by Frank Franiak
October 15, 2020
One my favorite quotes comes from Mark Twain who said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” So what does this have to do with trusts? The connection is that while many people believe they can rely on reports from financial institutions as 100% accurate, those reports can have errors or other issues that affect the trust. Things you are certain are true may not be.
Reports from financial institutions can have issues that cause a trust to be incorrectly valued or that affect that the calculation of tax liability. This can lead to decisions based on faulty data and create risk for the trustee.
The following are some of the issues we have encountered with brokerage statements from financial institutions.
- Cost basis discrepancies on transactions. When selling securities brokers may liquidate the wrong tax lot. For example, a client will want to liquidate the highest cost position but the broker will use a different method to determine which tax lot was sold. This can cause the account to realize a higher taxable gain than is necessary.
- Erroneous coding on gains/losses. Sometimes transactions involving capital gains are coded as dividends and vice versa resulting in incorrect tax treatment.
- Trade date versus settlement date1 If the broker reports positions as of the date a trade settles, then end of month transactions may not show up on the brokerage statement until the following month.
- Moving assets between accounts. When assets are moved between accounts, as in the case of a transfer from a parent to children, the selection of which tax lots are moved is also significant. If done incorrectly, one child can end up with a higher or lower basis than the other and be subject to more or less tax when the security is sold. This is usually not the intent of the grantor.
- Corporate actions. Corporate actions2 (dividends, splits, mergers and spinoffs) may be handled incorrectly. For example, in transactions involving spinoffs, sometimes the wrong formula is used to calculate what percentage of the cost basis should be assigned to the new security and what should be applied to the existing security.
- Wires sent from wrong account. If there are multiple trusts in a related group, brokers will sometimes wire money from the wrong account.
- Missing trades. At times trades that were executed can be missing from the brokerage report. However, to correct this it’s necessary to know which trades were actually executed and to reconcile them to the brokerage report.
- Improper charges. We have also seen cases where the financial institution charged fees for services that were in excess of what had been negotiated with the trustee.
Any of these issues can result in an inaccurate valuation of a trust as well as problems with the data used by the tax preparer. If the account has only a few positions or little investment activity, it may be easy to spot a problem by eyeballing the brokerage statement. But this can be a major risk factor for larger accounts with significant activity and positions. An error in pricing a security could lead to a materially inaccurate valuation.
The risks for trustees and trust organizations are substantial. These include financial liability, damage to your reputation, legal problems and unhappy clients.
One of the best ways to solve this problem is by “shadowing” the reporting provided by the broker. This means you keep a separate, independent record of the positions and activity that can be reconciled to the brokerage reports. This enables you to catch and correct these types of errors.
But this can be challenging with large and complex accounts. You need knowledgeable employees, data feeds and systems that automate the reconciliation function. These things may not be available to individual trustees and smaller trust organizations.
In a previous post, we discussed why trustees should consider outsourcing trust accounting. Outsourcing the valuation of investment portfolios is part of that accounting process and makes sense for the same reasons.
You get access to the systems, experience and personnel needed to reconcile and value the account accurately and efficiently. Another benefit is the correct classification of income versus principal items contained in the brokerage report.
Outsourcing also allows you to be more flexible with staffing and often can save you money because of the efficiencies that come with scale. Most importantly, it gives you peace of mind that this critical function is being handled effectively.
Frank Franiak is the President and CEO of TriPacta Financial Services LLC (tripacta.com), a Schaumburg, IL based firm that provides outsourced accounting and administration services to trustees, trust companies, individuals and family offices. He can be contacted at firstname.lastname@example.org or (224) 212-9183.
- For more information on settlement dates visit: https://www.investopedia.com/terms/s/settlementdate.asp
- For more information on corporate actions visit: https://www.investopedia.com/terms/c/corporateaction.asp
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