Unclaimed property audits and compliance issues will continue to be a challenge for companies in a wide range of industries. States view escheat as an important source of revenue, and contingent fee auditors will do their part to broaden the scope of escheat laws. State legislatures have been especially active in this area in the past few years, and 2020 promises to be another year of changes in state laws. Companies under audit confront difficult choices, while those companies not (yet) under audit face an uncertain risk and compliance landscape.
Here are five key trends to watch in 2020.
1. Rapidly Evolving State Unclaimed Property Laws.
State legislatures have been extremely active on unclaimed property issues over the past few years, and this trend is expected to continue in 2020. Following the promulgation of a new model law for unclaimed property in 2016 (the 2016 Uniform Act), more than half a dozen states have enacted wholesale replacements to their unclaimed property statutes,1 and other states are considering similar legislation. The 2016 Uniform Act carries forward most of the core provisions of current law, but with significant additions and updates on many topics: property types, dormancy periods, priority rules, and audit standards. In 2020, proposed overhaul legislation based on the 2016 Uniform Act is expected in at least several states, including Minnesota and Washington. In recent years, other states have adopted legislation and/or regulations focused on particular issues, such as gift cards, life insurance, or consolidated reporting, and 2020 is expected to see new proposals in a range of states. Holders should be prepared for continued changes in unclaimed property standards at the state level.
2. Audit Estimation Methods Again Under Assault.
The long-running dispute over the use of controversial estimation techniques has heated up again with a new round of litigation against Delaware filed by four companies in late 2019.2 Delaware’s estimation techniques, pioneered by its lead auditor Kelmar Associates, are controversial because they can result in a disproportionate assessment due to Delaware. Because the lookback period for an audit often exceeds typical record retention periods, auditors will use estimation techniques to estimate a liability for periods where records are not available. And most significantly, for companies incorporated in Delaware, the state continues to take the aggressive position that it has the authority to review all of the company’s data, regardless of jurisdiction, and to issue an estimated assessment for a 50 state liability, due to Delaware, for the periods where complete records are no longer available.
The new round of litigation against Delaware follows many of the themes of the 2016 federal court decision striking down Delaware’s prior estimation method as unconstitutional. In Temple-Inland v. Cook,3 the court held that the estimated findings at issue were a “gotcha” that “shocks the conscience.” Specifically, the court in Temple-Inland identified six “troubling” aspects of the assessment and held that Delaware violated the holder’s substantive due process rights by (1) waiting 22 years to audit Temple-Inland and then issuing an audit assessment for a 17-year period back to 1986; (2) avoiding the six-year statute of limitations by “exploit[ing] loopholes” under dubious circumstances; (3) giving holders no notice that they needed to retain unclaimed property records for periods beyond standard retention periods to defend against “unmeritorious audits” using estimation; (4) failing to articulate a reason other than raising revenue for retroactively applying a 2010 statute that authorized the use of “reasonable estimates”; (5) calculating an estimate on a 50-state basis and claiming the full amount for Delaware; and (6) subjecting Temple-Inland to potential “multiple liability” on the same property from various states. In the wake of the Temple-Inland decision, Delaware overhauled its unclaimed property statute and promulgated new regulations governing audits. Although Delaware made some changes in response to the court decision (such as shortening the state’s lookback period to 10 reporting years plus dormancy), the new regulations mostly repackaged the same disputed audit method as before.4
These new cases are in their earliest stages, but their progress could shape the unclaimed property audit landscape for years to come.
3. The Enforcement Push and Compliance “Invitations.”
States and third-party auditors are also continuing to target new companies for audits and enforcement, with increased expectations that all companies should be in compliance. A number of states are now using internal data to identify companies that they believe may be out of compliance, by looking for gaps in filing history, property types, and/or non-filers.
Delaware continues to be the most active state. The state initiates its enforcement process by sending a letter “inviting” the holder to enroll in their Voluntary Disclosure Agreement (VDA) program within 60 days. Companies that do not enroll are then audited by the Department of Finance using a third-party auditor. The 60-day deadline to respond to the VDA notice gives companies a limited window to consider their options upon receipt of a notice. Once under audit, other states may join in a multi-state audit. Delaware has also commenced a new “compliance review” process, which involves a review conducted directly by the Department of Finance. Delaware sent several rounds of invitation letters in 2019 and will likely send more in 2020.
Another state to watch, California, may well be considering a new process for voluntary compliance. As part of a budget bill passed in 2019, the legislature directed the California Controller to report on a possible plan to provide a one-time amnesty for late reporting or another option to increase compliance, such as a VDA program. Unlike many other states, California automatically assesses a 12% late interest charge on companies who report late property, and there is currently no VDA program available in California. A new amnesty or VDA program would allow holders with any past compliance issues to come into compliance in California while avoiding the 12% interest charge.
