Unclaimed Checks: Delaware on the Hunt Again?

Operations and compliance managers at US banks had better be prepared to defend their escheatment policies for uncashed checks and money orders to Delaware.

The state could use the data it uncovers during the discovery period of a Supreme Court case involving MoneyGram’s uncashed “official checks” to dig deeper into the unclaimed property records of financial firms in more than 20 states. Legal experts in unclaimed property warn that Delaware could even fine any financial firm it thinks didn’t report and turn over to the state a sufficient number of any uncashed checks and money orders.

Unclaimed accounts and other funds represent a cash cow for state coffers. States typically use the monies to close their budget gaps and return only a fraction of the accounts or cash involved to its rightful owners. Abandoned property, including money orders, accounts for about 15 percent of Delaware’s state government’s annual revenue, according to a task force that studied how the state collects revenue. That figure makes abandoned property the third largest source of revenue for Delaware.

When checks, money orders and other similar financial instruments remain uncashed for a few years, financial firms must report and escheat them to Delaware or another state. Should Delaware think it didn’t get its fair share, it could decide to fine a firm far more than the value of the account or the funds in question — up to 100 percent of their value. That punitive penalty is in addition to the value of the unclaimed account or money in question and interest for each year the account or money was not escheated.

Banks and broker-dealers know they are on Delaware’s radar. Compliance managers at three East Coast banks tell FinOps Report they have already instructed their operations managers to collect all information on uncashed checks and money orders going as far back as possible. “This isn’t the first time Delaware has been aggressive with its investigative tactics,” says one compliance manager. “The discovery period of the Supreme Court case just expands its reach to unclaimed checks and money orders, and gives it one more reason to conduct an audit.”

At the crux of the case between Delaware and over twenty other states now before the Supreme Court is whether uncashed “official checks” issued by MoneyGram belong to Delaware or the other states. Those include Alabama, Arizona, Arkansas, Colorado, Florida, Ohio, Oklahoma, Texas, South Carolina and Utah. The high court must decide whether to apply a 1974 federal statute or federal common law. That means previous Supreme Court decisions. The Supreme Court was forced to hear the case because it involved a dispute among states.

MoneyGram has been sending its  uncashed “official checks” to Delaware, but the other states want the estimated US$160 million. They say that based on their intepretation of the 1974 statute, they are entitled to the money if they were one of the states in which the MoneyGram “official check” was purchased. Delaware counters that the 1974 statute, called the Disposition of Abandoned Money Orders and Travelers Checks Act, doesn’t apply to MoneyGram’s “official checks.” It only applies to uncashed money orders and “similar instruments.” Therefore, MoneyGram’s “official checks” fall under the jurisdiction of federal common law and Delaware is entitled to keep the money.

The Supreme Court has previously ruled that when unclaimed accounts have no known address of their owners, the accounts must be returned — or escheated– to the state of incorporation of the issuers. MoneyGram’s uncashed “official checks” do not include any addresses. MoneyGram, which issues cashiers checks or tellers checks on behalf of other banks, is headquartered in Texas but incorporated in Delaware.

According to a January 31 letter to Judge Pierre Leval, the  special master appointed by the Supreme Court to help it rule on the case, Delaware and the states involved have agreed that the states would give Delaware data for the past ten years on all uncashed checks and money orders, not just MoneyGram’s “official checks.” Delaware would also receive any correspondence between the states and the ten largest holders of unclaimed checks and money orders about what the states have informed them as to their policies regarding whether particular types of instruments are “money orders, “similar instruments,” or “third-party bank checks.” Those policies would reveal how a state interprets the 1974 federal statute.

Delaware says it will use the data it receives only to prove its argument that it is entitled to the MoneyGram uncashed “official checks.” However, the law firm of Reed Smith suggests that Delaware is on a fishing expedition. “Despite Delaware’s explanation of how it would use this information, Delaware could use this information to audit targets,” writes Reed Smith in a blog dated January 31. “Indeed, Delaware has already indicated that it intends to use this information in order to conduct third-party discovery so it would not be much of a leap for Delaware to use this information in audit selection.” Reed Smith declined to respond to any further questions on its stance. The firm served as lead counsel in an amicus brief filed by the Unclaimed Property Professionals Organization which asked the Supreme Court to clarify federal laws on unclaimed property.

