Originally published January 23, 2003

Industry Trends And Current Topics; In-House Or Outsource And Case Study

The following materials of "Industry Trends and Current Topics" and "In-House or Outsource" were presented at the Lorman "Unclaimed Property Reporting" Seminar in Stamford, Connecticut, on September 21, 2001. The "Industry Trends and Current Topics" materials were prepared by Tara J. Foley, Manager, State and Local Tax Group, Andersen. The "In-House or Outsource" materials were prepared by Michael G. James, Manager, State and Local Tax Group, Andersen

I. INDUSTRY TRENDS AND CURRENT TOPICS

By Tara J. Foley – Manager State and Local Tax Group – Andersen

A. Voluntary Disclosure Agreements.

  1. Audits are becoming more common as many states have increased efforts to enforce their unclaimed property or escheat laws. Several states have substantially increased the number of auditors assigned to conduct unclaimed property audits and many states have hired third party "bounty hunters" to conduct audits on their behalf.
  2. Initiating the filing of unclaimed property reports on a prospective basis could trigger an audit. If reports have not been filed, the statue of limitations on those years generally would never close.
  3. If the unclaimed property exposure is significant, a voluntary disclosure might be the best solution for a corporation.
  1. A voluntary disclosure involves negotiating with the state(s) on a no name basis, to bring the holders unclaimed property filings current and close out prior year liabilities.
  2. Under most voluntary disclosure programs, the state(s) will waive penalties, and may limit the number of prior years for which the liabilities are due.
  3. This program is an initiative designed to increase the awareness of unclaimed property laws using a friendly, helpful approach to make it easier for businesses to comply with the law. It is designed to educate and inform holders of their reporting requirements. The voluntary compliance program is an attempt by states to alleviate the reluctance of holders to report abandoned funds.

B. Mergers And Acquisitions

  1. In the event of a merger or acquisition, unclaimed property can be an overlooked liability with potentially deal breaking consequences. If a company is in the process of merging with another company, it is important that in the process of due diligence, the possible unclaimed property liability is taken into account.
  2. For example, if information for unrecorded liabilities can not be found, then the purchase agreement for the company should specifically exclude unrecorded liabilities and the seller should indemnify the buyer from such liabilities.
  3. Also, it may be necessary, if the liabilities are very uncertain, to conduct an audit of all possible types of unclaimed property in order to assess the potential liability associated with the merger or acquisition.
  4. For example, a large manufacturer was in negotiations to acquire a company when the potential unclaimed property was disclosed to be millions of dollars. This discovery resulted in a cease of negotiation until the unclaimed property liability could be resolved.

C. Industry Differences

  1. Types of property that remain in a company's possession may differ by industry. For example, retail industries do not have the same type of unclaimed property as other industries, such as banks or insurance companies.
  2. In addition to different property types, different industries may have different reporting rules depending on their specific industry classification (i.e., rules governing utilities versus rules governing retailers).
  3. Common types of unclaimed property by Industry

a) Banks

Banks include in their common types of unclaimed property: accounts payable, payroll, savings, checking, money orders, cashiers checks, safe deposit boxes, travelers checks, retirement accounts, time deposits, matured CD's, collateral deposits, unidentified deposits, credit balances arising from loans, liquidated mortgages, consumer loans and consumer credit accounts.

b) Healthcare

The Healthcare industry would commonly have accounts payable, payroll, IRA, Employee benefit plans, outstanding checks issued to vendors, expense checks and pension check as types of unclaimed property.

c) Hospitals

Hospitals would also include accounts payable and payroll, but along with these common types of properties, also included would be patient credit balances, IRA, employee benefit plan, outstanding checks issued to vendors, expense checks, and pension checks.

d) Insurance

Insurance companies would list life insurance, casualty insurance, fiduciaries, matured endowments, death claims, amounts due under policy of non- insurance, refunds and other amounts due under policy terms, accident and health payments, annuity payments, agent's credit balances and policy dividends, accounts receivable and payroll.

e) Manufacturing

Companies involved in the manufacturing industry would most likely recognized outstanding checks to vendors, expense checks, pension checks, accounts receivable, payroll and customer accounts receivable balance due to duplicate payments as unclaimed property.

f) Pharmaceutical

Pharmaceutical companies would recognize rebates and commissions as unclaimed property.

g) Publishing

Companies involved in the publishing industry would most likely recognize outstanding checks issued to vendors, expense checks, pension checks, and royalties, along with accounts payable and payroll as unclaimed property.

h) Retail In the retail industry, along with payroll and accounts payable, gift certificates, credit memorandums, merchandise credits, layaways, commissions, outstanding checks issued to vendors, expense checks, and pension checks are all recognized sources of unclaimed property.

i) Trucking

The trucking industry recognizes three typical types of unclaimed property, which are payroll, accounts payable, and customer accounts receivable credit balances.

j) Utility

Utility companies commonly have accounts payable, payroll, deposits and refunds as sources of unclaimed property liability.

