Cost basis reporting has so many moving parts that firms can easily stumble when they integrate systems. But there is a silver lining for all the hard work and strife.
The current tax season is the first time that cost basis reporting (CBR) has become a new reality for trading firms and investors. The issue will hit home as 1099 tax forms arrive and investors start to drill down on the details. While firms may want to duck disgruntled investors, they cannot ignore a gathering storm of operational challenges.
Cameron Routh,
senior vice president,
Scivantage
Inspired by the Great Recession, the Internal Revenue Service wants to know more about the capital gains of equities transactions and CBR will require broker/dealers to file far more detailed information about their gains and losses. The rule requires firms to adjust the original price of a stock via several variables such as wash sales and corporate actions.
However, the impacts on trading firms and operations are likely to be far more profound than previously thought, especially for the operations staff, those responsible for stock transfers, the corporate actions unit, and groups serving registered independent advisors (RIAs), says Martin Bentsen, director of the cost basis practice at Wall Street systems integrator Jordan & Jordan.
Bentsen is working closely with Cameron Routh, senior vice president, managing director of strategic products at Scivantage, a trade processing and account management software provider. The two companies have joined forces to provide software, assessments and integration services for firms struggling with the CBR requirements.
“We’re going to have a huge number of corrections this year, in part, because the [CBR] data is wrong and because there is other data they need for cost basis that simply wasn’t available at the time the 1099s were issued. Investors will have to recalculate everything that’s impacted and will have to issue corrections.”— Cameron Routh, senior vice president, managing director at Scivantage
“For most people, there was no impact until right now,” says Routh. “We’re going to have a huge number of corrections this year, in part, because the [CBR] data is wrong and because there is other data they need for cost basis that simply wasn’t available at the time the 1099s were issued. Investors will have to recalculate everything that’s impacted and will have to issue corrections.”
Behind the scenes, the back offices of larger trading firms will be busy as smaller firms tend to lean on their clearing partners to help them sort out the details, Routh says. “The fun is just starting.”
Top-Down Concern
But all is not lost for firms struggling with CBR.
Late last year, market research firm Celent in reviewing CBR vendors said they would be focusing their wares on value-added features such as tax management and client-facing tools, and integration with other systems as compliance becomes a more pressing matter this year for mutual funds and for fixed income instruments in 2013. Celent examined the offerings of Broadridge, DST Systems, Eagle Investment Systems, NetWorth Services, Scivantage, SunGard, Thomson Reuters, and Wolters Kluwer Financial Services.
“For this type of product, the interest comes somewhat from the top down,” Routh says. “This is not something the operations managers can buy on their own.” And the CBR push can spur more spending for the back office. “My question is, ‘Are they [back office staffs] getting enough?’ And I don’t think they are,” he says.
Yet the expense of CBR might one day become a new asset for the firms that must gather clean CBR data, according to Celent analyst Alexander Camargos, co-author of the report released this past November. Firms should be looking look for ways to leverage CBR data. “This data is particularly useful for statement generation, performance reporting, tax management, and on help desk UIs,” Camargos says. “Integration between CBR solutions and other systems within each firm will become an increasingly high priority.”
Routh is in agreement with Camargo that systems integration will come to the fore this year, which is why Scivantage decided to partner with Jordan & Jordan.
“It seemed like the right thing to do to put together a service that really addresses the neglected components of cost basis reporting,” Routh says. “It was almost as if firms were saying, ‘We have a software product—we’re done. That’s it. We don’t have to do anything else.’ Clearly, that’s not the case.”
CBR has so many moving parts that firms can easily stumble when they get to integration, assuming that the cost basis calculations are based on good data. But even clean data can be thwarted by being poorly integrated leaving clients without access to information. Faulty integration can result in cost basis data failing to be distributed correctly to other applications, Routh says. “Education is also a big component of it because this is all new to investors,” he says. Bentsen says that Jordan & Jordan has been engaged with CBR issues for quite some time and has created modules to ease implementations. “When you do that, you start realizing the impact this has on a firm overall,” he says. Routh and Bentsen argue that the cost-basis problem requires much more integration than many realize.
