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Saturday, January 16, 2010

New Investor Tax Rules on the Way

Adapting to new rules for cost-basis tax reporting.

THE INTERNAL REVENUE SERVICE IN mid-December issued proposed regulations on cost-basis tax reporting. Under the measure, brokers would be required to report to the government the cost of equities sold by their customers in 2011. For 2012, they’ll have to report similar information about mutual-fund sales and, in 2013, options and fixed-income cost bases. At present, the cost basis of transactions is communicated only to clients, who are responsible for reporting it to the IRS. The comment period on the proposal ends on Feb. 8.

Investors who use online brokers have long complained to us that they have trouble getting accurate cost-basis information from the firms. So will the industry be ready in time to comply with the measure?

Even though the deadline for options is a little further off, figuring transaction costs there will be a particular challenge.

The new IRS rules will change the dynamics between investor and financial institution, says Cameron Routh, senior vice president of strategic products at Scivantage ( His company’s Maxit enterprise application provides real-time cost-basis and tax-based investment decision support to help financial advisors and individual investors minimize tax liabilities and increase after-tax performance. Several online brokers we cover have installed Maxit in their back offices, including TradeKing, Options- House and

“Not only is the firm going to be reporting your cost basis to you, but they’ll also be reporting it to the IRS,” says Routh. “Some [investors] might blame the broker for reporting private info; firms are going to have to educate their customers.”

Every firm eventually will introduce its own solution. Scivantage, obviously, is encouraging its online brokerage customers to get an early jump by installing the technology that would let them meet the IRS requirements now. Routh believes that getting on top of cost-basis reporting will help retail investors, and improve the investment experience by offering pre-trade tax analysis, portfolio analysis, tax tools and other applications, to leverage cost-basis tracking.

Scivantage’s Maxit competes with Gainskeeper (, which is offered to investors through online brokers including Firstrade, Zecco and optionsXpress. Gainskeeper is also available directly to investors, who can import their transactions and run the necessary reports. Maxit doesn’t have a retail version for traders, but we wouldn’t be surprised to see one in the next year.

Frequent traders already have to report wash sales themselves. These transactions are triggered when one sells a holding at a loss, and purchases it (or something that is substantially the same, like a similar ETF) again within 30 days. The loss on the sale is disallowed, though you can add it to the cost basis of the new purchase. The changes in the IRS rules place a new burden on online brokers to track and report wash sales, including a detailed list showing each sale on a single line. Some active traders generate thousands of wash sales per year.

The complications of wash sales can lead to accounting nightmares if you have to make all the calculations on your own. Some online brokers report wash sales if you make the transactions on their Website, but the wash-sale rules apply even if, for example, you sell a stock at E*Trade and then buy one that is considered substantially the same at Charles Schwab.

Traders who opt to change their accounting method from cash basis to mark-to-market aren’t subject to wash-sale rules. But they open themselves up to a great deal of additional scrutiny. Mark-to-market traders are few in number and require heavy-duty tax software that can’t be found in the usual mass-market products. We recommend Armencomp’s TradeLog MTM ( for these hyperactive traders.

WE’VE GOTTEN A STEADY STREAM of reader e-mails responding to our recent plea for input about online brokers for our coming annual review. We’re still open to any thoughts you can offer.

If you’ve been using an online brokerage account over the past year, please drop us a line at . Thanks.

Published in Barron’s, January 11, 2010. 

Posted by twcarey on 01/16 at 12:12 PM
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Tuesday, July 14, 2009

SEC Chair says staff will "explore transparency issues" regarding Dark Pools

An excerpt from SEC Chair Mary Schapiro’s testimony before the United States House of Representatives Committee on Financial Services
Subcommittee on Capital Markets, Insurance and Government-Sponsored Enterprises.  Her remarks are entitled, “SEC Oversight: Current State and Agenda,” and were delivered Tuesday, July 14, 2009. 

"In addition, our staff has begun exploring transparency issues related to markets known as dark pools. Dark pools are defined in various ways, but generally refer to automated trading systems that do not display quotes in the public quote stream. We have heard concerns that dark pools may lead to a lack of transparency, may result in the development of significant private markets that exclude public investors (through the use of “indications-of-interest” that function similar to public quotes except with implicit pricing), and may potentially impair the public price discovery function if they divert a significant amount of marketable order flow away from the more traditional and transparent markets. Given the potential risks posed by dark pools, the Commission will take a serious look at what regulatory actions may be warranted to respond to the potential investor protection and market integrity concerns that dark pools may raise.”

I’m pleased to see that the SEC will be checking out dark pools with a focus on transparency.  My main concern about these pools is that their existence removes a great deal of liquidity from publicly displayed venues, which may be resulting in incorrect pricing. 

