Shareholder recordkeeping managers will soon need to change their procedures and back-office systems to comply with new state regulations and, potentially, a Supreme Court decision affecting unclaimed accounts.
The assets in those “lost” accounts can help states close budget deficits, so states will do whatever it takes to get their hands on the money. Delaware and Illinois are among several states which have recently adopted new unclaimed property laws that will make it easier for states to get access to unclaimed accounts. Unfortunately, they also make it harder for financial firms and issuers to determine just when an account should be considered unclaimed and transferred to a state coffer.
The Supreme Court is also set to rule in October whether Delaware can keep over US$160 million in funds from uncashed official checks issued through MoneyGram or whether it must distribute the money to 29 other states. Depending on what the high court decides, banks could be forced to change their unclaimed property procedures for uncashed official checks and money orders.
Compliance with unclaimed property rules is cumbersome, because it involves exposure to both diverse state and federal regulations. As a result, transfer agents, issuers, and other financial intermediaries typically rely on dedicated departments with specialized technology to handle the multi-phased administration of lost accounts. First, an account must be established as unclaimed or abandoned, then the correct dormancy period must be applied, and there must be some last-ditch effort made to track down the account holder. When all else fails, the account must then be reported and “escheated” or transferred to a state. States are free to quickly liquidate assets in unclaimed accounts. Owners who might eventually show up to claim their accounts could end up losing out on a higher payouts from a market upturn, stock split, dividend or income payments or corporate spinoff.
Based on previous Supreme Court rulings, an unclaimed account must be transferred to the state of the last known address of the investor. If that is not known, it must then be transferred to the state in which the company or issuer of the securities is incorporated. Such a practice translates into a financial bonanza for Delwaware and New York because they are the most common states for incorporation.
States can impose penalties on transfer agents, issuers and other holders of unclaimed accounts — fines and interest — for either not escheating an account or being late to do so. However, if the transfer agent, issuer or broker-dealer erroneously or sometimes even correctly classifies an account as unclaimed and transfers it to a state, it could be sued by an investor. Transfer agents are not indemnified by issuers for any mistakes or litigation, but issuers are usually indemnified by transfer agents for any issues arising from escheatment.
A revised version of the US Uniform Unclaimed Property Act (RUUPA) enacted in 2016 made it harder for states to classify accounts as unclaimed, because it requires that mail sent to investors be returned as undeliverable by the post office. That is the same standard used by the SEC in its Rule 17ad17.
However, states are not required to follow all or even any of the provisions of RUUPA, just as they were not required to follow previous versions of the Uniform Unclaimed Property Act (UUPA). That leaves transfer agents, corporations and other financial institutions stuck with following a multitude of state regulations which might even conflict with those of the SEC. Those state regulations set the standard for when an account is considered unclaimed and the dormancy period — or how long it must remain unclaimed — before it is transferred to a state.
Delaware’s new unclaimed property law rejects the “lost” standard of unclaimed accounts applied by the SEC and instead uses an “inactivity” standard. It considers an account escheatable — or transferrable to a state — if an investor has not demonstrated any activity — or proactively communicated — with the issuer or its transfer agent or broker-dealer in three years. “Issuers who don’t pay dividends could see their shareholders in Delaware and abroad deemed inactive and have their shares escheated to Delaware three years after they were purchased,” warns Jennifer Borden, president of Boston-based Borden Consulting Group, which specializes in unclaimed property matters.
Delaware’s new law also explicitly says that the unclaimed accounts of foreign shareholders of corporations incorporated in Delaware are escheatable to Delaware even if the address of the foreign shareholder is known. The accounts of foreign investors can easily fall into the category of unclaimed when they decide to accumulate dividend checks in US dollars for several years until the value is high enough to offset bank fees.
Borden has represented the Securities Transfer Association (STA) and the Shareholder Services Association (SSA) in lobbying the Utah, Arkansas and Delwaware legislatures to change the proposed text of their new unclaimed property legislation to match the SEC’s definition of unclaimed. Utah and Arkansas agreed to do so, but Delaware refused to budge. The STA represents about 150 transfer agents doing shareholder recordkeeping work for registered investors while the SSA represents issuers doing their own work.
“Implementing Delaware’s new law will be difficult because the transfer agent and issuer will need to review all the different possible means of ‘contact’ in order to determine if there is any ‘activity’ to stop shares from being escheated,” says Borden. “It’s far easier to simply rely on one data element — such as whether the account is lost because of returned undeliverable mail.”