Everything Around CBR
For instance, Bentsen says that three online brokerage firms that are J&J customers had “25 separate projects” that addressed operational system issues and the handling of statements and confirms. The projects had “nothing to do with building a cost basis processing system, but everything to do with accommodating such a system within their back office processing,” he says. “Operationally, it has been a tremendous burden on firms.”
Three online brokerage firms had “25 separate projects” addressing operational issues that had “nothing to do with building a cost basis processing system, but everything to do with accommodating such a system within their back office processing. Operationally, it has been a tremendous burden on firms.”— Martin Bentsen, director of the cost basis practice at Jordan & Jordan
Firms have to accommodate new coding that has to be created and associated with particular transactions to enable better tracking to identify specific tax lots for transfers and CBR. Firms will also have to modify security masters, Bentsen says. “Plenty of the old systems are not really geared to do much of this because they’re Cobol-based or legacy systems.”
Back office and CBR systems will also need far greater precision especially when taking into account the results of corporate actions caused by reorganizations such as mergers, which will require more than setting up a CBR department, Bentsen says. Corporate actions such as stock splits, dividends and the return of capital distributions have to also be a part of the equation. “Every piece of that activity impacts either the old stock or the new stock,” he says.
Martin Bentsen,
director, cost basis practice,
Jordan & Jordan
“Firms have to look at the workflows especially when it comes to transferring securities … thereare time frames designated in the rules,” Bentsen says. In a 15-day time period when firms receive a stock, they have to clarify their cost basis “otherwise they have to contact the firm, in question, that transferred the account,” he says. The new rules governing ways to transfer securities will result in new interfaces, which will be sorely needed for data support.
“None of the back-office systems was designed with cost basis in mind,” Routh says. “There is a lot of information not readily available or even in the system that needs to flow into the cost basis system.”
A key challenge for the operations staff will be to insure that the right information is being fed into the system. An everyday event such as moving shares in and out of an account to rectify a situation can turn out to be problematic. “They traditionally do that just by moving the share and so the data flows into the cost basis system and the system doesn’t know what it means,” Routh says. “Was it sold? Was the original buy wrong? Was there bad data here? That can really pose problems for clean data.”
Deep in the Woods
Trading firms will also have to consider cost basis links to external services such as the Depository Trust and Clearing Corp. (DTCC), which has had to modify its Cost Basis Reporting Service (CBRS) to accommodate data transferred to equities. The DTCC’s Automated Customer Account Transfer Service (ACATS) will also need new connections to cost basis systems even though it offers connections to back office platforms, Bentsen says.
There are also new rules that govern transfers that are gifts or inheritances, which will require the transfer group to work closely with the legal department, Bentsen adds. In addition, if a firm needs to transfer a portion of an account, it can use standard methods or apply the customers’ specifications.
“A lot of firms have to modify their entire systems,” Bentsen says. “It’s deep in the woods.”
The situation parallels the options symbology initiative that required firms to revamp back office systems by 2010 so they could read the extra symbols applied to options instruments. “The same thing applies here. Systems that process and batch were not looking for certain codes that are now affiliated with trades because of cost basis,” Bentsen says. “You’re changing systems or processing programs because those records have been modified.”
The wide-ranging impact of CBR does straddle front, middle and back office systems and silos as it challenges the manner of the processing, Bentsen says. Tax lot selection can be done via the front office, for instance, and introduced later to back office systems. Or it can be done in real time.
However, Routh cautions that it is very difficult to break down silos. Instead CBR “makes the lines between them a little fuzzy. … In a perfect world, everything would be done in one system in house—the back office, books and records, cost basis, tax reporting and all the other stuff would happen magically in one system. Now you have the ownership of those different systems within different groups that feeds that silo environment.”
The firms that make the most of CBR will be those that look beyond the silos. “The smarter firms are thinking about this strategically and are making this data available to clients not just year end but throughout the year,” Routh says.
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