Unclaimed Property Audits: No Laughing Matter

Failure to Comply with Unclaimed Property Laws Can Cost a Company Millions in Interest and Penalties Alone

Many states continue to turn to unclaimed property as a source of revenue in the face of budget shortfalls. During the last two years, some state regulators have pursued non-traditional types of unclaimed property and state legislatures have revised their unclaimed property statutes to reduce dormancy periods, effectively causing companies to remit more unclaimed property in a shorter time frame. In New York, for example, the legislature lowered dormancy periods from five to three years for a number of different asset classes typically held by financial institutions.

Acting upon provisions in the Dodd-Frank Act, the SEC recently proposed to expand rules that would require brokers and dealers to escheat sums payable to security holders. Failure to comply with these laws can mean millions of dollars in interest and penalties for a company, which can negatively impact a company’s bottom line. For example, a growing number of life insurers are being audited by multiple states to assess their compliance with unclaimed property laws. One state regulator estimated that these life insurer audits could transfer “north of $1 billion” from the audited life insurers into the pockets of consumers, in the form of benefit payments, and revenue to the states, in the form of unclaimed property, interest and fines.

Unclaimed Property and State Audits

Unclaimed property laws require the remittance of certain types of property to the state for safekeeping if a business is unable to contact the owner of that property after a specified period, known as the dormancy period. Each state has its own set of laws that set forth the types of property subject to escheat, the dormancy period for each category of property, and reporting rules. Examples of items that can constitute unclaimed property include unused gift cards, uncashed payroll checks, uncashed stock dividend checks, abandoned corporate stock, and abandoned trust funds.

States have the ability to audit companies to determine their compliance with the unclaimed property laws. If an audit reveals improperly held or abandoned assets, states can seize the property, hold it in trust for a rightful owner, and impose costs, fines, and interest against the offending entity. In severe cases, the interest and fines can exceed the amount of unclaimed property at issue. These audits are often conducted by third-party auditors paid on a contingency basis, thus creating an incentive for them to maximize the unclaimed property uncovered. What’s more, the lack of a statute of limitations on escheat in most jurisdictions can lead to decades of accumulated unclaimed property liabilities.

35 States: How Does an Audit Get So Large?

Typically, an audit begins when a state engages a third-party auditor and provides a company with notice that it is under audit. The third-party auditor, being paid on a contingency basis, can expand its compensation by adding additional states to the audit. If only one state has authorized an unclaimed property audit, the thirdparty auditor only receives a percentage of the unclaimed property that was required to be reported to that state. However, if 20 states have authorized the audit, the third-party auditor now receives a percentage of the unclaimed property that should have been reported to 20 states, significantly increasing the auditor’s overall compensation.

This snowball effect is exactly what happened to some life insurers, and what could happen to any company. For example, the State of California initiated an audit of John Hancock in 2008. This audit was undertaken by Verus Financial L.L.C. Fast forward three years to 2011, and Verus has now been authorized by 35 states and the District of Columbia to investigate and audit numerous insurance companies. These audits center around life insurers’ claims handling processes. The Social Security Administration publishes a Death Master File, updated weekly, which can be used to verify deaths. Insurers have been using the Death Master File to find dead annuity holders in order to stop payments. On the flip side, the insurers have not been using the Death Master File to find deceased policy insureds in order to pay the policy beneficiaries. The states and Verus have seized upon this disparate use of the Death Master File in their investigation of whether the funds should have been paid out to beneficiaries, in the form of benefit payments, or the states, in the form of unclaimed property.

Why Should I Be Concerned?: John Hancock as an Example

As a result of the Verus audit discussed above, John Hancock reportedly negotiated a global resolution agreement with 29 states which took effect June 1. As part of John Hancock’s settlement with the State of Florida, John Hancock will pay over $2.4 million in investigative costs and legal fees to Florida, and will establish a $10 million fund to pay death benefits and interest owed to beneficiaries. The amounts owed to beneficiaries that cannot be located will be turned over to Florida’s unclaimed property division. In addition, John Hancock has agreed to change its claims-handling procedures. Throughout the process, John Hancock has maintained that it has not violated the law. Given the number of insurance companies currently under audit, news of further settlements should be expected in the future.

In light of success with life insurers, recent legislative changes and continued state budget crunches, it is reasonable to expect an expansion of audits to other industries. It is widely estimated that a significant percentage of companies are not in full compliance with unclaimed property laws. There is no statute of limitations in most jurisdictions, as mentioned above, so the look-back period can be fairly lengthy and cover periods for which the company no longer has adequate records. The auditor may estimate the unclaimed property liability for such periods, which can lead to a company paying more than it would have otherwise owed. Further, interest and penalties can be severe. For example, in California interest is calculated by state statute at 12% per annum from the date the property should have been reported.

Taking Control of Unclaimed Property Compliance

As a result of the states’ increased focus on unclaimed property, companies need to be proactive in monitoring and, if necessary, improving their unclaimed property compliance practices. As a preliminary step, companies should determine whether or not they are currently in compliance with the unclaimed property laws. Many states have voluntary compliance programs for companies that are out of compliance. Oftentimes, by entering into a voluntary disclosure agreement with the appropriate authorities, a company can retain control of the process, limit the look-back period (remember, there is often no statute of limitations!), and limit the penalties and/or interest that may be owed for non-compliance. Typically, these voluntary programs are not available to companies once they have been selected for audit. Analyzing a target’s unclaimed property liability exposure should also be part of the due diligence process in a potential acquisition. Attention to unclaimed property compliance now can save valuable company resources later.

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