D. Fraud

  1. Since unclaimed property is seen as assets with no owner, the funds can be easily misappropriated. Many institutions have received conspicuous press coverage, increased oversight from regulators, and damage to their reputation from incidents related to the mismanagement of unclaimed property or misappropriating these funds in managing earnings.
  2. The mishandling of unclaimed property is often the result of poor bookkeeping and recordkeeping practices that have been compounded over the years. Institutions whose books and records do not accurately reflect the ownership of property, as well as the age of the property, expose themselves to regulatory, legal, operational, and risk to reputation, and may also find themselves facing the prospect of criminal charges where the facts are conspicuous.

a) Examples of misappropriation of Unclaimed Property Funds and Fraud

1) Case 1: Brokerage Firm.

a. Four senior officers of a large regional retail brokerage firm, were involved in a multi- year fraud by diverting unclaimed property funds to corporate income, thereby inflating income. In addition to the diversion to income, three of the officers were also involved in diverting unclaimed funds for personal enrichment. The fraud went unnoticed for eight years until internal investigation revealed the inappropriateness of the situation.

b. The officers involved were either convicted or plead guilty to the crimes and were sentenced to federal prison. In addition, the firm had to hire legal counsel and independent consultants to perform a detailed investigation and review controls and procedures.

c. The company firm was fined and censured by the SEC and other regulatory agencies. As part of the agreement with regulatory agencies, the company had independent monitoring for two years and agreed to have independent consultant review internal controls periodically.

2) Case 2: Multi-State Bank

a. A Large Multi-State Bank was sued by its home state and various municipalities regarding the bank's role as a bond paying authority. Plaintiffs claimed that the bank had illegally kept money that should have reverted to state property. The Bank had to review and provide records relating to the bond paying activity for the last 25 years for over 7,000 accounts.

b. The Bank eventually settled out of court and paid several million dollars to its home state and various municipalities.

3) Case 3: Trust Company

a. Senior officers of a Trust Company utilized the unclaimed funds to offset operational losses and to fund reserve accounts, as well as to help meet targeted income projections.

b. The Trust Company was eventually indicted by the U.S. Attorney's office and plead guilty to fraud.

c. The Company was also fined and censured by other regulatory agencies. As part of the agreement, the firm agreed to significant fines, the remittal of the funds to the rightful owners and hiring independent consultants to review and develop comprehensive abandoned property procedures.

b) Practices which may be unintentionally violating the Unclaimed Property Laws

Following are some subtle corporate practices that may be in violation of the unclaimed property laws:

1) Following a policy of writing off unpaid liabilities

2) Following a policy of writing off unallocated credits under a certain threshold

3) Recognizing unclaimed funds due to another institution into income.

4) Writing off small balances in customer accounts where there has been no activity for an extended period

5) Netting unreconciled debits and credits (regardless of materiality)

6) Netting certain types of rounding differences

c) Risk Management

The only way to ensure proper compliance with all applicable abandoned property statues is to employ an appropriate framework of controls. Abandoned property impacts many, if not all, operating areas of an institution. As such, abandoned property controls must be imbedded or overlaid on an institution's normal daily operating procedures. A firm should look into the following steps to minimize risks when dealing with unclaimed property.

1) Centralize and raise the oversight of unclaimed property management within the overall corporate governance structure of the company

This step includes designating an Abandoned Property Officer (APO) who acts as the senior manager responsible for the company's compliance with Unclaimed Property Laws.

2) Establish "3-way" segregation of responsibility over unclaimed property management and processing

a. The creation of an APO as well as an Abandoned Property Coordinator (APC) and a Financial Officer would establish a away segregation of responsibility over abandoned property management and processing.

b. The APC would be responsible for controlling and monitoring the potential escheatable funds within each operating group.

c. The APC would also be responsible for accumulating abandoned property information and the day-to-day risk management of the process for their respective area.

d. A Financial Officer would be an individual, independent of both APC and the APO who would oversee all the current and potential unclaimed property of the firm, and would also give approval for any disposition of dormant funds before escheatment.

3) Segregate Dormant Property

a. Institutions must take steps to establish additional controls over inactive third party property as soon as it becomes inactive within normal business conditions. This is usually long before the dormancy period for escheatment.

b. For example, typical vendor checks are cashed within 30 days, and vendor checks cashed between 30 and 60 days are very unusual, so therefore any vendor check not cashed within 60 days should be considered inactive and segregated from the total of the account.

4) Institute proper authorization controls over the disposition of unclaimed property

a. Any disposition of unclaimed property after the defined inactivity period should require additional monitoring and authorization controls. Dormant funds should require the authorization of the APO.

b. For example, if the vendor check from the previous example was to be re- issued after it was 60 days past due, the reissuance should first be researched by the APC and then presented to the financial officer for approval.

5) Establish Monitoring Mechanisms

a. The activity in all segregated accounts should be properly monitored. All activity in this account should be properly analyzed and reported to the APO and Financial Officer on a periodic basis. The APC should have the responsibility of generating this analysis.

II. IN-HOUSE OR OUTSOURCE

By Michael G. James - Manager, State and Local Tax Group - Andersen

When deciding on whether to retain certain functions or processes in-house versus outsourcing them, a number of considerations should be weighed prior to making a final decision. The following is a discussion that will provide a perspective of both the pros and cons of each. In addition some tips and common sense advice is included if outsourcing is chosen.

