Earlier this year, executives at Old Republic Title Company had reason to realize the importance of passing unclaimed property on to its rightful owners. Years ago, an Old Republic agency subsidiary had failed to let $9.5 million of unclaimed escrow funds revert to California, as required under state law, according to a source. The failure to “escheat,” as the principle is termed, was one of a number of charges against the agency in a case that resulted in its paying the balance of over $33 million to the City and County of San Francisco in January after lengthy civil and private class-action legal battles.
In 1998, after San Francisco’s district attorney had prosecuted Old Republic’s then-CFO, Donald Barr, for embezzlement and tax violations, the city’s district attorney and its city attorney sued Old Republic. (Barr eventually pled guilty to two felonies and was sentenced to 16 months in prison.) During an investigation, “prosecutors learned of Old Republic’s practice of sweeping money and uncashed checks out of old escrow accounts and into company income,” according to a press release issued in March by the city attorney. Old Republic did not respond to a request for comment.
The title insurer’s case demonstrates the risks facing companies that don’t comply with unclaimed property laws. Indeed, businesses that haven’t met reporting requirements face the possibility of a state audit and must pay the liabilities—plus penalties, fines, and interest, according to Dave McCrystal, director of marketing at The Keane Organization, a compliance and risk management firm.
But those liabilities can be tough to track. Under state laws, unclaimed property may be an outstanding manufacturer’s rebate issued by the company, a payroll check, a workers’ compensation check issued by a self-insured employer to an employee, a gift certificate, or any of the over 100 property types that must be reported after three years or more of not being collected, explained Debbie Zumoff, chief compliance officer at Keane.
What’s more, state leniency for noncompliant businesses is waning and government auditors are being more aggressive. In the late 1990s, amnesty programs for companies that claimed ignorance of reporting requirements were prevalent, according to Zumoff. But those programs have all but vanished. In general, changes in state laws have shifted the burden of finding owners of unclaimed property from the state to corporations.
Within the past year, a number of states have implemented a new tool to monitor compliance with unclaimed property laws. With ACES, a software program by Boston-based Unclaimed Property Clearing House, states can view company reporting histories and identify non-reporting companies, said Zumoff.
The program helps states identify companies that underreport or fail to report liabilities. “Unclaimed property has been on the back burner and states realize that Sarbanes-Oxley changes that,” says Lynden Lyman, managing director of the Unclaimed Property Clearing House. Zumoff, however, says that the presence of the software will boost the chances that companies will face audits.
Material Holes in Internal Controls
At the federal level, the chance that failing to report, underreporting, or misreporting unclaimed liabilities could spawn both potentially misleading financial statements and violations of Section 404 of the Sarbanes-Oxley Act is also pumping up corporate risks, according to Zumoff.
Under Section 404, which requires companies to set up and maintain adequate internal controls over financial reporting, “we are seeing more and more companies taking a thorough, enterprise-wide look and finding material liabilities in terms of unclaimed property that must be disclosed in their financial statements,” Zumoff observed. “An unclaimed property from 10 years ago in itself may not be material, but when you add interest and penalties for non-compliance, it has a significant potential to become material,” she said.
In the process of escheatment, ownership reverts to the state for safeguarding until the rightful owner—the person to whom the money is owed—claims it. When the ownership rights are extinguished after 20 years or more (depending on the laws of the particular state), the property is permanently handed over to the state, notes Zumoff. The rightful owner can always claim the property.
The reporting requirements, procedures, deadlines, and penalties for companies that have issued un-cashed checks vary from state to state. Further, companies may have obligations in many states, since they’re required to report to any state in which the company conducts business. Interest payments to states on property due range from 4 percent to 12 percent, and the maximum fine for not reporting liabilities is $1,000 per year, according to Zumoff. Additionally, there are penalties of up to 25 percent of the unreported amount when there’s a willful failure to report.
Among industries, financial institutions, especially banks, are the biggest and most consistent reporters of unclaimed property, observes Steve Harris, chief of unclaimed property at the New Jersey Department of the Treasury. Smaller companies are sometimes unaware of the laws or are willing to risk an audit by not reporting.
Hefty perils can also beset acquiring companies in a merger—especially if the acquirer doesn’t know the liabilities it’s picking up. One of Keane’s clients completed an acquisition and learned of its target company’s large, unspecified unclaimed liabilities four months after the merger, according to Zumoff, who didn’t want to name the company.
Problems can also crop up when company officials aren’t aware of the compliance responsibilities concerning all parts of the corporation. “States are observing that many companies are not recognizing their compliance obligation on the general ledger side of the business and there is an incorrect assumption in the marketplace that unclaimed property law applies only to securities,” she said. In the case of a mutual fund, the company, also a client of Keane, reported unclaimed property that included stock, dividends, and interest stemming from its securities-trading side. But the business side of the firm, which issues checks to employees, vendors, broker-dealers, and distribution channels, never reported outstanding checks, according to Zumoff.
How to manage the risks? An unclaimed-property committee that meets consistently and has established procedures to track liabilities can be a big help in preventing unwelcome surprises like the discovery of obligations after an acquisition, experts say. The committee should consist of a wide range of executives, including representatives from accounting, information technology, law, human resources, accounts payable, and the corporate secretary’s office, according to Zumoff.
With the rise of regulator interest in unclaimed property, such committees are likely to have their hands full. At the state level, government appetite for fresh funds is driving the increased vigilance as much as the need to protect consumers is pushing it. In a study that the Unclaimed Property Clearing House conducted for the federal government last year, the firm found that states returned 30 percent of unclaimed property. “Without question, it is a revenue raiser,” said Mark Paolillo, national director of Deloitte & Touche’s unclaimed property services group.