Many states across the country have increasingly come to realize the financial importance of unclaimed property laws. Under these laws, a “holder” of unclaimed property has the obligation to report and remit property to a state after the property has remained unclaimed by its owner for a specified period of time (usually three or five years, depending on state law).
States are stepping up their enforcement as a politically acceptable alternative to raising taxes. In fact, for many states, the sale of unclaimed property is a significant source of operating funds. A recent report by California’s Legislative Analyst’s Office reveals that proceeds from the sale of unclaimed property comprise the fifth-largest source of revenue to the state’s general fund.
As these unclaimed property laws, and the states’ administration and enforcement practices, continue to evolve, it becomes more important for CFOs to keep pace with developments. Savvy CFOs can avoid stepping in an escheat mess that could impact the bottom line.
Every state has and enforces a unique set of escheat laws that apply to businesses that hold many different types of obligations, including: uncashed accounts payable/vendor checks; customer credit balances; uncashed payroll checks; uncashed benefit checks (non-ERISA); vendor credits; customer credits, uncashed royalty checks; gift cards/stored-value cards; uncashed/unused rebates; bank accounts; securities; and customer stock/brokerage/IRA/mutual fund accounts.
While states have dramatically increased their enforcement efforts in this area in recent years, many businesses are still unaware that they have filing and reporting duties. Even where some compliance process is in place, that process is often far from comprehensive. Consequently, many companies do not have a proper escheat compliance function in place that complies with state law.
Moreover, as part of their stepped-up enforcement, states have outsourced compliance examinations to third-party firms. This has resulted in significant disruption and financial harm to businesses that hold unclaimed property — especially when audits are conducted by third parties that are generally compensated on a contingent fee basis. Over the past few years, the number of contingent-fee audit firms auditing on behalf of states has increased. Each employs unique methods and practices, but a unifying characteristic of these firms is their aggressive assertions of liability.
In a related but troubling recent development, audits have increasingly become less about whether a company has technically adhered to a state’s unclaimed property law as written, and more about the state attempting to dictate certain market conduct. For example, life insurance and brokerage-industry audits designed and conducted by Verus Financial LLC have entailed efforts to enforce non-statutory dormancy standards, which often have the effect of overriding legitimate contract terms and industry-specific state regulations and practices.
The escheat bottom line is about your bottom line. CFOs should be aware of this multistate compliance regime for four key reasons:
- Managing exposures through robust compliance procedures
- Managing the financial statement implications of such established and/or contingent liabilities
- Effectively conducting audit defense, if necessary
- Implementing changes in accounting policies and procedures, as well as in business models (contracts, customer terms and conditions, and the like), that optimize compliance and may additionally offer planning opportunities.
CFOs can effectively conduct internal compliance self-reviews in order to gauge current levels of escheat compliance and to identify sources of exposure, which in turn can yield effective risk management strategies. A self-review process may be undertaken in conjunction with the defense of a single-state or multistate unclaimed property audit.
An abbreviated list of CFO best practices to effectively manage an audit defense or internal self-review includes:
- Assign a “lead” in-house counsel or project management professional to oversee the self-review and/or audit defense process. Be sure to allocate ample time and resources to this person.
- Manage internal expectations regarding the duration and work required to conduct the internal self-review and to establish best practices.
- If under audit, execute an effective confidentiality and nondisclosure agreement with the audit firm. In an age when data privacy and security are highly regulated at both the federal and state levels, and any security incident involving a company’s confidential data (including personal/financial data of employees, shareholders, and customers) could be catastrophic, it is important to manage these risks in the context of a contractually outsourced compliance examination.
- The CFO should consider a potential voluntary disclosure agreement (VDA) strategy in conjunction with its audit defense strategy.
- Review underlying business practices and transactional models implemented by the company or an affiliated group, which may be the source of escheat exposures (for example, whether and how contingent obligations are recorded, what terms and conditions pertain to business-to-business and business-to-consumer transactions and instruments, and contractual limitations periods for asserting claims to property).
As recent news indicates, “escheat happens,” and the states’ spotlight on unclaimed property is not going to go away. As unclaimed property compliance isn’t a one-size-fits-all approach, CFOs should remain vigilant in understanding its nuances.