What's in an Unclaimed Property Securities Audit?

A baby with moneyThe dreaded unclaimed property audit has taken a turn for the worse. In the past, many Delaware audits have focused solely on general ledger properties, including payroll, accounts payable, accounts receivable, rebates and gift cards. Current audits are now including securities as an additional property type; these securities audits are often conducted in parallel with a general ledger audit.

Securities audits are designed to determine unclaimed property compliance for company shares and dividends. Like the general ledger audits, Delaware maintains that it has authority to audit going back to transactions in 1981. This could lead to large, previously unconsidered exposures for many companies.

The Role of the Transfer Agent

Most publicly-traded companies have outsourced their securities management to an outside party, called a transfer agent. A transfer agent generally performs three main functions, according to the Securities and Exchange Commission (“SEC”), including:

  1. Issue and cancel certificated to reflect changes in ownership. In other words, the transfer agent is responsible for maintaining the books and records which establish ownership interests. The transfer agent is to keep track of who owns the shares and how many, including any restrictions placed on those shares.
  2. Serving as the intermediary for the company. This function includes mailing of necessary forms and notices to shareholders, issuing dividends, and serving as exchange or tender agents when necessary.
  3. Handle lost, destroyed, or stolen certificates. This function includes a general administrative quality of dealing with shareholders and their ownership interests.

When it comes to unclaimed property audits, the transfer agent should have the books and records necessary to complete the document requests from the auditors. These requests are sent to the company, who then coordinates with the transfer agent for the production of the records.

The requests are often burdensome, including a listing of all current shareholders, their ownership interests and contact information. The information request will also demand certain key information about each account, including when the last shareholder initiated contact was made (change of address, increase or decrease in ownership interest, or proxy/shareholder meeting vote).

Kelmar will also request information relating to policies and procedures for contacting shareholders, including how often mailings are made, how undeliverable mail is handled, and other similar procedures. Has your transfer agent properly implemented the SEC regulations related to lost payees?

Transfer agents can generally respond with a relative ease for requests about current shareholders and recent transactions. However, Delaware will often inquire about older transactions, particularly about mergers or acquisitions of publicly traded companies. Transfer agents often serve as exchange agents when such mergers or acquisitions occur and thus would have the necessary records to answer the question “have all the shares been exchanged?”

Record Retention

Federal law and SEC regulations require that companies, and therefore their exchange agents, maintain records for various time periods. The most common time period is six years. During this time, the SEC or other entities may audit the records for compliance with various laws and compliance schemes. However, this record retention policy comes nowhere near the requirements of a Delaware unclaimed property audit.

Delaware maintains that it may audit records back to 1981, although temporarily limited to a shorter look-back period. Almost no company, but particularly transfer agents, set their record retention policies to 30 plus years, to accommodate Delaware’s audit process. As such, extrapolations would have to be made, whereby the state estimates the amount of unclaimed property due in those early years. In the general ledger audits, these extrapolations have often bee n called excessive. The potential extrapolations for securities audits could be egregious and unconscionable.

Audit Methodologies

To overcome the burdensome requests of providing all the records, which could number in the millions for a large publicly traded company, Delaware agreed with the Securities Transfer Agent Association (“STA”) to rely on a sampling methodology to conduct the securities audits. This could include “systematic sampling (e.g., every tenth item in a population of 1,000 records); random sampling; block sampling; or risk-weighted judgmental sampling.” As of December 2012, STA reported that its members were still being asked by Kelmar Associates, Delaware’s third party contingent fee auditor, to provide 100% of the records requested and were not relying on sampling methodologies. In addition, STA reported that Kelmar requested screenshots of each account, and not spreadsheets of the records, thereby increasing the burden on holders. In Barganier’s experience with securities audits, Kelmar continues to require full documentation of each shareholder account, regardless of whether the shareholder resides in an audit participating or non-participating state.

Consequences to Holders

Holders contracted with transfer agents to handle the securities duties for the company. Transfer agents set their record retention policies in accordance to federal laws and regulations, not with state unclaimed property audits in minds. Further complicating the availability of records, transfer agents have undergone a series of mergers and acquisitions, resulting in the general unavailability of records for holders. This has given Delaware the opening it needs to open audits where it could create large extrapolations in favor of the state. In furtherance of this goal, their private firm auditor is requiring full documentation and not conducting audits based on generally accepted audit practices, including sampling. Holders can expect this trend to continue, with burdensome and costly requests from Kelmar followed by potentially egregious extrapolations when records are incomplete or unavailable.

See Also:
California Sues Life Insurance Company for Impeding Audit
Unclaimed Property Audit Nightmares: Select Medical Corporation
More Emphasis on Delaware Incorporated Entities to File Unclaimed Property Reports