Y2K Plus 10? Cost-Basis Rules Producing Technical Jitters
March 8, 2010
A modern version of the Y2K problem that brought fear to computer users large and small at the turn of the millennium is putting Wall Street on edge.
The potential crisis: How to deal with a proposed tax rule requiring brokers and dealers to provide accurate information on the original cost-basis of securities owned by their customers. And how especially to handle data-intensive wash sales as high-frequency trading churns out thousands of orders a second and millions every day, from a single firm.
If the systems are not set up right, broker-dealers face the threat of fines from the Internal Revenue Service.
And, like with the Y2K bug which threatened to shut down operations whose computer systems could not handle four-digit years, a firm deadline for compliance fast approaches at the turn of the year.
By January 1, 2011, self-clearing and correspondent clearing broker-dealers which custody assets will have to decide whether to replace all or parts of their cost-basis systems. Those systems, typically tied into a firm's core books and records, primarily process corporate actions and wash sales.
Another similarity to the turn of the millennium is that broker-dealers and other custodians affected by the proposal are likely to find their internal IT teams and potential vendors increasingly strained to comply in time.
As a result, an intricate mating dance between the custodians and a limited group of vendors that can address the problem is under way.
Some custodians may develop systems on their own, but most are in discussions with suppliers. Major Wall Street firms including Goldman Sachs, Morgan Stanley, and UBS say they are still exploring options.
Some are confident their systems are prepared, apart from some tweaks when the final rule language arrives.
Fidelity Investment's central operations group, for example, has had a tax-lot accounting system in use across the firm for more than a decade.
Tax lots are the detailed records of all holdings and their tax implications for a specific security in a portfolio. Tracking the purchase date and price enables the investor to decide which shares to sell to gain the greatest tax advantages.
In its National Financial Services correspondent clearing unit, "we're in the process of finalizing some formal documentation that will be issued to correspondent customers to walk them through the details of this legislation and how we're responding to it," said Bob Adams, executive vice president of Fidelity's internal operations and service group that services the technology needs of the giant financial services firm's various business units.
Broker-dealers who have less confidence in their cost-basis-reporting abilities and may need to pick a system from a vendor should decide quickly. Once a critical mass of brokerages starting signing contracts, and especially the big boys with hundreds of thousands and even millions of accounts across multiple business units, the vendors are likely to begin closing their doors to latecomers.
The vendors range from brokerage-processing powerhouses such Broadridge Financial Solutions and SunGard Data Systems to tax-focused GainsKeeper, a division of Wolters Kluwer Financial Services, to boutiques like G2 Systems LLC.
The vendors contacted by Securities Industry News unanimously said they are hiring project managers and other staff to accommodate the anticipated rush. And they all acknowledged the likelihood that latecomers may be unable to implement and test systems by the start of the year.
