Escheatment: money for nothing

If the CFO of your company hasn’t got the word ‘escheat’ in his or her vocabulary, now is the time to flick through the dictionary and take note of some fresh news about how tough a number of American states are getting and how much money they are extracting, via escheatment, from previously untouched company funds.

For years, the idea of dealing with unclaimed property laws was far from the radar at most companies, aside from banks, insurance companies and a few other financial institutions or agents responsible for tracking down lost shareholders. Over the years, some states have successfully raised substantial amounts of revenue by auditing more aggressively and thinking more expansively about what constitutes unclaimed property under their escheat statutes.

This development has transformed what was once a largely unnoticed audit function under the rubric of state comptrollers and treasurers into a sometimes adversarial enterprise that is attracting a flood of attention. ‘The growth in enforcement and in dollars had previously been incremental but is now verging on exponential,’ says Judith Welcom, securities litigation partner and leader of the escheat counseling and litigation practice at Sidley Austin. ‘No CFO or general counsel of a large corporation can afford not to pay close attention to the potential of unclaimed property exposure now.’

Early in 2010, in a closely watched case involving the question of whether rebate checks comprise unclaimed property, Sprint settled with the state of Iowa instead of proceeding to litigation, despite the fact that the settlement totaled $22 million. The amount Iowa sought was well under $1 million, but because states have often banded together in matters of unclaimed property – and did so behind Iowa’s lead – Sprint, in effect, settled with 37 states.

Time is not your friend
The agreement covered rebates from 1999 to 2002 – a short period, but one that draws attention to the time spans of liability companies may have to deal with. ‘The states have become even more aggressive in hiring third-party auditors and going after additional property types,’ notes John Buonomo, president of Equisearch, a company that specializes in lost account holder search and recovery services in the unclaimed property industry.

‘These audits can go back as far as 15-20 years and, if you don’t report it, the states can levy fines and assessments against the company,’ Buonomo says. ‘We work to locate folks and return the property to the rightful owner. Doing this for a company can save that company a lot of money in terms of penalties and interest assessments.’

Many growing businesses face the unpleasant discovery in their corporate maturation that they are subject to these laws. Usually the first understanding is of exposure to the unclaimed property statutes of the state in which the company has chosen to incorporate. But then there is the next, swiftly learned, reality: representatives of other states appear, announcing an audit to see whether they also have claims.

The states get aggressive
For a long time, unclaimed property constituted paper-based or electronically recorded items such as outstanding wages and benefits, funds in bank accounts, uncashed checks, abandoned phone or utility deposits, and orphaned stocks and dividends.

But things changed as a few state treasurers began to realize there was potential to collect new funds in untapped areas. What first appeared as consumer protection legislation morphed into a revenue-gathering opportunity. Moreover, because no one was being taxed, it was an easy move politically, providing new revenues without taxes at a time when states were seeing their funding gaps widen into major fissures.

When the financial system hit a wall in 2008, these fissures turned to yawning chasms and the state treasurers rapidly stepped up the learning curve to become financial mountaineers. Part of their discovery was that other types of assets beyond the financial sort had already been found by a handful of colleagues to fall under the purview of existing statutes governing unclaimed property. In other words, explains Welcom, they had identified property that is not specified in the statutes but which some provisions in the statutes could be construed as covering.

Further evolution has occurred as states have modified or expanded their laws to specifically cover assets previously not identified as unclaimed property; the pace and breadth of searching has opened up. Stored value and gift-card balances made headlines as new targets recently, and this year the federal government is adding its own overlay of requirements to the various state rules about those cards.

And now there is a movement to expand the coverage of state escheat laws beyond financial instruments to physical objects. ‘If I receive goods and I don’t pay for them, the amount I might owe the seller could someday be considered unclaimed property,’ Welcom relates. ‘There is already litigation pending in which a company is challenging that proposition.’

In the past, neither states nor companies were inclined to litigate escheat issues for fear of establishing undesired precedents. As a result, the judicial rulings in this area were sparse. Now companies are pushing back in court and challenging expansive state interpretations and statutory amendments that appear to be overreaching. This is, in itself, a huge change.

