Investor Brain

Saturday, May 17, 2008

New Tools for New Cost-Basis Reports

IT WON’T BE LONG BEFORE CONGRESS MANDATES THAT YOUR BROKER tell the Internal Revenue Service the exact cost basis of securities you’ve sold. The move, designed to help pay for new federal programs—such as those aimed at the housing crisis—will not only increase scrutiny on investors, but likely sharpen a budding competition between two software companies that make tax-aware portfolio-management software.

The House Ways & Means Committee recently passed the Housing Assistance Tax Act, which includes a cost-basis reporting measure that could bring in $8 billion in tax revenues annually. “You do things to help housing, and you have to pay for part of it with cost-basis reporting,” says Stevie Conlon, tax director at investment-software specialist GainsKeeper. Ways & Means’ passing a bill with that provision puts it on “an express train to passage.”

If passed, the law would require tighter cost-basis reporting for positions that are closed in 2009. The compliance dates would be Jan. 1, 2010, for stock, Jan. 1, 2011, for mutual funds, and Jan. 1, 2012, for debt and other instruments. Investors are supposed to report the cost basis for their sales now, but the new measures would tighten scrutiny and impose penalties for mistakes.

Given all the headlines about subprime mortgages, Conlon thinks there’s a high likelihood the measure will become law.

Cost-basis reporting was also a funding mechanism in the farm bill that has a May 16 deadline for passage. Only one bill can legislate it, so the existence of two makes new, stricter rules that much more likely.

Conlon says, “There is likely to be pressure from different groups in the financial industry to make some changes, especially from mutual funds.” For instance, she expects that effective dates could change, as well as what kinds of holdings—for example, stocks, commodities, derivatives—the new reporting requirement will cover.

WHATEVER ITS EVENTUAL SHAPE, the measure will further stir a new rivalry. For years, the only game in town was Conlon’s employer, GainsKeeper, published by Wolters Kluwer. It comes in several versions. Earlier this year, upstart Maxit was rolled out by publisher Scivantage. Intriguingly, a cofounder of GainsKeeper, Cameron Routh, was hired away by Scivantage last year, leading to a fierce marketing war and behind-the-scenes legal kerfuffles.

GainsKeeper was first offered as a Web destination. Customers signed up for an account, then imported their brokerage transactions. Now the firm offers an enterprise application to brokers that integrates with their Websites, allowing clients to use GainsKeeper while logged into their accounts.

GainsKeeper is integrated into online brokers like TDAmeritrade, Scottrade, E*Trade Platinum and ShareBuilder, where customers get it for free. OptionsXpress clients can set up a GainsKeeper account for $24.95 per year, while at Zecco, it costs $24.99 every six months. This summer, Firstrade is expected to offer it, too.

Other firms offer a link to the retail version of GainsKeeper. These include Schwab, Fidelity, thinkorswim, Siebert, Interactive Brokers, AB Watley, ChoiceTrade and E*Trade (for customers who don’t qualify for the Platinum level of service). Using the retail version requires a customer to export transactions to a file that’s then imported into GainsKeeper.

Maxit doesn’t have a consumer version, although its enterprise application is integrated into several newer brokerages. It’s now offered free to customers of TradeKing and Just2Trade. Options- House is in the process of making Maxit available; it expects to roll it out over the summer. Other brokers are expected.

Why does any of this matter to brokerage clients? With the potential for hefty penalties, filing a correct tax return is more important than ever. And GainsKeeper’s and Maxit’s tools help traders reduce taxes, and calculate statistics such as return on investment. It’s also important for frequent traders to correctly identify and report wash sales. Their ability to track ticker-symbol changes and stock splits, is helpful, too.

A company that chose Maxit says it was impressed with how its system reads database files, making portfolio updates in close to real time; GainsKeeper’s methodology involves converting several files, sometimes leading to a reporting delay.

The nitty-gritty of how the two programs deal with the transaction files is most important to the brokers. One executive said that the overall cost (purchase plus operating expenses), ease of integration, and functionality were important to his firm, which opted for Maxit. But GainsKeeper still has more brokers. And their rivalry should aid traders as well as brokers.

Published in Barron’s, May 11, 2008.

Saturday, April 12, 2008

A Bond, A Bear and a Bind

LOOKING FOR MUNIS TO ADD TO YOUR PORTFOLIO? Fidelity Investments has teamed with the electronic bond-trading outfit TheMuniCenter to increase the mutual-fund giant’s municipal-bond offerings by about 40%. Fidelity’s Open Bond Market service, available to customers online at http://www.fidelity.com, contains educational material as well as screeners and other tools designed to make trading of all sorts of bonds more accessible and understandable.

Fidelity’s customers also can now trade Treasury Inflation Protected Securities (TIPS) online at Fidelity.com; previously they could only trade TIPS through Fidelity’s phone representatives or in person at an investor center.

Launched in 2004, the Open Bond Market offers U.S. Treasuries and CDs (certificates of deposit), as well as corporate, municipal, government agency and principal-protected notes. The fees were lowered last year to $1 per bond (subject to $8 minimum); Treasuries can be traded at no cost.

IN THE WAKE OF BEAR STEARNS’ RECENT COLLAPSE, industry analysts worried about the financial stability of the Customer Assets Protection Company, which carries the brokerage firm’s coverage beyond that of the mandatory Securities Investor Protection Corp., or SIPC, coverage. Capco is backed by a consortium of brokers and SIPC is funded by member-brokers. SIPC covers individual accounts up to $500,000, and firms like Capco cover amounts in excess of that. (See “Are You Covered If Your Broker Fails?,” Dec. 17, 2007, and “If Your Broker Goes Belly Up, Part II,” Dec. 31, 2007 for more.) A Bear unit is a major securities-clearing firm and therefore handles transactions for lots of regional banks and brokers. The concern is that any failure would jeopardize these trades.