Good luck, SEC and Chairman Schapiro. 

Full testimony at

Posted by twcarey on 07/14 at 11:39 AM
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Sunday, March 15, 2009

Scoring Rubric -- Best Online Brokers

This is a sidebar I wrote for the Best Online Brokers piece that I hoped would run online, but it’s not there.  I’m getting a lot of questions along the lines of, “Where did those scores come from anyway?” so I thought I’d explain in more detail.


Trade Experience:
Working with a live account, we looked for a real-time quote and executed equity trades during market hours, making market buys and limit sales of a stock or exchange-traded fund. A real-time quote that is displayed without any additional user input (such as typing the symbol into a separate box or hitting a “Quote” button) receives credit here; if the trader has to make a duplicate entry of the ticker symbol to get a quote, the broker got zero.  Following the market buy, we tracked the execution and portfolio reports. We looked for pre-filled order tickets when selling a position, which eliminates possible errors during the closing process. After entering a limit-sale order, we examined the open-order reports and looked at ways to check the progress of the order, as well as ways to adjust the limit price or cancel the order. We also placed options orders, using options’ order-entry screens when available. We also examined mutual-fund, bond, and (when available) futures, commodities and foreign-exchange order-entry screens.

An overall score of 5 in Trade Experience means the order entry-and-execution process flowed easily from one step to the next, with real-time information (including buying power and margin balance) available when needed.

Trading Technology: The availability of price-improvement strategies and smart-order routing technology (which finds the best bid or offer) were necessary to earn a 5 in this category. Brokers offering price improvement—a sale above the bid price, a buy below the offer—received a fraction of a point depending on the portion of their transactions that benefited. Top marks were earned by brokers who offered a wide array of order types, including conditional orders. The ability to place a trade from a graph earned a fraction of a point. In addition, we looked for ways to customize the trading experience, such as setting a default number of shares or contracts, to speed order entry.

Usability: A 5 here means the site or program was easy to use and well-designed, didn’t bog down when moving from screen to screen, and can be tailored to the user’s needs. Constant availability of a trading ticket, and easy access to research and account status data is key. This year, we also looked at the account setup process and assigned up to a point for brokers that made it easy to open an account online and start trading. 

Range of Offerings: We awarded points for the diversity of investments that can be traded online, with partial points given for those that can only be traded offline. Since all the brokers allow long and short stock-trading, as well as single-leg options orders online, we don’t award points for those transactions. We asked brokers how many stocks, on average, their customers can sell short, and awarded up to a half-point based on their answer. Complex options trading, and the availability of mutual funds, bonds, futures, commodities and international trading were also considered. A 5 in this category means you can execute all of these transactions online.

Research Amenities:
This category measures the quality and accessibility of research, quotes and charting. We looked for research, news and charting linked to a customer’s portfolio and watch lists; the quality of third-party research and its integration with the rest of the site; and the availability of screeners, with special emphasis on options-strategy screeners. Brokers also won points for offering real-time streaming quotes at no additional cost, powerful charting capabilities, and Level II quotes.  Partial credit was awarded for features that generated an extra fee. 

Portfolio Analysis and Reports: The emphasis here is on clearly laid-out reports, updated in real time, showing current balances, positions and margin status. Portfolio-analysis reports, with links to news and research, as well as extensive transaction history, are most desirable. Tax reporting also falls in this category. Full credit is given for reports that can be created on the broker’s website, with no additional fees or data entry required.  Partial credit is awarded to brokers that populate services such as GainsKeeper and Maxit (tax analysis and reporting programs) for an additional fee. 

Help and Customer Access: We sized up online help such as live-chat capability, user guides and frequently-asked-question files. Offline help was assessed by making calls to customer service, and weighing the brokers’ reports of the average time spent on hold when a customer calls in. We took a look at the education offerings, both online and live. The ability to visit a broker in person, and to access the account via a mobile device, is taken into account here. This category also considers the rate a broker pays for a customer’s cash.

Costs: We looked at commissions for stock and options trades and margin interest rates, giving more points for lower costs. We scaled the points awarded so that the lowest costs in the group earned the maximum number of points, with fractions (and occasional zeros) given to the more expensive brokers. Stock commissions are the biggest factor here, but options and mutual-fund transaction fees are also considered. A 5 could be earned here by very low stock and mutual-fund commissions, less than $7.50 for 10 options contracts, margin interest rates below 3%, and no account-maintenance fees.  This year, we weighted the options transaction fees higher than in the past, and reduced the points awarded for low margin rates due to the lower use of trading on margin. 

Posted by twcarey on 03/15 at 04:16 PM
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