United States: Delaware Enacts Unclaimed Property Legislation That Addresses Some (But Not All) Holder Concerns

The Delaware Legislature appears to have heard some of the complaints of the unclaimed property community. Delaware Governor Jack Markell signed Senate Bill 11, which is based on the recommendations of the Delaware Task Force to Study and Make Findings and Recommendations to Improve Fairness and Compliance, established under the provisions of Delaware Senate Concurrent Resolution No. 59.

The holder community has expressed frustration time and again over the practices of the state's aggressive contingent fee auditors and their questionable hiring of past state unclaimed property administrators. The initial draft of the legislation addressed both the business practices of the contingent fee auditors used to conduct the audits and the audit practices they were utilizing and encouraging. The amendments removed the portions of the legislation that had the potential to impact Delaware's finances.

Contract Terms The legislation limits the contract terms between the state and the contract fee auditors to no more than five years and limits any single audit firm to handling no more than 50 percent of the state's audits. This limitation targets holder frustration with the zealous tactics of the currently contracted auditors. Typically, Delaware's outside auditors are capped in billing of time and materials, and receive the rest of their fee as a percentage contingent upon the audit results. The contingent payment can span multiple audits. Any holder that has gone through an audit knows that the audits often take five or more years to complete, largely because the financial incentive encourages an auditor to apply very strict review of the research provided to establish a given transaction does not have a credit or balance. A focus on testing to ensure that the holder was complying with unclaimed property rules and regulations is absent from the audit mission. The legislation, by limiting the contract terms, theoretically will influence auditors to improve efficiency. In addition, the limitations in the legislation should increase the number of contract audit firms that the state uses and, thus, reduce the influence and power of any single firm.

Hiring Practices The legislation also creates a window of time during which an outside audit firm cannot hire a senior supervisory role employee of the Delaware Division of Revenue or Department of Finance. The language identifies specific offices, namely the Secretary of Finance, any Deputy Secretary of Finance, the State Escheator, or Audit Manager, that cannot be hired by an audit firm for a period of two years from the time the employee leaves the employ of the state. Many may see this as a response to the hiring of Mark Udinski, fresh off his role as State Escheator, by Kelmar Associates. The hiring ruffled the feathers of many in the holder community. This amendment may appease the holder community, without affecting the state's bottom line.

Audit Limitations The original draft of the legislation included a provision that would have barred the state from issuing a notice of delinquency when a holder had filed an annual unclaimed property report, unless the State Escheator made a specific determination in writing that the holder filed a fraudulent report with the intent to evade the obligation to pay abandoned or unclaimed property. This provision would have significantly limited the periods the state views as subject to audit and, as a consequence, could have had a significant impact on the state's collections. The Senate amended the bill to remove this provision.

Appeal Process The legislation revises the appeal process. Under the old appeal process, the independent reviewer sent its finding of facts to the Secretary of Finance, who had the unilateral authority to accept, modify or deny the findings, before sending the findings to the holder. In contrast, under the new legislation, the decision of the independent reviewer is simultaneously sent to the holder and Secretary of Finance, and either party can object to the independent reviewer's findings by filing an appeal to the Court of Chancery. The court's review is limited to whether the independent reviewer's determination was supported by substantial evidence on the record. If the record is insufficient, the court shall remand the case back to the Department of Finance. These changes streamline and add some fairness to the review process.

However, the legislation did not address several issues involving the Delaware unclaimed property appeal process that are the source of significant holder discontent. For example, the legislation does not address the estimation methodologies used by the auditors. In cases currently pending in the U.S. District Court for the District of Delaware, two holders, each represented by Reed Smith, are currently challenging Delaware's authority to use estimation methods in its unclaimed property audits. In these cases, the holders are each arguing that U.S. Supreme Court precedents do not allow for estimation of unclaimed property, because such estimation is inconsistent with the identification of an actual property interest. However, barring a favorable decision in one of these pending cases, holders will continue to undergo Delaware audits involving revenue-driven estimation methods for any periods of time for which holder records are unavailable. This is especially frustrating because Delaware has never provided the holder community with record retention guidelines.

Audit Manual The legislation directs the Secretary of Finance to create a detailed audit manual containing procedural guidelines, and to update the regulations to ensure greater transparency and predictability for holders. This manual should give holders more leverage in dealing with contract auditors by distinguishing between the audit practices that the Department of Finance views as acceptable and those the Department views as prohibited.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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