The Final Straw of Corporate Actions Reporting

Ivan Schneider, Writer, specializing in financial technology | 1/24/2013 | 8 comments

Ivan Schneider
What would it take to get issuers of securities to adopt standards-based automation to reduce risks and costs across the entire securities industry? Although the brokerage industry may be wary of asking the government for anything these days, perhaps a push toward standardization would be welcomed.

Brokerages and custodians who manage customer assets on the brokerages' behalf have a critical role in managing the information flow between issuer and customer.

Yet from a data management standpoint, the link between broker and customer is much stronger than that between broker and issuer. Brokers know very well their customers' portfolios, preferences, and plans. By contrast, brokers tend to be in the dark when it comes to figuring exactly what corporate issuers are planning or doing. For that they rely upon market-data intermediaries to capture, scrub, and distribute corporate actions data after it's released to the public in whatever idiosyncratic format the issuer chooses.

Internally, brokerage and custodian IT departments have to implement solutions that consistently cross-reference corporate actions data against their own holdings to figure out who's affected, and then respond accordingly. As an example, suppose a company makes a rights offering where existing shareholders have to decide whether to buy in or not. The custodians and brokers in the middle have to notify anyone who holds that security of the offering, request and capture their election choices, and execute on same.

If the brokerage fails to give the notification or makes a mistake, they're liable for resulting losses and damages. Furthermore, a broker is more than likely to pay up without a fight just to preserve their reputation, even if the error was attributable to a custodian, data provider, or the issuer.

Making the situation even more fraught with peril, recent tax code changes require every broker to maintain a complete dossier on every covered securities sale involving a US taxpayer, taking into account all relevant corporate actions.

Under rules that took effect last year, securities brokers are now responsible for reporting to the IRS the tax status of the sale of covered securities, which include most corporate-issued securities that a US taxpayer might own, including shares in foreign companies. Previously, brokers just had to report the gross proceeds of a sale. Now, brokers have to record, calculate, and report to the IRS the customer's adjusted basis for each sale, whether the gain or loss was short-term or long-term, and any customer instructions provided. With this requirement, the IRS has a way to cross-check what taxpayers are telling them with what their brokers are reporting.

Furthermore, the IRS has also told securities issuers that they must also file a new information return, Form 8937, to report anything that affects the basis of securities. This prevents brokers and their customers from conspiring to cook the books. The IRS will receive information from three sources -- the issuer, the broker, and the customer -- and if something doesn't match up, it'll stick out. As a result, we should expect to see higher compliance rates with capital gains tax payments.

The downside is the increased compliance burden on the securities industry.

Corporate actions processing is already an expensive headache for financial institutions, which they then pass along to their customers. On top of that, brokers now have to quiz their customers on each security in their portfolio, maintain that information for tax purposes, make corrections as needed, and provide extensive reports to the tax authorities. That's a hefty added responsibility with no discernible commercial advantage.

To comply with the IRS reporting requirement calls for an investment in IT and legal support, giving the largest players a scale advantage to the detriment of smaller players. From this, we might expect lower levels of competition in the securities industry, and therefore higher prices to investors.

Adding insult to injury, there's a good technological fix at hand that isn't being adopted fast enough. If issuers of securities were to start sending corporate actions messages using the industry standard ISO 20022 messaging format, everybody touching those securities would benefit immensely from increased efficiency and lower cost.

Yet there's not a strong-enough incentive for issuers to conform to a financial industry messaging standard. The issuers call the tune and everyone else dances. It would be quite a trick to convince CFOs worldwide to pay for ISO 20022 encoding out of their own budgets, even if the total cost is dwarfed by what the securities industry spends collectively on corporate actions processing.

With IRS Form 8937, we have a typical tax form with spaces for typewritten answers, submitted only to the tax authorities, useful to nobody except for the data vendors who get paid to translate corporate actions data into formatted codes.

Instead of requesting paper forms, what if the government required issuers to provide corporate actions data for covered securities in the digital, industry-standard ISO 20022 format? Not only would the IRS receive their information faster, but the entire securities industry would receive some form of belated compensation for having to build an extensive infrastructure to help the IRS catch tax cheats.

Some questions: Is it reasonable for brokerages to take on such extensive reporting requirements? Should issuers have to conform to a certain protocol for corporate actions and other reporting? Or should investors have to pay for the task of scrubbing data? In the comments, let's hear what you think about the intersection between corporate actions and tax reporting for financial IT.

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Ivan Schneider   The Final Straw of Corporate Actions Reporting   1/28/2013 2:22:15 PM
Re: yes no maybe
Mostly (b), with a healthy dose of "what's in it for me?"

When an issuer adopts standards for announcing corporate actions, they don't benefit directly. It's the financial intermediary who saves money, which in turn should help shareholders and bondholders. 