Checks and balances
The National Association of Unclaimed Property Administrators has said the amount gathered in state treasuries is holding at about $33 billion this year, the same as last year, but Buonomo says that estimate is low. ‘They have about $50 billion, and it grows every year,’ he maintains. The growth comes both from increasingly aggressive collection and from the interest the money earns.

Some of the money goes into reserve funds, ready to pay out when the missing rightful owners show up. Most of them never do, however, so the reserve fund stays fairly steady and excess funds collected get put into the state’s general spending fund. Even then, the money in the reserve account is working for the state, drawing interest, or in some cases becoming collateral for state bonds to help pay for public projects such as road construction.

Part of the ever-expanding reach, experts note, can be attributed to the fact that financial services companies have been so heavily scrutinized over time. Insurance companies are always audited for uncashed claims drafts; banks go through not only audits but also examinations by the SEC and state banking regulators. Financial institutions are now regulated by a variety of overseers. As there is broad oversight for them, they are well prepared to protect themselves from the worst-case situation (for which, read ‘the situation most profitable to the states’) of paying back penalties
and interest.

The SEC mandated searches by companies for ‘missing’ shareholders in the early 1990s. That, along with the move to paperless stock certificates, has resulted in more and more people on the shareholder side keeping their records up to date, notes Buonomo. ‘We see less attention there so we are following the trends where states are going after general ledger property and individual companies,’ he says. ‘The attention of states has definitely shifted away from the companies that now do a good job of tracking things related to share ownership.’

Now that states know they can edge into new areas, there appears to be no stopping their efforts, beyond companies starting to litigate against the moves. Some companies have been trying this, but success is another story, as the Sprint settlement shows. According to Buonomo, the industry buzz has it that oil and gas companies will be the next big targets.

Delaware takes the lead
One of the leaders in grabbing cash is the state of Delaware. Many companies flocked to the tiny East Coast enclave decades ago when it was clearly the most welcoming state for incorporation. But at least a few of today’s corporate finance teams must be griping about their predecessors’ decision as Delaware dips into corporate pockets to retrieve cash never before seen as available.

Delaware has made itself well known to all concerned with aggressive state escheatment actions in the past decade, but it may well come out of 2010 as an even more feared leader in the field. In what experts are calling a stunning turn of events, CA (formerly Computer Associates) ended litigation over unclaimed property with the state earlier this year, agreeing to pay $17.65 million to settle state claims. Most of the amount was in penalties and interest covering the period from 1991 to 2010.

Meanwhile, Delaware recently put the word out that it wants new and expanded help looking for more ways to go after corporate property. ‘It put out a request for a proposal to increase the number of third-party auditors, which in turn will increase the dollar value of what they receive in unclaimed property,’ says Buonomo. Third-party auditors are companies that go in on behalf of states to see what may be on company books that might be subject to being turned over to the states.  

Further obstacles
The states have implemented a couple of other policies to make the unclaimed property area less easy for companies to navigate. Each state sets a time period for what is known as dormancy – the elapsed time between a company first trying to find a rightful owner and the date set by the state by which the unclaimed property must be turned over to the state.

This dormancy period has dropped from up to seven years to just three years in many cases. It was also fairly common for a company to go voluntarily to a state having realized liability, and then get a quick settlement. That option has all but disappeared, however, as states choose to audit and perhaps find more assets instead.

The situation gets all the more complicated when considering that the size of liabilities, or potential liabilities, to the states may well be of a large enough size to be considered material under Sarbanes-Oxley. This  means that, in addition to the negative impact of state audits and fines, a company may encounter issues for incomplete or misleading filings with the SEC.

‘The awareness of this and its potential impact on financial statements is clearly bubbling up to the top,’ Welcom adds, in a message that corporate secretaries can take to heart. ‘It makes our job so much easier because you speak with authority when you talk to your people and say, We’ve got to get this together.’