Standard & Poor’s issued a bulletin on March 19 in which it said that Capco is maintaining its A+/Stable rating, in spite of the claims that may ensue in a post-Bear Stearns universe. Of interest is the rating agency’s assertion that “In the event of an excess SIPC claim related to Bear Stearns, Capco should benefit from a guarantee provided by JPMorgan Chase for Bear Stearns’ obligations. In addition, clients withdrawing funds from their personal accounts actually reduces CAPCO’s potential maximum loss.” (Sentence Italicized by Barron’s.)

As the S&P bulletin spells out, SIPC, and excess coverage like that of Capco, is aimed at restoring missing, lost or stolen accounts. They don’t cover a decline in the market value of a client’s investments.

We’re looking at a problem of market value, which was adversely affected by management choices that turned out to be inappropriate, rather than outright theft. Alas, there’s no insurance against poor judgment.

A BARRON’S READER WHO’S A CUSTOMER OF A MAJOR online brokerage and lives outside the U.S. described an interesting situation via e-mail recently:

“I am a long-time investor who generally purchases shares of undervalued micro-caps that are often thinly traded, which I usually hold for periods of over a year. In recent months, my broker is refusing to allow Internet purchases for many of these companies, requiring me to phone a broker. They are vague about why they are doing this; for legal and security reasons, they say. This requirement has even been in place when I wanted to add to a holding that I originally purchased in an Internet trade, and when I tried to adjust the price of an open order by a few pennies.”

My theory, verified by the broker in question, is that the trading pattern—even though it’s completely above board—resembles that of a crooked pump-and-dump scheme that usually involves stealing an online trader’s identity and then redirecting his account to buy securities at huge premiums that benefit the thief. The broker, in my view, is being appropriately cautious, particularly since this is a ploy often used by overseas scamsters. It may be really inconvenient for an honest trader, which is a terrible drag, but it’s just part of the current reality.

The writer’s broker verified that it monitors securities for suspicious activities and will, from time to time, restrict those transactions until the client phones a broker so that the firm can verify that he or she is in fact a client and not an identity thief. “It is for the protection of our clients that we make these decisions, and while we realize that it can be an inconvenience to them, it is done with their best interests in mind,” says the broker.

More patience—or a change in investing strategy—may be needed.

Published in Barron’s, April 7, 2008

Saturday, March 29, 2008

A Timely Boon for Small Investors

WHEN THE MARKETS ARE MOVING RAPIDLY, WITH THE PRICE OF A stock changing every millisecond, how can you know whether you received the best available price when your trade was executed?

The Nasdaq Data Store has introduced a new program called Market Replay (https://data.nasdaq.com/MR.aspx) that might answer this key question. You can access a demo at the Website, although the program itself isn’t available yet. Eventually, online brokers and retail market-data providers will license this technology and begin offering it to their customers.

Claude Courbois, head of product development at Nasdaq/OMX Data Products, says that Market Replay was born out of a frustrating problem he has encountered as a small investor—executing an order, but finding that he has paid a price that appears to be higher than the current quote.

The question an investor asks himself when this occurs is uncomplicated: What the heck happened? But getting an answer isn’t easy.

The small investor doesn’t have the tools for retrieving quotes at an exact moment. If that person complained to Nasdaq and it agreed to help, Courbois relates, “we would have to pull quotes out of a database and rebuild the order book to figure out when something weird had happened. It was not a user-friendly experience.” He says that the Market Replay system is intended to give people confidence and understanding of the markets—not to catch brokers doing something bad.

To use Market Replay, you enter a stock symbol and a date, then the time you want to examine—for example, 10:15 a.m. The standard replay is 10 minutes of market time, but you can request an hour or a day. The pertinent data get pulled into the program in 10-minute increments; it can take some time to download the information if you try to get a long-time-span record of an actively traded issue. Currently, 2008 trading data for Nasdaq securities are available, and the Data Store is moving backward through 2007.

If the information for a requested date hasn’t yet been loaded, the customer will get a message stating, “We don’t have this data ready yet, but will have it tomorrow morning.”

When the replay is downloaded to your computer, you’ll get a list of available information under the “Replays” menu on the display’s left side. A vertical blue line in the middle of the screen denotes the time requested. A few minutes of additional data, showing earlier and later prices, will be displayed on either side. Users can move forward and backward to the exact time that the trade went through, and take a screen shot that captures the display. Hit “Play,” and you can watch the market move in real time. You can also pause it and play it backward.

The program can also do a time-span analysis by highlighting a range around the time of your transaction that will display the range of prices at the Nasdaq and other exchanges during the specified period. “It’s comforting to be able to prove to yourself that you’re getting the best price. It’s amazing how valuable information is, even if you know the system usually works,” says Courbois. “You can find times when a price is available for literally a millisecond; no way to see that unless you have access to this kind of data.”

By the end of March, Courbois says, the program will cover NYSE- and Amex-listed shares, too. It’s fascinating for a data junkie to be able to track market movements, like the craziness that erupts at the close of the trading day or the action when news hits.

The Data Store would like to work with brokers to create tracking numbers for transactions, similar to those UPS and FedEx use for packages. Customers would simply click on the number and get a replay of the transaction. “One of the biggest problems any broker has is educating customers so they understand why something happened,” Courbois concludes. “This product helps investors gain confidence in the markets.”

Published in Barron’s, March 24, 2008.