Unclaimed Property: The Changing Landscape

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Cecilia Caldwell
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1 Unclaimed Property: The Changing Landscape Mark. K. Webster / Treasury Alliance Group LLC Robert S. Peters / Duff & Phelps, LLC March 12th, 2010

2 Agenda Unclaimed Property: Overview The Perfect Storm: State Trends Types of Unclaimed Property Gift Card Developments Consumer Rebates Planning to meet, but not exceed potential liability 2

3 A Little History Traditionally unclaimed bank accounts On the corporate side, it does include uncashed payroll and dividend checks. Typically considered a pure compliance function often administered by low level personnel. Historically state personnel responsible for administration were sparse and enforcement of rules was lax. Due to lack of enforcement, most companies considered the area a low priority with nominal financial risk. 3

4 Unclaimed Property Unclaimed Property refers primarily to intangible items that for some reason or other remain uncashed, unapplied or otherwise unaccounted for: Bank Accounts Safe Deposit Boxes Uncashed checks Payroll Vendor Dividend Unapplied Credit Balances Unused gift certificates, stored value cards, etc. 4

5 Who Benefits? 1 st Priority Last known address of owner/payee 2 nd Priority Location of company/holder 3 rd Priority Location of transaction 5

6 Growth In UP Collections $ Billions $ Billions Collections Returns Source: When Unclaimed Property Becomes Unclaimable Marketplace Money

7 Sarbanes-Oxley Concerns Unquantified or potential liabilities for escheatment of unclaimed property present very real concerns for CFO s, Controllers and Treasurers Public companies have been cited for material weaknesses resulting from unclaimed property Virtually all public and private companies are faced with the challenge of: Estimating exposure Remediating past liabilities Establishing ongoing compliance procedures Planning opportunities still exist to reduce liability 7

8 New Awakening! States have aggressively stepped up audit and compliance campaign Ability by states to reduce budget deficits without raising taxes Bounty Hunters: third party contingent fee audit firms Audit firms are using sophisticated statistical audit techniques to uncover unreported unclaimed property Audits can extend for long periods (3+ yrs) tying up considerable internal resources No Statute of Limitations 8

9 States Looking Everywhere Expanded Definition of Unclaimed Property Accounts receivable (customer) credit balances, customer overpayments Unidentified remittances, unapplied cash, security deposits, refunds, credit memos, lease, royalty payments Write-offs to miscellaneous income Inventory received, not invoiced Bottle deposits Unredeemed gift certificates, gift cards, stored value cards $87 Billion in Gift Cards: $7.8 billion unredeemed 9

10 GIFT CARDS 10

11 Types of Product Gift certificates Gift cards Closed-loop Open-loop Other Merchandise credits Promotional cards Telephone cards Other stored value products (e.g., Mio card) 11

12 Unclaimed Property? Are unredeemed gift cards unclaimed property? About 30 states have some type of exemption for gift certificates and/or gift cards : BUT BEWARE! Sometimes, conditions to receive exemption GCs cannot have expiration dates or fees GCs must be below a certain dollar amount (e.g., $100) GCs cannot be redeemable for cash State may not define gift certificate or gift card Even if defined, inconsistent treatment of open-loop cards, promotional cards, etc. 12

13 Are Cards Escheatable? If cards are escheatable, what is the amount subject to escheat? Majority States: price paid for gift certificate Several States: 60% of face value A few allow retailers to keep their profit margin and escheat only cost of goods sold If GCs have fees, may be deductible if: imposed pursuant to valid and enforceable written contract, charges are not regularly waived and charges are not unconscionable (new federal laws) 13

14 How to Minimize Escheat GC ReOrganizations First-priority rule: Often a concern if GCs sold online or with rewards/loyalty programs Second-priority rule: The holder can be domiciled in a state that has favorable unclaimed property rule for GCs Third-priority rule: Strong arguments that this rule is unconstitutional, but sometimes restructurings can be designed to avoid the rule altogether 14

