#substantiallyidentical

Last week, at Scivantage's Client Conference in Scottsdale, AZ, I was a guest speaker on the Cost Basis Reporting Track, “Industry Panel: Mobilizing for Fixed Income & Options Reporting.” I had the privilege of working with some of the foremost cost basis reporting (CBR) experts from top financial services, research & consulting and audit & accounting firms. Ellen Bocina from Fidelity Investments, Isabella Fonseca from Celent and KPMG’s Dan Mayo joined me as fellow panelists.

In preparation for the panel, the four of us tried to restrict the topics to only the most pressing issues surrounding Phase 3, for which answers are not readily available.  We knew we only had an hour and the list of proposed topics was huge.  It took two long prep sessions to limit the scope to what we thought we could tackle in the allotted time.  Guess what?  We got it all wrong.  By the end of the session, we had covered only about 50% of the proposed topics.

The reality is that Phase 3 is particularly messy because bonds (even fixed income schedule bonds) are messy and complicated bonds (not fixed yield or fixed security, such as convertible bonds or stripped coupon instruments, which are popular for Treasury notes) are, well . . .even messier.  Debt instruments are inherently highly complex investments because, unlike equities, a wide range of terms and conditions, such as maturities, principal amounts, coupon schedules and seniority issues determine their value. Prior to the introduction of the cost basis legislation, the complexities of bond math was left to a few back-office geeks charged with calculating the differences between ratable accrual and constant yield amortization. Now, like it or not, bond math has become a front-and-center issue, dredging up branches of mathematics we thought we had put to bed back in sophomore year of college.  This long-forgotten math is integral to correctly reporting cost basis and creating accurate 1099-B forms.

Do we defer before we amortize or vice-versa?  Do we treat Buy-Buy-Sell wash sales differently than Buy-Sell-Buy wash sales when the security being traded is a bond? As was clear from the panel, not even the experts agree on how to answer these questions!  This is a sobering thought given the complexity of debt instruments. To learn more about these inherently complex instruments as they relate to wash sales and realized gains and losses, see Advanced Topics in Wash Sales: Substantially Identical Bonds.

The January 2014 Phase 3 deadline applies to simple debt instruments. I can only imagine what further chaos might ensue when the IRS provides final regs on complex debt instruments, which have a January 2016 reporting deadline.