Companies at risk for compliance failures as states aggressively pursue unclaimed property
As state and federal budgets feel the impact of the recession, governments are desperately seeking any extra income stream and their attention is increasingly turning to an area that is a low-level priority for many companies – unclaimed property and escheatment. Escheatment is a common law, on the books in all 50 US states, the District of Columbia, Puerto Rico and the US Virgin Islands, as well as Quebec, British Columbia and Alberta in Canada, that prevents unclaimed property from remaining without ownership, instead transferring it to the state of the property owner’s last known address. And, says Judith Welcom who is a partner in Chicago-based law firm Sidley Austin’s New York City office, companies have been learning about the laws the hard way, through increased audits, along with fines, interest and penalties for non-compliance.
‘On the corporate side, it’s something companies have completely ignored,’ she says. ‘Often it has been an area handled by low-level operations employees, but as states have become more aggressive in enforcement it has bubbled up through the management ranks because it is something that can create real balance sheet liabilities. Now, many companies are realizing how important compliance really is.’
Compliance with escheatment rules is becoming increasingly complicated. Each state sets its own rules and time frames in its definition of what constitutes unclaimed property. The key element is the definition of ‘dormancy’, which is the period of time that an asset, payment, receivable or other instrument can remain inactive before it can be considered unclaimed. During this period, which typically ranges from three to seven years, a company must take steps to locate the owner of the asset. If it is unable to do so, it must then hand the asset over to the relevant government.
Escheatable property varies by state and includes a wide range of assets, such as uncashed wage and expense checks, uncashed dividend checks and underlying shares, insurance claims, premiums or payments, and bonds or mutual fund, bank or other accounts for which the issuer does not have a current address of the holder. Once the state considers these assets abandoned over a specified period of time, they must be turned over.
The grab for cash
How much is at stake? The National Association of Unclaimed Property Administrators (NAUPA) says that state treasurers and other agencies are currently holding $32.9 billion in unclaimed property. John Buonomo, president of Equisearch, an Elmsford, New York-based firm that helps companies with unclaimed property compliance in various states, puts that number at closer to $50 billion. Of that, only a fraction is discovered returned each year. In 2006, for example, $1.7 billion was returned to property owners. According to research done by Equisearch, unclaimed property has become Delaware’s third-largest source of revenue, generating $365 million at the end of the 2007-2008 financial year. The firm also found that California’s unclaimed property collection program has added as much as $300 million in a single year to that state’s general fund.
Buonomo says the close of the last legislative session saw a flurry of changes in escheatment laws as a number of states sought to step up collections of unclaimed property, and that in some states, unclaimed property can be the second or third-largest source of revenue. He adds that since such a small percentage is ever claimed, unclaimed property is a revenue stream with little political downside, so it is in states’ best interests to beef up collection practices as a revenue stream.
NAUPA president Shane Osborn says that this year several states have decreased the dormancy periods before which property will become reportable, while others have coordinated audits of companies that may retain unreported stock, refunds, individual retirement accounts and other assets.
Escheatment 101
Although intrusive, escheatment is not as nefarious a practice as it may sound. ‘Escheatment provides an important safeguard that the owner’s property will remain available in perpetuity,’ says Osborn. Escheatment relieves companies of the liability and expense of holding and managing unclaimed property, assigning it to the state’s custody to maintain and conduct outreach in an attempt to find the rightful property owners. The state does not always make any effort to locate the rightful owner, however. To address this, NAUPA maintains a website with links to each state’s reporting section, where most have online databases where individuals can search for unclaimed property by name and address.
Escheatment has been making other news in recent years. In late 2007, the state of California was ordered to pay interest on its $5 billion unclaimed property fund, after the Ninth Circuit Court found that the state had mishandled both public and private unclaimed property. The price tag for that finding was somewhere between $508 million and $1 billion to cover the interest liability on the 8.7 million accounts in the fund. In addition, the ruling overturned a 2003 law that halted interest payments on unclaimed property (see Line between theft and ownership, March 2008).
