Unclaimed property laws have become a steady, reliable source of funding for state budgets.
A report issued by the National Association of Unclaimed Property Administrators (NAUPA) suggests that $3 billion of unclaimed property is added to states’ coffers annually. The Unclaimed Property Professional Organization (UPPO) Claimants’ Representative Committee reports that state unclaimed property programs may return only 8.6% to 59% of property collected to rightful owners. The result is that states enjoy the use of millions of dollars in unclaimed property in support of their own budgets. Yet unclaimed property programs are showing signs of ill health. The golden goose is crying out for help. This article offers a diagnosis and some suggestions for treatment.
Unclaimed property is a “golden goose” for state budgets
Aesop’s cautionary tale of “The Goose & the Golden Egg” describes a goose that laid a single golden egg every day. While the eggs provided a steady, reliable source of income for the owner of the goose, the owner of the goose became impatient and killed the goose in an effort to collect all of her golden eggs at once. Of course, there was no gold inside the goose, and the man had destroyed the source that had sustained him. In his haste to get rich, the man lost everything.
Based on English feudal society, unclaimed property laws arise from the idea that where property is without an owner, it “reverts or escheats to the people, as forming part of the common stock to which the whole community is entitled.” See 4 James Kent, Commentaries on American Law 449 (1826). “Such property … is used for the general good rather than for the chance enrichment of particular individuals or organizations.” Standard Oil Co. v. New Jersey. As “[t]he state may more properly be custodian and beneficiary of abandoned property than any person,” Connecticut Mut. Life Ins. Co. v. Moore, states can play a dual role in the area of unclaimed property—as custodian, until the property’s rightful owner can be located, and as beneficiary, on behalf of the common good.
Conceptually, these principles for an unclaimed property system make sense. The problem is that unclaimed property has become such a significant source of state revenue that the incentive structure for the states has shifted. Indeed, the states’ role as beneficiary has begun to overshadow the states’ role as custodian for lost property. Delaware, for example, relied on unclaimed property as its third-largest revenue source during the 2019 fiscal year. During 2019, Delaware collected $554.0 million in unclaimed property and returned $114.3 million, for net collections of $439.7 million.
The gap amounts to an appreciable source of funds allocable to budget items and shortfalls. It is not uncommon to see legislation appropriating funds from unclaimed property to specific government projects. For example, in 2018, Illinois unsuccessfully sought to reroute unclaimed property collections to allow the Treasurer to purchase and renovate a new building. In vetoing Senate Bill 2921, Governor Bruce Rauner (R) warned against using the unclaimed property act “as a mechanism to fund the Treasurer’s building projects.”
States begin to squeeze the golden goose
With an increasing dependence on funds generated by unclaimed property, legislators and administrators focus on increasing those collections. For example, new laws deem property “abandoned” sooner, require companies to turn over amounts more quickly, and unsettle consumer expectations. See, e.g., Am. Express Travel Related Servs. v. Sidamon-Eristoff (addressing the contractual impact of New Jersey’s retroactive dormancy period reduction from 15 years to three years); BBB Value Servs. v. Treasurer, State of N.J. (finding that New Jersey improperly refused to refund remittances attributable to gift cards not subject to escheat). States have sought to broaden the definitions of “property”, to set aside arms-length contract terms (Highland Homes Ltd. v. State), and have removed long-standing exemptions from the law (see Illinois Public Act 100-0022 (SB 9 of 2017), retroactively eliminating the state’s business-to-business exemption; Indiana Senate Bill 188, pre-filed on 1/5/21, proposing to retroactively eliminate the state’s business-to-business exemption; see also C.R.S. tit. 38, art. 13, effective July 1, 2020, retroactively eliminating standard deduction for certain property). Perhaps the most egregious aspect of modern unclaimed property program policies is the requirement that privately-held securities be turned over to the state and immediately liquidated, regardless of any harm to the shareholder. See, e.g., S.D. Codified Laws Section 43-41B-23(c) (requiring that securities be sold within 180 days of receiptou) Fla. Stat. Section 717.122 (requiring the sale of securities upon receipt). Each of these changes serve to move owners’ property to state coffers at a faster rate, all for the ostensible purpose of protecting state residents.
Due to waning internal resources, states routinely engage private firms to perform audits of companies’ financial records. These audit firms conduct often costly and burdensome forensic examinations on behalf of multiple states at once (some of which pay an hourly fee and others of which pay based on a percentage of the property they “uncover” in an audit). The audit firms follow their own methodology, which tends to be standardized even across states with substantially different laws, and by their own admission, almost always succeeds in “finding” unreported unclaimed property. SeeLegislative Analysis, Michigan House Bill 5577 dated May 30, 2012 (noting business community concern that “the focus, often by contingent fee third-party audit firms, is on creating state assessments based on minor theoretical discrepancies in ancient paperwork rather than on restoring truly unclaimed property to its rightful owner.”). Companies have alleged that the auditors’ control also extends to providing guidance to the states in changing their laws and regulations. In other words, states have outsourced the care of the golden goose. See State of Delaware, Department of Finance v. AT&T, Inc. (noting the Delaware Department of Finance “appears to have lent the State Escheator’s investigatory authority to [a private audit firm] to use as it sees fit.”).
