the brokerage industry encountered logistical problems due to a failure of their record-keeping technology to keep up with trading volume. Known as "back office" problems, they were experienced by many member firms on the New York Stock Exchange (NYSE or Exchange), including Goodbody. These problems included the following types of transactions:

(1) Fails to Receive-securities which the broker should have purchased at a stated price were not purchased. Gain or loss was incurred on these transactions measured by the difference between the customer's contract price and what the broker had to pay to obtain the securities.

(2) Fails to Deliver-securities which the broker thought were sold to another broker but for which no "comparison" for proof could be provided. These securities then had to be sold and the gain or loss incurred was measured by the difference between the original sales price and the actual proceeds received.

(3) Securities Differences-these represented differences between the securities the broker's records stated it should be holding for its own or other's accounts and the securities actually "in the box." These resulted mainly from incorrect deliveries, receipts, or theft. Gain or loss was measured by the value of excess securities or their replacement cost.

(4) Dividend Errors-the broker was responsible to its customers for dividends and interest on securities which it held as nominee for its customers, securities held in "street name." If the broker failed to receive a dividend or interest payment when due, it was still liable to its customer for such amount.

NYSE members, including Goodbody, were subject to Exchange rules. Exchange rule 64 provided that settlement-payment for securities received or delivery of securities sold-must occur within 5 days of the contract date. Violations of this rule, caused by "back office" failures, resulted in the offending broker being liable to replace any missing securities or money.

Goodbody experienced a substantial amount of "back office" problems. Although the firm earned a profit in 1968,

in 1969 it sustained a $678,793 loss. These "back office" problems continued unabated and precipitated Goodbody's eventual financial instability during 1970.

As a consequence of the large losses generated by the "back office" problems, subordinated lenders withdrew capital from Goodbody. This in turn triggered concerns that Goodbody (and other firms) could violate the minimum capital requirements of the NYSE. Rule 325 of the Exchange stated that a firm's liabilities could not exceed 20 times its liquid capital.2

On August 28, 1970, Ernst & Ernst (Ernst), an accounting firm, pursuant to the Exchange's request, commenced a surprise audit of Goodbody for purposes of reporting on Goodbody's capital position. By letter dated September 11, 1970, Exchange notified Goodbody that certain withdrawals of firm capital would cause Goodbody to violate rule 325 as of October 1970. Another letter dated September 15, 1970, requested attendance of certain Goodbody partners at a special meeting of a committee of the Exchange to respond to concerns about Goodbody's capital requirements and securities count differences then estimated at $45 million.

In order to avert the impending capital violations, Goodbody sought to obtain additional capital from outside parties in September and October of 1970. On September 16, Goodbody's board of directors met and discussed its possible merger with Shareholder's Capital Corp. (SCC). Negotiations were still continuing with SCC when, on October 12, Utilities & Industries Corp. contacted Goodbody about the possibility of investing capital in the firm. The SCC negotiations terminated on October 15, and on October 28, Utilities & Industries Corporation terminated its negotiations.

In subsequent letters, Exchange directed further remedial measures, including liquidating some proprietary positions. Exchange's October 15 letter indicated that Goodbody had, according to calculations resulting from the surprise audit, fallen below the capital requirements by approximately $7 million. The letter warned that unless remedial capital measures were taken, Goodbody could be suspended from 2Under certain circumstances, subordinated borrowings could be considered liquid capital.

the Exchange, and, subsequently, could likely lose all of the firm's capital.

NYSE officials and its members, including Merrill Lynch, were concerned that a collapse of Goodbody, coupled with the resulting default in its customer accounts, would seriously erode public confidence in the securities industry. Moreover, other member firms were having similar difficulties and there was a concern that a default by Goodbody in its obligations to other firms would cause a "domino" type failure of a number of other firms. On October 22 and 27, 1970, Exchange officials met with representatives of major member firms in an attempt to assist Goodbody. Although Goodbody's precarious situation and the possible ramifications of a Goodbody failure for the industry as a whole were placed before the NYSE membership, no firm volunteered to assist Goodbody. Merrill Lynch, the largest firm in the industry, was represented at these meetings but, like the other firms, did not offer to assist Goodbody. Subsequently, the president of the NYSE went to see the chairman of Merrill Lynch in an attempt to convince him to change his mind and assist Goodbody. Merrill Lynch, the largest company with the most resources, was one of the few firms capable of absorbing the fifth largest firm, Goodbody.

On October 28, 1970, Goodbody, Merrill Lynch, and NYSE entered into an agreement under which Goodbody was to refrain from entering into any transactions, including borrowings, other than those arising in the ordinary course of business, and to provide Merrill Lynch all needed information and documents to facilitate Merrill Lynch's decision to assist Goodbody by assimilating it into Merrill Lynch. By agreement, most of the general partners of Goodbody authorized a representative group to negotiate with Merrill Lynch. Also, the U.S. Department of Justice advised Merrill Lynch that it did not intend to institute any antitrust proceeding as a result of a Goodbody acquisition.

On November 5, 1970, Merrill Lynch, NYSE, and Goodbody entered into a series of agreements under which Goodbody transferred its assets and liabilities to Merrill Lynch. The agreements are described below. Pertinent portions are quoted and others are summarized.