Illinois’ new unclaimed property law deviates even more from RUUPA than Delaware’s. Illinois has come up with a new trifurcated system for determining the timing of when an account is unclaimed. It says that an unclaimed account can be transferred to Delaware under the earlier of one of three conditions: either three years after correspondence to a shareholder is returned to the transfer agent as undeliverable, five years after inactivity or two years after an owner’s death. Illinois defines inactivity as the lack of proactive communication between an investor and a company or its transfer agent.
“The new legislation makes it easier for Illinois to access unclaimed accounts because it adds the new criteria of three years after correspondence is ureturned as undeliverable,” says Borden. “However, transfer agents, issuers and other financial intermediaries will have a hard time programming their systems to account for the complex three-tiered requirement,” says Borden. “The bill is also written in such as way that many of its provisions would be applied retroactively thus subjecting issuers and transfer agents to interest and penalties.”
Voluntary Isn’t Voluntary
Delware’s new unclaimed property legislation gives companies who are in the midst of an audit begun in July 2015 the ability to avoid interest and penalties by switching from an audit to a voluntary disclosure program. They have 60 days after the state’s final unclaimed property legislation is published to make a decision. That legislation must be finalized before before December 1, 2017.
However, legal experts caution that what seems like a generous offer comes with plenty of strings. For starters, the company would have to audit its own books and have records on unclaimed accounts to prove its findings going back ten years. Hopefully, the company will have held onto records for that long. If not, Delaware can say the account is unclaimed even if it isn’t. What’s more, even with the records, any decisions reached by the issuer on what is unclaimed and what isn’t unclaimed can still be rejected by Delaware.
“The switch to a voluntary disclosure program doesn’t apply to audits of unclaimed securities accounts. Holders of unclaimed accounts which converted to the voluntary disclosure program would also have to agree to Delaware’s method of estimation the years in which there are no researchable records,” cautions Sara Lima, a partner in the law firm of Reed Smith in Philadelphia. “Delaware’s estimation is based on a methodology that was previously ruled unconstitutional, when combind with other factors, by a US district court in 2016.” By contrast, companies who continue with an audit can appeal any assessment to the Delaware Chancery Court.
What does Delaware really want to accomplish by offering the voluntary disclosure program? “Delaware doesn’t appear inclined to abandon its use of the estimation methodology that the Temple-Inland decision in 2016 found deficient and unlawful,” says Lima. “It appears that, by allowing companies currently under audit to convert to a review under the state’s voluntary disclosure program, the state is trying to avoid further legal challenges to its estimation methdology similar to those raised in the Temple-Inland case.”
As if transfer agents and issuers wouldn’t have enough problems dealing with Delaware and Illinois’s new unclaimed property law, banks could also have to change their policies regarding unclaimed official checks and money orders if the Supreme Court rules against Delaware. Until now, the decision of which state takes control of the checks and money orders has depended on the individual bank’s policy. Three of the five unclaimed property managers contacted by FinOps Report say that their banks send unclaimed checks to Delaware. Two say the checks are returned to their own states.
MoneyGram, which issues cashiers checks or tellers checks on behalf of other banks, returned uncashed money orders valued at over US$160 million to Delaware. That decision was based on Delaware’s assertion that a 1974 federal statute doesn’t apply to MoneyGram’s “official checks,” because it only applies to money orders. The federal statute ” says that uncashed money orders and “similar written instruments” should be returned to the state in which they were issued. Delaware says that because the financial instrument issued by MoneyGram was a “check” and MoneyGram is incorporated in Delaware, Delaware is entitled to the money based on its interpretation of previous Supreme Court rulings.
If a bank has been sending its uncashed official checks to its state of incorporation and the Supreme Court rules in favor of Delaware, the bank has nothing to worry about. However, if the Supreme Court rules in favor of the other states, that same bank might have to revise its unclaimed property procedures and recode its escheatment platform to report the unclaimed checks to the states where they were purchased, explains Freda Pepper, an attorney with Reed Smith. The law firm serve as lead counsel in an amcus brief filed by the Unclaimed Property Professionals Organization (UPPO) which wants the Supreme Court to clarify federal laws regarding unclaimed property.
When it comes to unclaimed accounts, all that is certain is that transfer agents, issuers and other holders have to be prepared to deal with a constant state of flux. “There is no uniformity, and there is often change,” says Lima. “Therefore, all companies face the challenge, and often the substantial expense, of keeping up with the times and working to update their procedures and systems accordingly.”