Cost Basis for Stock Transfer Agents – A Year Later

January 1, 2012  marked the first full year stock transfer agents in the U.S. had to capture  additional “cost basis” information on shareholder transactions and related  record keeping pursuant to Section 403 of H.R. 1424, known as the Emergency  Economic Stabilization Act of 2008.   It  was a challenge to implement in 2010 and 2011, and will be a continuing  compliance challenge in 2012 and beyond.

Agents  are now recording stock purchase price (cost basis), and the “tax lot” of the  stock so as to identify exactly which stock (lot) is subsequently sold.   When that stock is sold, the transfer agent has to report cost basis information to  the IRS and the shareholder via a newly formatted 1099B.   The new information reveals the time the  stock was held as well, so it is clear whether a short or long-term gain was  enjoyed by the shareholder, and thus what kind of tax is owed.   While shareholders have been required to report all this historically, it was felt that “less  diligent” citizens were not properly complying – to the tune, allegedly, of  $6.67 billion in under-paid taxes per  year, a figure many consider inflated.    The new law was therefore imposed to increase disclosure responsibility for  stock transfer record keepers.

Routine  transfers became subject to these new rules as of January 1, 2011.   DRIP and Direct Stock Purchase Plan (DSPP) shares  – and mutual fund shares – became reportable on January 1, 2012.   Options and debt securities will fall under  the new rules on January 1, 2013.

The  most challenging part of cost basis for transfer agents so far has been…

Choice of shares sold – meaning, the IRS  allows a shareholder to choose whether shares sold, and therefore the cost  basis, are FIFO (first in/bought, first out/sold), LIFO (last in, first out),  HIFO (highest-priced shares bought, sold first), LOWFO (lowest priced shares  bought, sold first), specific share lots sold first or, for DRIPs/DSPPs,  electing average share price over time.   These  different permutations add meaningful complexity to the stock transfer process.

Wash sales – capturing whether a stock was sold  (at a loss) and then re-purchased within 30 days, which disqualifies the sale  from being accountable by the shareholder as a loss.   This gets really complicated with DRIP/DSPP  plans, when dividends are reinvested between the purchase and sale date; or,  when there are multiple additional investments of cash in the plan that need to  be tracked to multiple additional sales.

Corporate actions – adjusting records  when the issuer buys another company for stock, at a particular share-for-share  ratio.

Transfer agent/broker “mismatches” – transactions  requiring research and phone calls to resolve discrepancies, usually where brokers  do not use the Depository Trust and Clearing Corporation’s Cost Basis Reporting  System (“CBRS,” often pronounced “sea breeze”).    CBRS minimizes out-of-balance transactions because it is completely  electronic, and automated.

Interpreting transactions presented by  non-brokers – where extra work is needed to ensure proper treatment has been applied to share  gifts, private sales and inheritances.

Getting ready to handle more shareholder  inquiries in 1Q12 – when investors get their newly formatted 1099 forms, showing cost basis  information for the first time.

Can  transfer agents handle all this cost basis “drama”?   Yes, indeed.    Since over 90% of listed public companies use transfer agents that each  serve more than a million registered shareholders (and we are including the  likes of SunGard which provide stock transfer record keeping software to  companies serving as their own transfer agent), there is operational and  technological scale available to get  the job done.   Put another way, most  large transfer agents already had the staff and expertise on hand to implement  the new cost basis requirements, without having to hire extra people  (temporarily or permanently) or pay overtime to existing employees.   Does that mean no outside help (IT, Legal) was needed for implementation, and that  ongoing compliance is easy?   Not at  all.   It was hard, and compliance  continues to be so.   But qualified  resources are in place, and they are dealing with cost basis admirably.

We  put out some feelers out on the approximate “cost of cost basis” to transfer  agents and, for implementation, we heard – very roughly – $.50 to $1.00 per  registered shareholder; and, for ongoing compliance, $.25 to $.50 per  registered shareholder per year.   The  actual numbers are impossible to determine precisely, and vary by agent  depending on client base and staff size.    Offsetting these transfer agent costs over time, though, are: 1) growing  experience with cost basis, 2) more and more automated services to shareholders  via book-entry and internet functionality, and 3) the previously-mentioned  operational scale that will grow as transfer agents decrease in number faster  than the population of registered shareholders does itself.   (Note:  Companies who paid a lot more than $1.00 per registered shareholder as a cost  basis “assessment” in 2011 should pause and reflect on the fact that transfer  agents who did make such assessments could not, as a practical matter, have  charged a 750,000 registered shareholder company $750,000, and a 500  shareholder company $500.   They  reasonably needed to squeeze the assessment amounts into a “middle  ground.”   Having said that, there was no justification for transfer agents  charging “willing companies” a lot, to make up for some of their clients refusing to pay very much, if anything.)

Like many new developments in the stock transfer  industry that we have discussed in recent years, cost basis is here to  stay.   How it fully manifests itself may  take time, however, and we hope you will check this website periodically for  updates.