Most custodians we have spoken to, including Schwab, TD Ameritrade, and Fidelity, can accommodate fractional shares in a customer account at the individual tax lot level, but not at the customer account level. Consider the following example: A customer has three tax lots for a converting mutual fund that each have 1.5 shares at the following tax bases:
- Lot 1 – 1.5 shares @ $11.80 purchased on June 8, 2002
- Lot 2 – 1.5 shares @ $9.92 purchased on October 27, 2008
- Lot 3 – 1.5 shares @ $23.22 purchased on May 24, 2020
These lots represent a total combined position of 4.5 shares at the customer account level. Because custodians cannot accommodate fractional shares at the account level but can at the lot level, only the 0.5 fractional share amount will receive cash in connection with the mutual fund to ETF conversion. The lot that will receive the cash in lieu of the fractional share will be identified based on the tax lot methodology that is being applied to the account. For example, if the account uses FIFO (first in, first out) methodology, the 0.5 shares that will be cashed out will come from Lot 1 since it is the oldest lot. Lots 2 and 3 will retain the fractional shares and the cost basis will carry over in connection with the conversion since the sum of these is a whole number. The amount of cash paid for the 0.5 shares will be based on the market price at the time the custodian executes the sell order. This is expected to occur shortly after ETF shares are allocated to each customer account. The cash paid will be made available in customer accounts upon settlement of the trade at T+2. Generally, custodians have indicated that this will be reflected as a separate cash-in-lieu transaction in a customer’s account.