4. False Claims Act Litigation Raises the Stakes for Compliance.
Another concerning development for holders is the emerging trend of state false claims act lawsuits involving unclaimed property. These lawsuits typically allege that a company has knowingly and willfully underreported amounts owed to the state. Because the false claims acts are quasi-fraud statutes and provide for treble damages, the potential for false claims act litigation raises the stakes for unclaimed property compliance and risk management. Holders not only need to be prepared to defend their escheatment and reporting decisions against state revenue departments and third-party auditors, they now may also face lawsuits by private parties. The false claims acts invite a new class of potential opponents—state attorneys general and the plaintiffs’ bar—who may be driven by incentives that do not necessarily align with the purpose of unclaimed property laws.
There were several key developments in 2019 that make this an issue to watch in 2020. In July 2019, after four-plus years of litigation in a long-running dispute over unredeemed gift cards, a Delaware court entered judgment of more than $7 million against a major retailer, finding that the company violated the Delaware False Claims Act by not reporting the balances of unredeemed gift cards to the state as unclaimed property.5 The case had proceeded to a jury verdict in 2018 and covered four years of reporting and nearly $3 million in unredeemed gift cards. Although the trial only involved one retailer, the case initially swept in nearly two dozen retailers and restaurants and challenged an escheat planning structure the companies had used for their gift card programs. The case reportedly generated more than $25 million in settlements.
In another recent case, a New York trial court declined to dismiss a false claims action against a financial institution for alleged underreporting of late interest owed on unclaimed property, holding that the obligation to pay interest on late escheat reporting is “automatic.”6 The case alleges that the company submitted false reports to New York by not self-calculating and paying late interest on items reported after the normal dormancy period, notwithstanding the long-established practice of the New York Comptroller to review reports and send interest assessments to holders after reports are filed. The decision raises the stakes for companies to stay current on unclaimed property filings, avoid late reporting, and proactively address with the states any potential late reporting issues.
Not to be outdone, the California Attorney General has also recently gotten into the game on false claims act and unclaimed property, filing an action against an operator of golf and country clubs in June 2019. The complaint alleges that the company failed to repay more than $10 million owed to more than 9,000 California residents and then falsely omitted these amounts from unclaimed property reports filed with the California Controller.7
Each of these cases illustrates the potentially toxic mix between the false claims acts and unclaimed property laws.
5. The Impact of Changes to Federal Law for Retirement Accounts.
In 2020, changes to federal law will continue to have ripple effects on state unclaimed property reporting for retirement accounts, including both individual retirement accounts (IRAs) and employer plans (such as 401(k) and 403(b) accounts governed by ERISA). In late 2019, Congress passed the Secure Act, which among other provisions, raises the age for required minimum distributions (RMD) from 70½ to age 72. For IRAs, this creates an immediate tension with unclaimed property laws in states that have codified a dormancy trigger based on age 70½, which was the RMD date under prior law. States may need to amend their escheat laws on this point; notably, the 2016 Uniform Act also lists age 70½ as a relevant date for triggering escheat of IRAs. In addition to the Secure Act, the ERISA Advisory Council issued recommendations to the Department of Labor in 2019 recommending that ERISA plans have the option to begin escheating uncashed distribution checks as unclaimed property. State reporting would be voluntary, not mandatory, for ERISA-governed plans, but this could lead to a big shift in how these checks are currently handled. Finally, IRA custodians continue to work to implement an IRS ruling that escheatment of IRAs constitutes a taxable distribution that is subject to tax withholding, a change from longstanding practice.
Conclusion
We expect to see many more developments in 2020 on these and other issues, with rapid changes in legislation, regulation, litigation, and audits, all of which will present a range of challenges for holders this year and beyond.
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1 Delaware, Illinois, Tennessee, Utah, Kentucky, Maine, and Colorado.
2 AT&T v. Geisenberger, 1:19-cv-2238 (D. Del. filed Dec. 6, 2019); Eaton Corp. v Geisenberger, 1:19-cv-2269 (D. Del. filed Dec. 12, 2019); Fruit of the Loom v. Geisenberger, 1:19-cv-2273 (D. Del. filed Dec. 13, 2019); Siemens USA Holdings v. Geisenberger, 1:19-cv-2284 (D. Del. filed Dec. 17, 2019).
3 192 F. Supp. 3d 527 (D. Del. 2016). Another case, filed in 2018, raises some of the state issues but is more generally challenging retroactive application of the new Delaware law and the scope of audit authority. Univar v. Geisenberger, No. 18-1909 (D. Del. filed Dec. 03, 2018) (motion to dismissed granted in part and denied in part on Sept. 17, 2019). There are also parallel proceedings pending in state court involving some of these audits.
4 Delaware continues to make estimated assessments based on items from other states. Both the audit regulations and VDA regulations state: “To the extent permitted by law, names and addresses identified in the Base Period shall not be used to determine which state has the priority claim to the abandoned property estimated to be due over periods where records of owners’ addresses do not exist.”
5 Delaware ex rel. French v. Card Compliant et al. (Overstock.com), No. N13C-06-289-FSS (Del. Super. Ct. New Castle County, filed 2013).
6 State ex rel. Raw Data Analytics LLC v. JPM & Co., No. 100271/2015, 2019 WL 4148055 (N.Y. Sup. Ct. Aug. 30, 2019).
7 People of the State of California v. ClubCorp Holdings, Inc. et al., CGC-19-576620 (Super. Ct. Cal., San Francisco filed Jun. 11, 2019).
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