The problem is that the motives of for-profit, private firms differ greatly from the long-standing purpose of escheat, as espoused by the states. Instead of a focus on reunification and returning funds, contingent-fee auditors engaged by the states are incentivized to maximize the collection of funds for their own private benefit. It is the health of the state’s unclaimed property programs, the goose, which ultimately suffers.
States’ lack of supervision over private audit firms puts unclaimed property revenue at risk
To continue the analogy, in engaging private audit firms, the farmer (or state government) has found a way to generate more eggs (unclaimed property) with little to no expenditure. But the short-term success of this approach to managing the programs comes at the risk of the states’ long-term fiscal health.
The auditors’ methodologies and expansive legal interpretations have forced audit targets to defend their rights and their own profits by mounting successful challenges in court. Courts, primarily in Delaware, have begun to voice concern with the actions of private audit firms and warn states about the programs’ susceptibility to exploitation. For example, in Temple-Inland, Inc. v. Cook, the United States District Court for the District of Delaware found a private auditor’s methodology to be a “game of ‘gotcha’ that shocks the conscience.” That same year, Justices Alito and Thomas of the Supreme Court of the United States cautioned that “many States appear to be doing less and less to meet their constitutional obligation to provide adequate notice before escheating private property.” Taylor v. Yee (concurring in the denial of certiorari).
State unclaimed property agencies have not answered these warning calls. They appear to be allowing audit firms to increase collections through aggressive audits without sufficient oversight or mediation. See Hopkins and Young, Unclaimed Property Audit Fallacies and Myths, The Tax Advisor (9/1/19); State of Delaware, Department of Finance v. AT&T, Inc. (quashing a subpoena in part due to the potentially “pernicious incentive” for the state’s audit firm to “engage in aggressive enforcement tactics” that appeared to benefit the auditor rather than the state). There are many reasons a state may elect to work with contingent-fee private audit firms: pressure for increased collections due to state revenue shortfalls, inadequate funding support for staff from the legislature, or technical limitations faced by the agency responsible for unclaimed property administration, for example.
Despite such challenges, state legislators and administrators should take heed of the court’s admonishments. Inflexible audit tactics may promise more short-term funds, but they invite broad challenges. See, e.g., Texas v. Clubcorp Holdings, Inc.; Taylor v. Westly (warning that the court may undertake supervision of the program if the state does not). Even worse, they incentivize and encourage companies to reincorporate in other states. The unavoidable result is the depletion of the strength of the unclaimed property programs overall.
Treatment: Recommendations and Considerations
State administrators can fix the problem, even while they continue to benefit from contingent-fee or private-firm arrangements (so long as courts do not hold such arrangements to be unlawful, of course). However, they require sufficient internal resources to do so. State controllers and revenue departments responsible for unclaimed property require personnel—to research and draft balanced policies, as well as to participate in, negotiate, and resolve legitimate audit disputes. Departments should not focus narrowly on single-year annual revenue collections. State leaders must acknowledge and communicate that program oversight is the province of state government, divorced from an individual profit incentive. In other words, someone must care for the goose without personally benefiting from her eggs. Such short-term investment will support long-term fiscal stability, to the extent state politics allows.
By delegating policy itself to for-profit companies, state unclaimed property programs focus on short-term collections to the exclusion of other legitimate policy goals. This renders them vulnerable to broad legal challenges—for violating constitutional rights, jeopardizing citizens’ own privacy, and conflicting with the states’ own contract law. States must consider these issues in drafting regulations instead of only on expanding the scope of collectible funds and the ability of private audit firms to “hunt” for them. (Hopkins and Young, supra).
Further, states have the authority, if not the capacity, to tailor the methods crafted by private auditors to their own state laws and goals. Yet, they rarely do. States appear reticent to intervene in audit disputes, or mediate legitimate disputes in legal interpretation, even though they could avoid costly, blanket legal decisions like the one in Temple Inland if they did so.
As the Supreme Court and several courts around the country have noted, the goose seems unwell. The solution is for states to ensure compliance and enforcement in a manner that is consistent with long-term policy goals. States should steer their unclaimed property programs to stabilize state coffers. They should start with adequate oversight of private audit firms, ensuring those firms’ methods yield to long-term state goals.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Sara A. Lima is a partner, Freda L. Pepper is counsel, and Ashley R. Rivera is an associate at Reed Smith.