15 Legal Issues 1 Consumer protection issues Use of fees and expiration dates Disclosure issues Contract issues, particularly in negotiation with gift card processing company Tax issues Deferral of recognition of income under IRC Section 451, Rev Proc , and newly issued TAMs State tax nexus issues 15

16 Legal Issues 2 Potential application of third priority transaction-based custody rules Pre-existing GC liabilities Potential challenges to Giftco structure: Lack of business purpose? Lack of Economic substance? On public policy grounds? As a result of their independent dealings with purchasers? 16

17 Do They Work? If undertaken for valid business purposes and properly implemented, GC reorganizations are, we believe, perfectly legal If properly structured, implemented and operated, a GC reorganization should result in the GiftCo being considered the holder of the unredeemed GCs for UP purposes States (including DE and NY) have consistently respected these structures on audit if properly implemented 17

18 REBATES 18

19 Rebate Agenda Rebate trends Evolving positions of the states, courts and holders? Overview of the rebate controversy Rebate replacement vehicles the good, bad and ugly What s a company to do? Likely next steps in ongoing controversy 19

20 Rebate Trends Rebates continue to be growing trend in the consumer market industry for over the past 20 years Rebates have surged from less than $10 million to over $100 billion since 1990 Rebates as a marketing strategy continue to attract customers into stores 75.4% More Likely To Buy 15.4% No Effect Over 850 participating rebate sponsors in retail and manufacturing sector Estimates of slippage range from 6-12 percent, or more, of checks originally issued 20

21 Rebate Controversy Fulfillment companies practice of treating uncashed rebates as fee income, not returned or escheated as unclaimed property Rebate sponsors agreed to reduced pricing, with little knowledge of escheat implications Consumer protection advocates sought broader regulation to curb abusive past practices States looking at potential windfall to recover funds from rebate sponsors and fulfillment companies 21

22 Common Arguments We used the slippage to negotiate a lower fulfillment cost Rebates were actually funded by our vendors Based on FTC CompUSA case, vendors looked to retailer as responsible because they advertised the manufacturer rebate Our rebate form said offer is invalid if check is not presented according to our offer terms Our checks expire in 90 days (not actually accurate) in most cases they would only be dishonored 90 days after the last check was issued 22

23 Current Status Suit initiated by Iowa and 43 states against Young America, T-Mobile, Walgreens, and Sprint in Courts required each state to bring separate action, two have done so N.H. and Ak. Upheld auditors rights to obtain fulfillment company s customer lists of rebate sponsors 2009 decision laid ground work to pursue rebate sponsors vs. fulfillment companies Settlements have been reached with Walgreens and T-Mobile and now Sprint ($22 million) 23

24 Next Generation of Rebates Pre-paid gift cards: rebates or gift cards? Closed Loop: Redeemable for merchandise only at rebate sponsor or related retail store. Open Loop: Issued by rebate sponsor, or financial institution, redeemable at any retailer State Restrictions against advertising rebates in form of cards 2009 Federal Credit Card Act Fees limited to monthly charge Card must be inactive for at least 1 year, in order for fee to apply Expiration date cannot be less than 5 years Loyalty cards excluded 24

25 Pre Paid Cards Benefits include: Higher levels of consumer confidence Rebate sponsor can reinforce its identity on cards Capable of reloading cards at retail locations Potential to mitigate unclaimed property exposure Potential obstacles Misrepresentation of rebate State restrictions (MA. and Ct.) 25

26 Prepare Yourself Broaden participation in current rebate negotiations Take Inventory of: Past, present and future fulfillment supplier agreements Personnel familiar with historical arrangements Availability and access to historic bank accounts Ability to credibly research outstanding rebate checks Access impact of system conversion Consider Impact on consumers, fees paid to 3rd parties, coordination with state consumer regulatory requirements. Transactional planning is option much like gift cards. 26

27 Join fellow alumni from this and other Treasury Alliance Group programs in networking about the issues discussed and simply keeping in touch. Go to: 27

28 Contact Information Mark K. Webster, CPA, CCM Robert S. Peters

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