Unclaimed securities and other accounts are an operational and legal burden for financial firms because states have different requirements as to when an account is listed as unclaimed, how long the dormancy period lasts and how it must be reported and escheated. Financial firms must develop policies as to when and why to list unclaimed accounts as “abandoned” and keep track of the dormancy period– the number of years they have to wait before they must report and send the accounts to a particular state. Financial firms have to document every step they take to prove they have followed the correct state’s escheatment statute.

Unclaimed checks and money orders are typically far harder for financial firms to handle than unclaimed securities accounts. Their decision on which state to send the unclaimed checks and money orders often depends on how they interpret the 1974 federal statute. Industry practice is to consider unclaimed securities accounts as being governed by federal common law.

“Compliance managers will need to prove to Delaware that they have been following their financial firms’ policies when it comes to how they designate a check or money order as uncashed and unclaimed,” says Kendall Houghton, a partner at the law firm of Alston & Bird in Washington DC. “They must also explain the reasons they may have deviated from their policies.”

Internal counsel typically create the policies on unclaimed property, which are then translated by compliance managers into rules and procedures. Operations managers then use those rules and procedures to help IT managers code a workflow process into their back offices as to when accounts are flagged as abandoned and when they are reported and escheated to a particular state.

“The fact that a financial firm has been following its policies won’t preclude the possibility that Delaware will find cause to penalize it,” cautions Houghton. “The firm will just stand a better chance of defending its decision should Delaware dispute its rationale.” The only recourse financial firms have to overturn Delaware’s financial penalty will be to appeal to Delaware’s Chancery Court.

During the discovery period of the Supreme Court case, operations managers at financial firms will need to produce at least ten years of records showing why and when they flagged a check or money order as unclaimed and why and when when they transferred the funds over to a state. That could be either Delaware or another state.

If a firm can’t produce all of its records for the entire ten-year period during an audit from Delaware, it could be forced to accept Delaware’s estimate of the value of the funds that were not escheated. Delaware would also impose additional fines.

What to Do

“Operations managers responsible for unclaimed accounts will now need to sift through their records to determine which accounts have been escheated to a state other than Delaware,” says Benjamin Blair, an attorney with the law firm of Faegre Baker Daniels in Indiannapolis. “If a financial firm has escheated an account or money to another state, it can ask for indemnification from the other state.”

Practically speaking, Delaware would then have to take up its dispute with the other state and not the financial firm. Most states do indemnify financial firms from liability from other states for accounts and funds already escheated.

Should a check or money order meet the definition of abandonment, but has not yet been escheated to any state, Delaware could claim it is entitled to the funds rather than the state marked by the financial firm on its back office system. Or Delaware could even say that an uncashed check or money order should have been marked as uncashed and abandoned if the firm has not done so already.

Financial firms concerned about a potential audit from Delaware could always decide to accept its “voluntary disclosure” option, says Blair. The financial firm would then stand a fighting chance to negotiate the number of years worth of records Delaware wants and limit its fine. Delaware would still likely require all of the funds it deems abandoned and reportable to Delaware plus interest. Delaware would waive any larger punitive fines.

However, the “voluntary disclosure” option comes with one big catch. The financial firm and Delaware would have to agree to a methodology to calculate any potential money due to Delaware if the financial firm can’t come up with its records for any of the 10 years. Delaware has the ability to require a particular methodology be used to complete the voluntary disclosure. The calculation might not be in a financial firm’s favor.

Financial firms could ultimately have more to worry about than just what to do during the discovery period of the case involving MoneyGram’s uncashed “official checks,” warns Blair. Banks and broker-dealers might have to change their escheatment policies and procedures depending on what the Supreme Court decides. And that is not just for uncashed checks and money orders.

Some legal experts believe that the Supreme Court could rule in Delaware’s favor based on the court’s 1993 decision on a dispute between Delaware and New York. In that case, involving unclaimed dividend and interest payments, the high court ruled in favor of Delaware saying that the payments must be returned to the state of incorporation of the issuer involved when the investor cannot be located.

However, other experts contend that the Supreme Court could use the case involving MoneyGram to take a broader look at how unclaimed securities accounts and other property is handled. “There is always the possibility the Supreme Court might take the opportunity to overturn its previous decisions and rewrite federal common law about unclaimed property,” says Blair.