The line between theft and ownershipt

In a situation that might come as a shock to many mid-Atlantic residents, California has become the center of the universe, at least as far as unclaimed property is concerned. The state has been the focus of considerable debate and a growing legal storm over reclamation of unclaimed bonds, stocks, payroll checks, insurance payouts and other financial payouts.

Unclaimed property, not always at the top of the corporate secretary’s or general counsel’s focus list, has been attracting growing attention in recent times. Changes to proxy distribution and voting rules are resulting in a renewed focus on shareholder compositions at public companies.

The big news in the world of unclaimed property, however, involves the state of California and its mishandling of public and private unclaimed property.

The state’s unclaimed property fund has endured a turbulent history and late in 2007 federal Judge Seeborg, of the Ninth Circuit Court, ruled that the state must pay interest on the $5 billion fund. This leaves the state needing to find almost $507 million dollars to cover its liability for 8.7 million accounts in the unclaimed property fund. Some experts believe the total interest may in fact top $1 billion. The ruling overturned a 2003 law that had halted interest payments.

Judge Seeborg made the ruling in Suever v. Westly/Connell (Westly and Connell are former state controllers). He determined that accrued interest must be restored to the $5.1 billion in private funds. Some of the accounts have been accruing interest since 1959.

Many states have, over the past several years, aggressively pursued unclaimed property and seem to view it as a good revenue stream. Laws have been broadened to include a wider range of ‘property’. The timeframe that an asset must remain inactive before it can be deemed unclaimed has been reduced; in California it has shrunk from seven years to only three in certain circumstances. For stock, it’s three to seven years without cashing dividend checks, voting proxies or otherwise contacting the issuer or brokerage. And many states now employ teams of auditors to examine corporate books to locate any lost or inactive property.

The requirements for locating the rightful owners of the property have, in many states, also been reduced, making it even easier for the states to reclaim funds.

Leading the pack
While many states have been actively pursuing unclaimed property as a way to bolster their coffers, the changes in California have been the most invasive and probably the most important. The state holds almost a seventh of the nation’s unclaimed property value.

In May 2007, a federal appeals court in San Francisco found that the state made a routine practice of seizing and liquidating unclaimed assets without making proper attempts to notify the owners before taking action. The court subsequently barred the state from accepting unclaimed assets until a new notification system was put in place.

So why is this important? Many investors, upset by what they see as the theft of their assets, are taking legal action against the state to get the property back and also secure interest they should have earned while the stock was in state hands. They are also looking to the corporations to make a better effort to identify owners before releasing shares to the state.

For the past 30 years California paid interest of 5 percent, compounded annually. That rate has changed several times in the past few years (before interest payments were stopped). Judge Seeborg is determining exactly how much the state is going to have to pay.

Apart from the payment of outstanding interest accruals, the state also faces claims that non-cash property was illegally taken without proper notice to its owners and transferred into the unclaimed property account.

Several cases involve stocks and bonds whose value escalated between the time the state took possession of the asset and when the owner realized the property had been transferred to the state.

California’s new state controller, John Chiang, who took office after many of the aforementioned legal problems had already occurred, wrote on the state’s website: ‘For two decades, misguided state laws restricted my office from contacting the owners of what amounted to more than 80 percent of all unclaimed property accounts sent to the state.’

A spokesman for Chiang points out that reform legislation passed in 2007 makes California one of only two states (along with Hawaii) that require an attempt to notify owners before their property is seized.

The controller recently added property targeted for seizure to a website that allows persons to search for property that has already been taken.

Claiming the unclaimed
A number of important legal cases came to rulings during 2007. Apart from Suever v. Westly/Connell there was a suit brought by Chris Lusby Taylor. This case resulted in the California unclaimed property program being shut down for almost four months from June 2007. After a review of policies and procedures, and a vow to enforce more rigorous rules for locating owners of dormant stock, the program was reopened.

Taylor was an employee at Intel during the 1970’s and 1980’s. Based in Europe, he designed microchips for the Silicon Valley tech giant. His wife was also a company employee. She served as general counsel for the European division.

During his tenure at Intel, Taylor accumulated 52,224 shares in the company, which he deposited with a London-based bank. Despite having the original share certificates safely locked in the bank, the shares were not safe from the state of California’s controller’s office. In 1992 the state declared the stock ‘unclaimed’ and seized the shares. This was done without making any real attempt to notify Taylor.