  1. Advantages Of Retaining A Function Or Process In-House
  1. Management can determine which personnel will be assigned to the job. Management will already know the skill sets of those chosen as well as the expected performance level of everyone involved with the project.
  2. Management will have a better grasp of controlling costs involved. The decisions of hardware and software expenditures can be determined up front and budgeted. Any costs outside the project can be reviewed on an as needed basis. An example of this would be adding additional resources to meet a deadline.
  3. Direct oversight and accountability of the implementation. Senior corporate managers can quickly obtain the status of the project from subordinates who are directly responsible for a particular aspect of the project.
  4. The project duration is solely determined internally. Management determines what factors will influence when an objective or milestone is reached.

B. Disadvantages Of Retaining A Function Or Process In-House

  1. Often times a company will lack the required expertise in- house for a project implementation or for carrying out an ongoing job function. Specialized skill sets are needed to fully ensure a successful project completion.
  2. Dedicating personnel to one project can place a strain on any company's human capital. Cost constraints and the lack of capable personnel to fill the roles of those assigned to a project can jeopardize customer relations and subsequently company performance.
  3. Costly software upgrades when outsourcing an IT function, such as web hosting, can play a role in determining if a function should be kept in- house.
  4. Retaining a job function or system process requires ongoing administrative costs, including hiring experienced personnel that will capably fill a position, or capital costs such as system upgrades necessary to keep pace with changing company needs.

C. Advantages Of Outsourcing A Function Or Process

  1. By outsourcing a function or task, a company will free valuable personnel to focus on core tasks and thus create value for their department. An example of this is outsourcing a tax function. Andersen statistics indicate that tax personnel spend over 50% of the time preparing or defending tax returns. A better allocation of time could be planning for current and future periods.
  2. Firms that provide outsourcing services are often experts in that field. This provides a company with assurances that the most knowledgeable people available are carrying out a function that is most likely not a core competency of the company.
  3. Payroll costs are reduced by decreasing the need to staff for non-core functions.
  4. Capital costs are reduced for outsourcing functions that require upgrading software or hardware. This can be a significant benefit to an enterprise by removing the necessity to annually budget for the replacement of outdated assets.

D. Disadvantages Of Outsourcing A Function Or Process

  1. Communication between the outsource provider and the company is a primary key to success. A problem here could doom the entire project. Management must also be sure to keep the information flowing internally so all affected parties are kept abreast of progress and problems.
  2. Containing costs is also a key ingredient for a successful outsourcing. By turning over the work to an inexperienced outsource provided, a company risks incurring unplanned expense which can lead to a poor working relationship and other issues with the outsource provider.
  3. Another risk to outsourcing is that the company no longer has full control over all tasks. The management of the outsource provider must have a full appreciation of the fiduciary role placed upon it when accepting this type of work.

E. Key Elements A Company Should Consider When Choosing The Correct Outsourcing Tasks Or Processes

  1. A prime candidate for outsourcing would be non-core tasks or those where the company has weak competencies. Examples that fall into this category are:

    a) high turnover positions
    b) purely administrative roles
    c) highly repetitive tasks
    d) specialized skills are needed
  2. Select areas that will add value to the company and to stakeholders. Enhanced or improved e-business systems from the outsourcing of web functions can result in improved sales.
  3. Select work areas where minimal resistance to change is anticipated. Some examples here include

    a) jobs that are hard to fill
    b) departments that are experiencing overwhelming work loads
  4. Select work processes that are easily separable from the organization without having any affect on delivering value to the customer.

F. Other Elements That Are Key For The Success Of An Outsourcing Include:

  1. Assigning a project manager or designated contact person to the outsourcing firm. This eliminates duplicate questions, unfulfilled requests and management having to contact more that a single person for updates.
  2. Agree on a work plan and establish milestones. This forces all parties to work as a team to accomplish tasks and meet deadlines. It also provides a clear path on how the project will proceed from inception to completion.
  3. Select dates and times to meet on a regular basis. This will help keep the team focused and raise any issues before they become potential hazards in meeting milestones. In today's business environment, meetings are held through a number of different methods. Conference calls, net meetings or video conferencing are just a few examples.
  4. Perform due diligence on the outsource provider. Research the company to determine if they are reputable and deliver a quality product on time. Ask the firm to provide references from companies that have had similar work done. Finally, ask for the qualifications of the individuals assigned to the outsourcing engagement to verify that they possess the desired skills and expertise.

G. Some Common Examples Of Outsourced Functions Are:

  1. Software implementations
  2. Tax return preparation
  3. Data entry of cash receipts (lockbox)
  4. Billing
  5. Collections
  6. Help desk
  7. Food services

III. CASE STUDY OUTLINE

A. The Company – "Arizona Widgets, Inc."

  1. Background facts
  2. Types of items held by Company that should be reported as "Unclaimed Property."

B. Group Discussion – What Possible Exposure Does Arizona Widgets Have For Unclaimed Property (prepare list of items)

C. Wrap Up Discussion by Moderator