February 14, 1997

Mr. Lawrence Summers
Deputy Secretary
United States Treasury
1500 Pennsylvania Avenue
Washington, DC 20220

Dear Larry:

Could I ask you to glance at the attached note. We believe that the Short-against-the-Box proposal in the President's 1998 Budget does not apply to DECS, mandatory convertible security that we have created. Since there is a large public market in DECS we need to respond to investor's concerns.
Thank you. I will call you next week.

Yours sincerely,

Deryck C. Maughan
Chairman and Chief Executive Officer
Salomon Brothers
New York, New York

February 6, 1997
SHORT-AGAINST-THE-BOX PROPOSAL IN FY 1998 BUDGET

The President's Fiscal Year 1998 Budget, released on February 6, 1997, contains a tax increase proposal to require a taxpayer to recognize taxable gain (but not loss) arising from a "constructive sale" of a security. The proposal was inspired by the growth in the popularity of shorts-against-the-box, but the proposal also applies to any transaction that "SUBSTANTIALLY ELIMINATES" a taxpayer's risk of loss and opportunity for gain. The proposal appears to be identical to one made by the Treasury Department in January, 1996.

The constructive sale proposal would apply to a constructive sale taking place on or after January 13, 1996, if that constructive sale is not unwound on or before the date 30 days following the date (some months from now) that the budget is enacted into law. In practical terms, therefore, this proposal would apply retroactively to capital markets activities over a period of roughly 18 months leading up to its enactment into law.

The proposal does not, in our view, apply to DECS. 11DECS11 is the Salomon Brothers tradename for a widely popular capital markets instrument issued by many public corporations to public investors. (1) DECS give an investor economic exposure to most (but not all) of the performance of a specified portfolio stock investment owned by the issuing corporation; at the same time, DECS protect the issuer from all of the downside on that stock, while enabling the issuer to share significantly in any price appreciation in the portfolio stock. (2) Because the issuer retains a material opportunity for price appreciation, DECS do NOT in our view "substantially eliminate" an issuer's opportunity for gain on the underlying portfolio stock.

It is essential, however, that the Treasury Department clarify that the proposal does not apply to DECS as a SUBSTANTIVE matter, because the phrase "substantially eliminates opportunity for gain" is an invitation to endless legalistic wrangling. Billions of dollars of DECS-type instruments already trade in the capital markets, and tax ambiguity is debilitating to the efficient operation of those markets. We therefore think it simply inappropriate that the "substantial elimination of opportunity for gain" language was not clarified in the FY 1998 Budget to make it explicit that DECS-type instruments fall outside the proposal's intended scope. Without clarification, the phrase "substantially eliminates opportunity for gain" represents a cloud on the marketability of such products.

As a PROCEDURAL matter, and whatever the merits of a retroactive effective date for shorts-against-the-box, a retroactive effective date as applied to DECS is palpably unfair. A DECS issue is widely distributed in the public capital markets, and CANNOT be unwound prior to its maturity (typically, three years). Thus, if one ultimately were to conclude that the proposal reaches DECS (a view that we obviously take exception to), a DECS issuer would be unable to unwind its trade within 30 days of the date that legislation is enacted.

This retroactive result would not only be unfair, but is inconsistent with the Treasury's own public statements (as recently as January 30th) that the FY 1998 Budget revenue-raising proposals would apply prospectively (with one irrelevant exception). Finally, the proposal for retroactivity spreads confusion over a substantial part of the equity-linked capital markets, which is precisely the concern expressed by Congressman Archer (Chairman of the Ways and Means Committee) and Senator Roth (Chairman of the Senate Finance Committee) in their joint press release last year rejecting the Treasury's attempts in 1996 to suppress capital markets activity in advance of Congressional action.

(1) Other investment banking firms have copied the DECS format and sell such instruments under their own tradenames.

(2) A typical DECS might provide, for example, that the issuer will retain all of the first 20 percent of any price appreciation on the portfolio stock, and 17 percent of the appreciation beyond that threshold.