The stock was deemed unclaimed because Taylor had not cashed any dividend checks or voted a proxy within three years. As his lawyer, William Palmer points out, the company did not issue dividends during that period so this was far from a fair test. And as most of us know, many retail shareholders never even open proxy statements. We just throw them in the garbage.

After the shares were deemed unclaimed the state demanded that Intel issue replacement certificates which the state then promptly sold and used the revenue for funding general state activities.

It is worth noting that Intel is not even officially a Californian company. It is listed in the state of Delaware.

Taylor discovered the transfer several years later when he went to sell some of the shares and then filed a claim against the state. He was originally offered $200,000 but Palmer took the action to court demanding that the shares be valued at the current market value and that amount be paid to his client. A federal appeals court ruled Taylor was entitled to the current value of the shares, then roughly $3.8 million.

Taylor has since settled his case but many others like his remain open and a new class action is pending against the state which could have devastating effects on the controller’s office.

The state controller’s office says it is taking steps to improve the situation. Chiang has taken steps to improve notification procedures and decreed that seized stock be held for up to two years before being sold. His office also maintains a website that lists the names of all people whose property has been seized.

Part of the problem is that, like many other states, California outsourced unclaimed property recovery to private vendors. These vendors would trawl through corporate and state records looking for any dormant accounts and then report those to the state. They are paid a commission on every dollar that is recovered and it is argued that under this model they have very little incentive to find the real owners. If the owners are found they do not get paid.

Time for review
Some states are looking to review this model but it is unlikely to change quickly. Many states rely heavily on unclaimed property as a source of income. The state of Delaware, the legal home to most large US public companies, reports that unclaimed property is the number three source of revenue, accounting for almost 11 percent of the state budget.

Although the states are required to return the value of holdings when the rightful owners step forward, most of the time no one makes a claim and the states are then permitted to use the money for public programs such as schools, infrastructure, public health and prisons.

The New York state controller reports on its website: ‘Every year, hundreds of millions of dollars in unclaimed funds are turned over to my office. The money comes from a wide variety of places: dormant bank accounts, un-refunded utility deposits, forgotten stock certificates, unredeemed gift cards, life insurance policies never cashed in or tax refund checks that never found their way home. When the rightful owners don’t claim their money, the law requires companies to turn the money over to my office to keep safe on your behalf.

My office is stepping up its efforts to inform the public that we’re holding $8 billion of abandoned or unclaimed property in 22 million different accounts. We want to give that money back to its rightful owners. Last year, we reunited $169 million with rightful owners, and this year we hope to have even better results. While we occasionally process claims for thousands of dollars, most claims are in the $50 to $100 range.’

Companies need to take action
But the onus for identifying and returning any unclaimed property does not just fall to the states. In the case of stocks and shares, the companies are required to take steps to locate the rightful owners before turning funds over to the state. Conducting regular odd-lot clean ups and unclaimed property reviews will help to identify owners of shares who may have been inactive for several years. Cases such as that of Taylor and his Intel shares can have a damaging effect on corporate reputation. Several legal sources are suggesting that after various actions against the states are completed it is likely the plaintiffs will turn their attention to corporates. The argument is likely to be that shares should never have been turned over in the first place.

But there is another reason for companies to be keeping a close eye on its shareholder base and locate any unclaimed shares. The new proxy distribution rules that are widely referred to as ‘notice and access’ have resulted in a renewed focus on investment bases at public companies.

While adoption of the notice only model, where a company sends out a notice of availability of proxy statement to shareholders and then posts the full proxy and voting tools on a website, has been slow, the changes have driven most companies to take a much closer look at their shareholder base.

Under the notice only model, companies with large and dispersed retail share ownership are concerned about potential loss of voter turnout and challenges in achieving quorum requirements.

Of companies that have chosen to adopt the notice only model, many of them are looking to undertake an odd-lot clean up in order to consolidate the retail shareholder base before voting takes place. Having fewer total accounts should make it easier to achieve required voting levels, experts explain. Intuitively it would seem to make sense that dealing with a small number of accounts – which also have larger holdings – would be easier than trying to get thousands of small investors who may only own a few shares each, to vote.

Ensuring maximum voter turnout, maintaining a solid reputation among investors and ensuring that millions of dollars worth of shareholders’ assets are not turned over to the state are just a few important reasons to more closely monitor who owns your shares and where they might be.