Reconciliation

Reconciliation

Core Concepts

1. Reconciliation Types and Hierarchy

Reconciliation is the systematic comparison of records across two or more systems to identify and resolve discrepancies. In securities operations, reconciliation ensures that the firm's internal records (the investment book of record, or IBOR) match the custodian's official records (the official book of record, or OBOR) and, where applicable, the clearing firm's records. The reconciliation hierarchy proceeds from the most fundamental data element (positions) through increasingly derived data elements.

Position Reconciliation. The foundational reconciliation. Compares the number of shares or units held for each security in each account between the firm's portfolio management system (PMS) and the custodian. Position reconciliation is typically zero-tolerance: any share count difference, no matter how small, constitutes a break. Fractional share differences (common with dividend reinvestment plans) must also be identified and resolved. Position reconciliation is performed daily, using end-of-day files from the custodian compared against the PMS position ledger.

Cash Reconciliation. Compares cash balances between the PMS and the custodian, accounting for settled cash, pending settlements, accrued income, and pending fee debits. Cash reconciliation is more nuanced than position reconciliation because timing differences are inherent — a trade executed on day T settles on T+1, and the PMS and custodian may record the cash impact on different dates. Cash tolerance thresholds are common, typically a small dollar amount (e.g., $0.50 to $5.00) to accommodate rounding differences across systems. Balances outside the tolerance require investigation.

Transaction Reconciliation. Compares individual transactions (trades, dividends, interest payments, transfers, fees) recorded in the PMS against the custodian's transaction ledger. Transaction reconciliation operates at the trade level, matching on security, quantity, price, trade date, and settlement date. Unmatched transactions on either side constitute breaks. Transaction reconciliation is typically performed on a T+1 basis — comparing yesterday's activity after the custodian's end-of-day file is received.

Market Value Reconciliation. Compares the total market value of each position and each account between systems. Market value breaks often result from pricing differences — the PMS and custodian may source prices from different vendors or apply different pricing hierarchies for thinly traded or illiquid securities. Market value tolerance is typically expressed in basis points (e.g., 5-10 bps of account value) rather than absolute dollars, because a $100 difference on a $50,000 account is more significant than a $100 difference on a $5,000,000 account.

Accrued Income Reconciliation. Compares accrued interest on fixed-income holdings and declared-but-unpaid dividends. Accrued income differences frequently arise from day-count convention differences (actual/actual vs. 30/360), ex-date vs. record-date timing, or different treatment of defaulted bonds. This reconciliation is particularly important for fixed-income-heavy portfolios where accrued income is a material component of total value.

Cost Basis Reconciliation. Compares the tax lot-level cost basis for each position between the PMS and the custodian. Cost basis discrepancies are among the most difficult to resolve because they may originate from historical corporate actions (splits, mergers, spin-offs, return of capital adjustments) that were processed differently in each system. Since the custodian reports cost basis to the IRS on Form 1099-B, cost basis discrepancies can result in incorrect tax reporting if not resolved. Cost basis reconciliation is typically performed less frequently than position reconciliation — monthly or quarterly — but with zero tolerance for discrepancies.

2. Three-Way Reconciliation

For advisory firms that use a portfolio management system separate from both the custodian and any clearing firm, three-way reconciliation is the standard of practice. The three records being compared are:

Advisor System (PMS / Portfolio Accounting). The firm's investment book of record (IBOR), maintained in the portfolio management system (Orion, Black Diamond, Tamarac, Addepar, or similar). This is the record the firm uses for performance reporting, billing, rebalancing, and client-facing communications. The advisor system reflects the firm's understanding of what each client owns.

Custodian Records. The official book of record (OBOR), maintained by the custodian (Schwab, Fidelity, Pershing, or similar). This is the legally authoritative record of client assets. The custodian is responsible for safekeeping assets, settling transactions, and reporting to the IRS. When the advisor system and custodian disagree, the custodian record is presumed correct unless the firm can demonstrate otherwise.

Clearing Firm Records. For firms that clear through a separate entity (introducing broker-dealers that clear through a correspondent clearing firm), the clearing firm maintains its own record of positions and transactions. The clearing firm processes settlements, maintains margin calculations, and generates customer statements. In a fully disclosed arrangement, the clearing firm's records should match the custodian's, but discrepancies can arise from timing, corporate action processing, or data feed errors.

Authoritative Source by Data Element. Different systems serve as the authoritative source for different data elements:

Reconciliation Frequency. The standard frequencies are:

• Position reconciliation: daily (end of each business day)
• Cash reconciliation: daily
• Transaction reconciliation: T+1 (one business day after the trade or event)
• Market value reconciliation: daily
• Accrued income reconciliation: daily or weekly, depending on portfolio composition
• Cost basis reconciliation: monthly or quarterly

3. Break Identification

A break is any discrepancy identified during reconciliation between two or more records. Break identification is the process of detecting, classifying, and prioritizing breaks for investigation and resolution.

Tolerance Thresholds. Not all discrepancies warrant investigation. Tolerance thresholds define the minimum discrepancy that constitutes a reportable break:

Break Categorization. Breaks are classified by root cause to enable pattern analysis and systemic remediation: