Q & A: Cameron Routh, Senior Vice President, Managing Director of Strategic Products at Scivantage

Although few tend to look forward to tax season, this year’s cost basis reporting (CBR) rules definitely won’t make this time of year any more appealing. Cameron Routh, Senior Vice President, Managing Director of Strategic Products at Scivantage, talks about what brokerages should expect, how they can deal with the influx of investor requests and how the Cost Basis Reporting Assessment (CBRA) Program can help alleviate many of the concerns.

Q: Now that we’re in the middle of tax season, what should brokerages be focusing on?

A: In terms of cost basis, there is so much going on that is difficult to suggest focusing on one thing. Firms are still cleaning up CBR Phase 1 (equities), mutual funds just went into effect, we’re right in the middle of the first tax reporting season of the CBR era, and planning has started for fixed income and options (Phase 3). While brokerages need to work on all of those projects simultaneously, one area that shouldn’t be over-looked is the internal communications about 1099 corrections. For the remaining few months of this tax season and for the next several years, in fact, there will be a significant volume of 1099 corrections compared to what we’ve seen in the past. January trading activity that triggers wash sales in the previous tax year is one reason. Income reallocation is another. In fact, any change that impacts the cost basis being reported on 1099s will result in corrections. Cost basis reporting regulations require that firms do corrections for three years. So if a client transfers a security from another firm and the security was purchased after Jan. 1, 2011, the other firm is responsible for providing cost basis to our client. A few years from now, that other firm may realize it made an error and issue a correction to the client.

Q: 1099s are in the process of being sent out at this very moment. Is it too late to do anything else to ease this tax season?

A: Between the end of January and April, firms really need to focus on education and proper management of expectations, both internally and externally. This includes educating investors so they know why they’re getting the 1099, what is cost basis, why the IRS is receiving this information, what went into the calculations, what is a wash sale, what are the rules around transfers, what happens in a correction. Don’t wait until a client comes across a correction; managing expectations and educating the client, will reduce confusion and angst for those investors who do receive corrections. And there will be a lot of corrections this year. However, it’s important not to overwhelm the investors. Tell them enough to let them know what to potentially expect, including the negative aspects, which is important. But stop short of using overly technical explanations.

Q: What behavior should firms expect from investors?

A: This year is the first year that investors will receive cost basis in their 1099, which will immediately trigger red flags and a lot of calls to the help desk asking questions like “why is my information being provided to the IRS?”. Investors tend to be very protective about trading information and so even when the data is correct, firms are going to have to field calls from agitated investors. This is one of the reasons we encourage firms to get ahead of the game in terms of education – not just simple FAQ about cost basis, but really getting through the details of why and how it works.

Q: What other issues are you anticipating firms will face?

A: There will be a lot of corrections to the 1099s this year. For starters, this is the first year of the cost basis reporting regime. Change always leads to errors initially. Also, a lot of data was not available when firms generated their initial 1099 extract. For instance, wash sale calculations require 30 days past the disposal of the security. For example, if I sell something for a loss on Dec. 27th and I buy it back on Jan. 25th, that’s after firms have sent their data to the 1099 print shop. My brokerage will have to issue a correction to state the cost basis correctly on my 1099. Similar problems result for income reallocation, which generally also occurs after the initial tax extract.

Q: What can firms do to lower the number of corrections or the cost of the help center? What are you advising your clients to do now?

A: There are several things they can do. As a cost basis vendor, we help clean up the data, we help identify position breaks, corporate actions that weren’t processed correctly or the data was wrong or missing or incomplete. This reconciliation process occurs year-round. But during tax season we apply additional scrutiny on activity which has an impact on the current tax season. We can help clean up that data and reprocess it. Any number of transfers will impact cost basis, so we can help with all those things, too.

But it’s still the client’s data, so they’re going to have to do a lot of work on their side. They’re going to have to look at their books and records, and not just look at the data. They also have to look at back office processes. Back office systems were not designed with cost basis in mind. And the policies and procedures used to support those systems were also developed independently of current cost basis reporting rules. Reviewing these procedures and making cost basis “friendly” changes will go a long way to ensuring that data which is passed to the cost basis system is as clean as possible. One last recommendation is to manage internal expectations. Until this year, corrections were only necessary when information on the securities sold changed. This year, and going forward, corrections will be required not just for changes to closing transactions, but also opening activity for covered securities, income reallocation, wash sales, incorrect lot selection, or virtually anything else related to cost basis.

Q: Does the Cost Basis Reporting Assessment (CBRA) program, in partnership with Jordan & Jordan, offer a template for brokerages looking to educate their investors?

A: The CBRA program provides a few tools in this area. It does include some facts and some basic concepts that we feel are important for investors and brokerage employees to understand. In addition to the basic concepts, the CBRA process itself will stimulate self-evaluation that will generate additional ideas for education. CBRA also provides a number of check points that instill confidence that everything is included, which is important because there’s a fear of the unknown here.

Q: What can be done about employee concerns?

A: When we talk about the need for education we’re principally thinking of investors. But it’s also critical to manage expectations internally. Brokerage professionals who have been doing 1099s for years may think they know 1099s, but this is a whole new ball game this year with the addition of cost basis data on tax documents. Any metrics that were used to gauge tax reporting in the past go out the window here because everything changes. There shouldn’t be expectations that this tax season is going to be flawless. However, once the executives understand that, they’re half way to keeping things calm through April.

Q: What do brokerages need to look out for when reviewing the CBR processes?

A: In addition to the education, the key element here is that the focus for most firms has likely been primarily on technology. But firms haven’t looked as closely at operations processes, which can lead to bad cost basis calculations. They have vetted the technology, but they haven’t vetted the entire process, including how the data integrates with other systems, and that’s where the CBR assessment really comes in handy, it looks at the process end-to-end and identifies opportunities for improvement.

There is a technology component to the assessment, of course. But the CBRA program we have developed in partnership with Jordan & Jordan is more focused on operations issues and data questions. It’s about evaluating the processes, front-to-back, in a holistic way. Firms have the ability to improve their processes, which will help reduce cost, eliminate redundant activities and improve efficiency not just in the CBR procedure, but companywide, as well.

It’s not always black or white; sometimes there are different grades of response that CBRA provides to help firms identify what areas they can improve. It’s not that they’re failing; there are just some areas where they can do better. The CBRA can also help justify additional resources internally. If it’s clear that additional work has to be done, it helps the manager justify the request for more people or technology.

Q: What is the benefit of outsourcing your CBR processes assessment versus doing it in-house?

A: Everybody is resource constrained and I don’t know a firm yet that doesn’t look at cost basis reporting as anything but a cost center issue. Firms don’t have a lot of extra staff that they can assign to assess the cost basis reporting processes, especially when everyone is busy during tax season. Most firms are woefully low on staff as it is. Also, it’s helpful to have people come with a broader perspective on cost basis, as well as bringing experience with the assessment itself. This results in a clear understanding of the questions and what types of responses the assessment is looking for.

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