Facing An Escheat Audit: What Are Your Company’s Rights?

Companies and their counsel are often caught by surprise
when they receive notification of an escheat audit. The 50 states and the
District of Columbia are aggressively pursuing presumptively abandoned
property.

The variety of such property runs the gamut from dormant
bank accounts to uncashed checks and unused gift cards.

Some companies mistakenly believe that they can ignore the
audit letter. The states take their parens patriae role seriously.
Increasingly, the states are relying upon third-party auditors, typically
retained on a contingent fee basis, to identify audit candidates. Given the
fact that the audit findings, with interest and penalties, often run into seven
figures, the audit letter deserves the same careful response as any regulatory
investigation.

Companies often ask: Is there any limitation upon a state’s
right to conduct a compliance review of the holder’s books and records?

Statutory Limitations

Section 23 of the 1954 and 1966 Uniform Disposition of
Unclaimed Property Acts stated: “The [State Treasurer] may at reasonable time
and upon reasonable notice examine the records of any person if he has reason
to believe that such person has failed to report property that should have been
reported pursuant to this act.”

The 1981 Act in Section 30 maintained the requirements of
reasonable time and reasonable notice found in the predecessor Acts, but
expressly eliminated the “reason to believe” that the holder was
noncompliant. Section 30(b) reads, in pertinent
part: “The administrator may conduct the examination even if the person
believes it is not in possession of any property reportable or deliverable
under this Act.”

That language is repeated, almost verbatim, in Section 20(b)
of the 1995 Act. That new section also expressly allows the administrator to
contract with an independent third-party auditor to conduct an examination.

These changes have made the examinations easier for the
states that have adopted the examination statute from either the 1981 or 1995
Act. However, a number of states still retain the “reason to believe”
requirement of the 1954 and 1966 Acts.

Judicial Interpretation

What constitutes “reason to believe”?

Four decisions have interpreted a state’s right to conduct
an examination. In the first case, a retailer attempted to block the
examination by claiming the statute of limitations had expired. The trial court
judge rejected that argument and the retailer appealed.

The Massachusetts Appeals Court upheld the trial court
judge’s decision and allowed the audit to proceed.

In the 1980s, a trust company attempted to avoid examination
by claiming Illinois’s exemption of an “active express trust.” The trial court
accepted that argument. The Illinois Court of Appeals reversed the trial court
and rejected the trust company’s contention. To do otherwise, the court stated,
would “allow the regulated to become the regulator.”

In Oklahoma, a state bankers’ association tested the
sufficiency of evidence necessary to constitute “reason to believe.” When the
bank received the audit notice, it obtained an injunction. At trial, the
Oklahoma Tax Commission presented evidence that it had found unreported
property at each of its prior bank audits. Further, the Tax Commission proved
that it had utilized neutral, non-discriminatory factors in its selection of
audit candidates. The Oklahoma Supreme Court allowed the audit.

The final question is: When must the administrator formulate
his/her “reason to believe?” A recent decision from Maryland Court of Special
Appeals states that the administrator’s decision need not be made prior to the
notification of examination. Although this company had reported
securities-related property, the company had never reported general ledger
items such as payroll and vendor checks. Given the volume of the company’s interstate
leasing business, the lack of escheatable general ledger items was very
unusual.

The company argued that the Comptroller’s allegations were
too vague. The motions judge allowed the Comptroller to amend his pleading. The
trial judge, however, viewed the amendment as an admission that the Comptroller
had initially lacked a “reason to believe” and therefore dismissed the case.

The Comptroller appealed. The Court of Special Appeals found
in favor of the Comptroller, stating, “The right to audit comes into being at a
discrete and easily identifiable point in time – whenever the Comptroller has
‘reason to believe.’”

The states have been able to persuade courts that there is
sufficient “reason to believe” that the company has been non-compliant. While
the company has the right to raise any defense such as the statute of
limitations or claim any statutory exemptions for the broad coverage of the
law, it is also clear that such possible defenses or exemptions will not
prevent the initiation of the audit. The company, of course, always retains the
right to object to the audit results on both a legal and factual basis.

Confidentiality Of Records

Assuming that auditors have satisfied any “reason to
believe” test, the company must permit the auditor to examine the company’s
books and records. However, companies are frequently conflicted by numerous
privacy concerns such as the Financial Right to Privacy Act, HIPPA and other
statutes.

The states’ escheat statutes offer protection. Section 20(d)
of the 1995 Uniform Act reads as follows: “Documents and working papers
obtained or compiled by the administrator, or the administrator’s agents,
employees or designated representatives, in the course of conducting an
examination are confidential and are not public records.”

While a company is entitled to rely on the statute’s
protection, prudent counsel will seek a separate confidentiality agreement with
the auditors. Such an agreement not only reinforces the concept of
confidentiality but also imposes liability directly upon the auditors.

At a minimum, the agreement should require that all
information (not simply names, addresses and monies owed) remain confidential
and such information may be shared only with the state(s) sponsoring the audit.
Additionally the agreement should insist that all audit work papers be
destroyed upon conclusion of the audit or, better yet, returned to the company.

Brooke Spotswood has handled escheat matters for more than
20 years. He is the co-author of the original treatise on escheat. His website, www.unclaimedpropertylaw.com,
contains additional articles.