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David Wagner   The Final Straw of Corporate Actions Reporting   1/28/2013 11:47:19 AM
Re: yes no maybe
OK, so can we infer from what you are syaing is that people who are faling to use the standards are either a) wasting their own time b) unaware of the benefits c) trying to hide something in those PDFs?
Ivan Schneider   The Final Straw of Corporate Actions Reporting   1/28/2013 2:23:43 AM
Re: yes no maybe

ISO 15022 does the job currently, and ISO 20022 is an improved version built using XML.  The standards are very general, meant to deal with financial information at a very high level. Yet that's enough to enable machine-automated processing of that information.  

Issuers can already use either of these standards to encode their corporate actions filings, and by doing so greatly simplifying downstream processing. Still, those issuers are equally at liberty to use no standard at all, i.e. a PDF on their website. 

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David Wagner   The Final Straw of Corporate Actions Reporting   1/28/2013 1:49:59 AM
Re: yes no maybe
I'm generally with you, Ivan. But is it reasonable to come up with a standard form for reporting such vast and varied information? I would assume there would be quite a lot of variance from institution to institution.
Ivan Schneider   The Final Straw of Corporate Actions Reporting   1/26/2013 6:45:48 PM
Re: yes no maybe
Hi Sara,

I'm not entirely convinced that the financial services industry is a special case. 

We know that certain transactions have tax implications. Buy or sell a home, buy or sell stock, give money to charity, work at a job for a year, whatever. 

Individuals get to self-report their income tax, and there are places on the tax form where reasonable people can come up with different interpretations (even if there's only one "correct" answer).

That's why the IRS confirms what you self-report using information requested from businesses, such as Forms W-2, 1099, and so on. Brokerages' reporting requirements are an extension of what other businesses are required to report. 

It stands to reason that brokerages, by nature of what they do, have an important role to play in tax compliance by keeping track of their customers' cost basis for items held in their portfolio. In the old days, I might transfer a big portfolio containing all manner of financial instruments from one place to another, and the broker on the receiving end would have no information about how much that portfolio cost me to acquire. Now, that same brokerage would have to request and record the cost basis for each item. I suppose that's not the hardest thing in the world to implement -- perhaps another few columns in a database table, with some workflow revisions on portfolio intake.

Yet the other part of the compliance requirement is that brokerages keep those cost basis calculations up-to-date using information sourced from a world of issuers, i.e. anyone issuing securities held by U.S.-domiciled investors. That's a lot harder than just recording what the customer tells you about cost basis. To comply with that mandate, the brokerage has to subscribe to some service that finds, scrubs, and normalizes corporate action data, and then applies that data to internal records on a near-real-time basis. Because there's no standardization of issuer data, that's an expensive service. 

Stepping back for a second, we see that the government has exercised its power to compel an entire industry to subscribe to an expensive information service in order to improve tax collection efforts. That's what's exceptional about the financial services example.

However, if the government requires a private entity to supply its tax authorities with information compiled from third-party data, shouldn't it at least make sure to minimize the cost of gathering that information?

That's why I believe securities issuers should be required to provide the public and the financial services industry with information about corporate actions in a standardized, machine-readable format. Only governments have the power to compel participation in industry standards for corporate actions, and as a matter of policy, it's fair compensation to the securities industry for having been deputized as tax enforcers on their behalf. 


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KeithGrinsted   The Final Straw of Corporate Actions Reporting   1/26/2013 5:57:18 PM
Re: yes no maybe
The issue here seems to the bystander to be one of a policy / procedure that has developed over time with various add-ons resulting in a complex over-burdened process.

It sounds as if the entire system could do with a complete overhaul with proper checks and balances established and with reporting procedures that reflect the technology of today.

OK, technology is changing so rapidly that today only runs to midnight and tomorrow brings another batch of challenges.  But there has to be a line drawn somewhere.

When I was running an SME a few years ago I adopted the policy of reviewing every process in the business every 12-18 months.

I simply asked the question - If we were starting up in business today, knowing what we already know, would we still do 'x' or 'y' this way?  Or would we devise a different process, form of paperwork, system, whatever?

Many businesses could do with adopting this process.
kicheko   The Final Straw of Corporate Actions Reporting   1/26/2013 3:51:14 PM
Re: yes no maybe
Standards make work easier in the long run and give continuity to it because of how independent it becomes of environment and people. on top of that, synchronizing across industry will enable them to collaborate and share data much easier where there are relationships e.g. in the case of reinsurance and such business.
Sara Peters   The Final Straw of Corporate Actions Reporting   1/25/2013 5:51:22 PM
yes no maybe
You ask a lot of difficult questions, Ivan.  "Is it reasonable for brokerages to take on such extensive reporting requirements? Should issuers have to conform to a certain protocol for corporate actions and other reporting? Or should investors have to pay for the task of scrubbing data?" Extensive reporting is never fun, and often unnecessary -- however, in financial services I think that reporting is more necessary than in some other kinds of businesses. Should issuers have to conform to a specific protocol? Maybe not, but maybe it would be easier if they did have a standard to follow.

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