Mandatory reporting guidelines apply to both investment management companies and brokerages. While fund companies are not singled out specifically, security-specific rules and the current state of cost basis offerings create unique, often challenging, problems for mutual fund companies - starting with wash sales and lot relief methods, for instance. Fortunately for investment management firms, legislation doesn’t impact pure mutual fund providers until Jan. 2012 (firms with brokerage arms will be required to cover equities beginning in 2011). 2012 may seem like a long time from now, but considering all the changes basis reporting requires, that effective date is a lot closer than it seems. More over, there are many reasons that investment management firms may not want to wait any longer before implementing a cost basis solution.

Historically, mutual fund providers have used Average Cost as the default lot relief method (LRM). The legislation requires that firms support any lot relief method desired by investors.  This presents two challenges for investment management firms:  the first is the business logic required to support FIFO and Specific ID. Legacy systems that were only designed to support average cost will be very difficult to modify in such a way to efficiently support other LRMs. In most cases, the results will be systems which require substantial manual (e.g. expensive) support. The other issue, which is often over-looked, but can be very difficult to resolve and will actually change the nature of the relationship between firms and shareholders, is addressing the requirement that shareholders be allowed to select the LRM of their choice. Satisfying this requirement means opening a communications channel with the shareholders. If this is executed poorly, the result is a confusing and unsatisfying experience for clients and a costly exercise for firms.

Another consideration for introducing a cost basis solution well before 2012 is that clients will begin receiving adjusted cost basis data from their brokerages in 2011. This means customers will receive tax reporting assistance, in the form of adjusted cost, from their brokerage, but not their fund company. At a minimum, this will lead to client confusion and a spike in help desk traffic; but in some cases, it also could result in dissatisfaction leading to a shift in assets. Those companies that introduce cost basis systems next year will not only  get ahead of the legislation, they will be perceived as innovators within the industry and potentially be rewarded with in-flows from firms that are slow to respond.

The bottom line is that investors have always struggled with tax reporting. Mandatory reporting or not, providing adjusted cost basis to shareholders improves the overall investment experience and increases customer loyalty.

One leading investment management firm that has already moved to tackle the cost basis challenge is Vanguard, which recently selected Scivantage Maxit to track cost basis for its client base.  By addressing the basis reporting challenge now Vanguard once again has distinguished itself as an innovator among peers.