Press Coverage

Survey: Firms Unprepared for New Cost Basis Rules

October 16, 2009

By Luisa Beltran

Most financial services firms, including fund companies, are still at the drawing board when it comes to complying with a new cost basis reporting law.

That's according to a recent survey out from Celent, a Waltham, Mass.-based research and advisory firm. The survey found that although most firms have done considerable research to comply with the new cost basis regulation, many have not yet begun to implement a solution or even allocate a budget to address the issue.

Indeed, the survey found that a majority, or 84%, of financial services executives questioned said they have conducted some research or attended a conference on the new law, known as H.R. 1424. But only 12% said they had a solution in place.

More importantly, 75% of survey respondents estimate that it will take at least 13 months to make the needed changes to comply with the law. However, only 16% of executives have allocated some budget to cost basis reporting, the Celent survey said.

That worries David Easthope, the author of the study, who says financial services firms are underestimating the amount of time needed to comply with the new regulations.

Fund groups need to be in compliance by Jan. 1, 2012. Brokers need to be in compliance by Jan. 1, 2011. While that may seem a ways off, most agree that annually reporting the adjusted cost basis for mutual funds to shareholders and the Internal Revenue Service will require massive upgrades to recordkeeping and accounting systems.

Further, firms are still awaiting promised guidance from the Internal Revenue Service, but delaying action until that happens could be a mistake, says Easthope.

"They need to have a solution in place by the end of 2010 at the latest," he says. "The industry, particularly the broker-dealers, shouldn't wait for the IRS guidance. Many are waiting for the IRS to tell them specifics on what they should do. We don't think that's wise."

H.R. 1424 was adopted in November 2008 and imposed new reporting requirements for broker-dealers and fund firms. The new rules require that firms provide cost basis information to customers and the IRS when securities are sold.

Cost basis - which is the original price of an asset - is used to calculate capital gains or losses for tax purposes. Where cost basis can get complicated is in how it is calculated. There are several different methods to determine cost basis, and investors can choose whichever method gives them the best tax treatment.

"In some segments of the financial services industry, there has been a slow realization that mandatory cost basis actually has an impact on their products," says Jeff Naylor, Sungard's president of business development and industry relations.

Cameron Routh, senior VP of strategic products at Scivantage, says that most firms do not have the expertise to understand the complexities of cost basis compliance. Traditionally, brokerages and mutual fund firms have not had a position that specifically deals with cost basis, Routh says. "There isn't that individual in the firm that is making the case to create the budget," he says. "So firms are late to the process. They aren't involving enough people and they're not creating a budget."

Twelve percent of respondents said they already have a solution in place, while 18% plan to have a clearinghouse or custodian manage the requirements. Another 8% plan to buy a compliance plan, 12% said they will build it and 16% expect to use a combination of buy and build. Meanwhile, 29% said they are not sure what they will do, Celent says.

Deanna Flores, a principal with KPMG's national tax practice, says the low level of implementation may simply be due to the survey's timing. Celent, in conjunction with Wolters Kluwer Financial Services, interviewed 175 executives from the financial services sector over the summer. The size of the firms ranged from more than $15 billion assets under management to less than $1 billion, Celent said.

"A lot of folks with 2011 deadlines were getting their budgets approved in summer 2009," Flores says.

Companies with a 2012 deadline wouldn't have allocated a budget to the project during that summer for that deadline, she says.

Still, many pointed to the IRS as one of the main reasons firms are unprepared. "We are waiting on the IRS and Treasury to issue very important guidance," Flores says. "That guidance isn't out yet."

"There is still some degree of uncertainty about what the final IRS regulations surrounding mandatory cost basis reporting might be, and some have cited this uncertainty as a reason for inactivity," Naylor says.

Cost basis guidance is still being developed by Treasury and the IRS, says an IRS spokeswoman, who declined to give a timeline when the agencies would issue their long-awaited recommendations.

Regardless of the reason for the delay, Scivantage's Routh says that many firms are unrealistic about how quickly they can comply with the new rule. Some firms, he says, believe they can add some "bells and whistles" and they will be in compliance with H.R. 1424. Routh is also not in favor of firms' modifying their existing systems with an internal build or outside vendor. "All cost basis calculations should be done on a single system," Routh says. "It's very difficult to retrofit an existing legacy system."

Scivantage owns Maxit, which tracks and calculates adjustments to cost basis for clients and the IRS. Wolters Kluwer, which conducted the survey with Celent, owns GainsKeeper, a rival of Maxit.