On Saturday, April 1, 2017, the Delaware Department of Finance (DOF) promulgated two regulations that would repeal all existing unclaimed property regulations and replace them with a single DOF regulation containing a revised Reporting and Examination Manual. The Secretary of State (SOS) also promulgated a regulation that outlines the method of estimation to be used for participants in the Voluntary Disclosure Agreement (VDA) Program. These promulgations are in accordance with the General Assembly’s instructions to do so in Senate Bill 13, which was passed in January and enacted by Governor John Carney on February 2, 2017.
Any written submission in response to these regulations must be sent to the respective agency by Wednesday, May 3, 2017 at 4:30PM EST.
When in final form, the regulations take effect upon adoption. The regulations are still important to existing VDA participants and audits because “[t]o the extent practical, the Regulations shall apply to any ongoing examination [or voluntary disclosure] that commenced prior to the effective date of these Regulations.” Thus, holders in the midst of a VDA or audit should review them.
An Explanation of Sampling, Estimation, and Projection
The regulations explain the standard procedure in some depth. They provide somewhat of a judiciable standard–“reasonable representation”–for appeals of the methodology used in an audit.
The concept of “complete and researchable records” is somewhat defined. This is the standard used to determine whether projection is necessary to years for which such records do not exist. The concept of complete and researchable records has been a problem in some audits. Complete records are those that can be reconciled to the general ledger. Researchable records are those that lead to the resolution of the item. (But see below).
The pre-approved example Confidentiality and Non-Disclosure Agreement (NDA) included as part of the proposed regulations is a step in the right direction and fixes many of the reoccurring concerns with past versions utilized by the DOF. Specifically, the revised NDA contains: (i) a provision requiring holder consent prior to adding additional states to an examination; (ii) language making the third-party auditor responsible of any breach of the agreement by its representatives; (iii) a restriction allowing the third-party auditor to only disclose confidential information to the participating states that is relative to each particular participating state; (iv) a provision clarifying the restriction on the third-party auditor’s use of confidential information to solicit additional state participation; and (v) a restriction on disclosure of confidential information outside of the United States. (Some of these items were already being applied in practice). In addition, the revised NDA incorporates language relating to: (i) compelled disclosures; (ii) compliance with applicable laws; and (iii) injunctive relief.
Holders may determine which entities and which property types are included in the VDA.
Negative reports are now allowed.
The regulations explain what part of a gift card’s value may be retained by the holder (ostensibly as profit that would have been received had the card been redeemed). The amount remitted to the state is determined by reference to the federal income tax return. The formula suggested is: Line 2 COGS + Line 27 Total Deductions – Line 19 Charitable Contributions – Line 20 Depreciation – Line 21 Depletion.
New Audit Types
The regulations fail to provide any additional guidance on the “expedited” audit process or “compliance reviews” referenced in Senate Bill 13. This is troubling, given that Senate Bill 13 expressly requires the DOF to “adopt rules governing procedures and standards for a compliance review” and sets the deadline for an expedited audit election as “within 60 days of the adoption of [the estimation] regulations.” See § 1172(c), (e). Holders under audit need guidance to make an informed decision about whether the expedited audit is right for them. For example, some holders question how timelines for responses to document requests will be set and what rights they have if unrealistic timelines are imposed. None of this was touched on in the recently promulgated regulations.
One problem is proving whether researchable records exist. A holder may believe it has documentation to reach a resolution on property for a certain time period but the auditor may impose a stricter standard. It might be helpful if the final regulations or subsequent guidance provide examples of what is and is not a record that provides a sufficient resolution.
Audit Payment and Release Form
Delaware should have a standard release form that releases holders from all property types and years through the end of the audit.
Modern Indication of Owner Interest
While the regulations provide examples of actions that do not indicate sufficient owner interest to toll the dormancy period, they do not address electronic communications.
The Not Great
Holders are required to provide documents that are retained in electronic format electronically to the auditor. Holders should have the option of an on-site review to protect sensitive documents (even the best security is not as good as maintaining a document in the first place).
The term “remediation” is not defined. The remediation process should be described as well as examples of what it means to remediate and item. Examples of sufficient proof that property is not unclaimed are important for both the audit process and general record retention guidelines.
The approved remediation letter should have an additional box to allow putative owners to check off that the item is not owed–period–with no additional explanation necessary.
The Monster under the Bed (and not in a Monsters Inc. way)
To absolutely no one’s surprise, the regulations explicitly retain the status quo in Delaware’s VDA and audit practices with regard to how property with known owner addresses will be used to project liability to years without adequate records (hint: the address is not likewise projected). This practice was specifically called out by the court in the Temple-Inland case last year, but the court did not explain if and how it should be addressed.
Also to no one’s surprise, the proposed regulations expressly provide that Delaware has jurisdiction over foreign-addressed property, a position that is currently being litigated in the JLI Invest case pending in the Chancery Court.
Things to Note
There are numerical differences between an audit and a VDA. The standard base period for VDAs is two years where for audits it is three years. The exclusion from the sample for voided checks is 90 days for VDAs and 30 days for audits.
For both VDAs and audits, holders are required to provide a binding representation regarding which records are available, for which property types and for what years. However, for VDAs this representation is done early, just after scoping is completed, while for audits it is completed nearer the end, after document production is complete. While it is to be expected that holders should have a better understanding of their records entering a VDA than an audit, the reality is that the process of reviewing records may disclose that the original understandings were incorrect, particularly for complex organizations.
Non-dormant periods may be used in both VDAs and audits if other records are inadequate.
This may be a quibble, but it would be a nice pro-holder gesture for Delaware to post the auditor contracts on its website. The regulations appropriately require Delaware to make available the contracts, but only upon request. This seems like an unnecessary step.
A last known address must not have conflicting fields. For example, the state and the zip code cannot conflict for the first priority state to have jurisdiction. Sometimes an internet search can demonstrate the correct state and this should be sufficient for the first priority rule to apply.
Overall, the proposed regulations are what was expected and provide useful guidance to holders unfamiliar with the Delaware’s traditional audit practices.
The complete lack of reference to the expedited audit process or compliance reviews suggests that Delaware should issue additional guidance on these issues. Guidance on remediation and adequate records is also needed.
We encourage holders to contact the authors to discuss whether filing a written submission in opposition to all or portions of these regulations would be a productive exercise.