Remember the Y2K scare?

Information systems of all kinds were supposed to go on the fritz on January 1, 2000, when internal calendars set up for just two digits of a year suddenly had to recognize four.

Nothing stopped. But now comes the mutual fund industry's turn, to avoid the wrong fate.

Beginning January 1, 2012, the cost basis of shares in mutual funds will have to be reported by fund companies to the Internal Revenue Service on Tax Form 1099-B. Fund companies will have to ask each shareholder to make a choice of the method for recognizing the cost basis of each sale, before the settlement of any sale.

This is going to get tricky. Operations Editor Chris Kentouris will look at this in some depth next week, in these pages. In this issue, we explore why this issue is making tax knowledge perhaps the decisive factor in picking a transfer agent this year.

The choices are going to be many, from first-in, first-out to average costing to "specific identification." But "specific identification" rolls up just about any form of repeatedly calculating the cost basis of shares, from last-in, first-out to highest-value, first-out or other minimum tax tactics.

"Y2K probably was a larger effort from a development standpoint, by number of hours,'' said Craig Hill, vice president of sales and marketing at Boston Financial Data Services, a transfer agent. "But this has been an enormous effort and cost from an internal standpoint, to comply with cost-basis legislation and tracking all these lots, which these fund companies have to do, to stay in business and operate."

And doing it right is paramount, because the financial repercussions are huge. For investors, it's a bottom line question. For transfer agents and the fund companies they serve, getting it right is non-negotiable. If you want to keep the lights on.

"It's the job of the transfer agent, if you're going to be a viable supplier, to do everything necessary to your internal process to give a mutual fund company everything it needs,'' Hill said.

That fund company, after all, is subject to a regulatory agency audit.

"The SEC could walk in and close the doors and say you cannot accept another new dollar, until you're fully compliant,'' Hill said. "It's a real possibility, if you're cutting corners and are not doing what you're supposed to be doing,'' he warns.

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