Companies that don’t employ proper escheatment management protocols can face potentially devastating consequences. Public or private companies failing to comply with state unclaimed property laws could face interest, penalties and even criminal liability. The 1995 Uniform Unclaimed Property Act provides for penalties of up to $25,000 plus 25 percent of the property’s value, as well as 12 percent interest on penalties. In addition, the act permits states to require holders to report and deliver unclaimed property to the state even if the holder does not ‘do business’ in that state. So, companies are liable for knowing the escheatment laws of every state or region in which their customers live.
Enforcement of escheatment laws is on the rise, according to Karen Anderson, senior compliance advisor at Abandoned Property Services. ‘I see more states enhancing their audit programs, hiring more third-party auditors and authorizing them to do a greater number of audits each year,’ she says.
In theory, property turned over to the state can always be reclaimed by the rightful owner. However, some states immediately liquidate equities and other asset classes to get their immediate cash value, so the holder is only entitled to reclaim the net proceeds of the sale price at the time of the sale. That could mean big losses for holders whose stocks are down and who are banking on holding them for the long term. Plus, says Buonomo, it can mean angry former shareholders, and a challenge for companies who are monitoring stock ownership by activist and other types of shareholders.
Staying out of trouble
Many experts believe that most companies have some level of exposure. One area under particular scrutiny now is accounts payable, where unclaimed credits are subject to escheatment, says Buonomo. In a climate where many states are shortening dormancy periods and increasing enforcement, or may soon begin to, it’s important to take action, says Daniel Crane, a partner in the corporate and securities group at Drinker Biddle & Reath.
So what does your company need to do to avoid getting caught up in the complexities of escheatment problems? First, you need to have a comprehensive system in place to help you avoid unclaimed property in the first place, says Crane.
‘Most companies I’ve come across do not have very good procedures to track funds that are subject to existing laws,’ he notes. ‘It’s an area that many institutions have struggled with.’
Keeping on top of changes in state laws can be difficult, says Welcom. For large companies with accounting and legal compliance procedures already in place, this is one more thing to add to the plate. For smaller companies, she says, monitoring these diverse laws can be a daunting task, and they may wish to turn to an escheatment consultant or software program to help them determine any compliance issues.
Investor relations and corporate governance offices need to be vigilant in maintaining investor records, says Welcom. Failure to have proper procedures in place to manage escheatment – from tracking asset holders to remitting escheatable property – could put a company in violation of SOX. ‘SOX requires you to have the necessary controls to ensure that your financial statements are accurate,’ Welcom explains.
When it comes to escheating securities, the SEC regulations require companies to make ‘a diligent effort to try to locate the account owner’ before turning over securities. Anderson says that typically means undertaking at least two separate searches for the holder, using databases, online research tools and public records. Failure to maintain reasonable attempts to keep in touch with investors regularly could also be grounds for action to be taken against the company. Anderson recommends communicating regularly with shareholders via both direct mail and email.
‘Some states will consider electronic contact, especially in cases where the contact has a unique password and accesses an account online,’ Anderson says. Even in cases where that is not feasible or considered acceptable contact, email addresses may remain valid after the shareholder’s physical address has changed, so they can be a useful tool for finding investors.
The economic climate may make the establishment of compliance procedures even more difficult, says Welcom, as corporate layoffs disproportionately affect the very back-office personnel who handle this function. ‘People who are laid off may be the only ones who know how the company’s process works,’ she notes. ‘Corporations may be losing institutional memory as these people leave, creating more compliance holes.’
If you suspect your company has escheatment exposure, Crane says the best option is to work with a qualified professional to conduct an internal audit of escheatment exposure and to determine the potential liability of the company, and then reach out in an appropriate manner to the proper authorities. That’s not something any company will relish, but it certainly beats having to deal with a third-party auditor hired by the state who is compensated based on a percentage of the escheatment proceeds.
One solid argument for ‘taking control of one’s own destiny’ in this way, says Crane, is that states are also likely to step up collection of penalties and interest. ‘In Pennsylvania, the statute has a provision that permits 12 percent interest,’ he explains. ‘This may be a case where companies can find themselves owing significant amounts of money on top of the funds that are subject to escheatment.’
Of course, if the auditor is knocking at the door, says Crane, that opportunity is likely to be lost. As that scenario becomes a greater concern in states that are seeking ways to generate more revenue, all of the experts agree that evaluating your company’s current unclaimed property management system and making necessary improvements is an investment that is no longer optional.
