Issue Information

LEGAL & BUSINESS REGLUATION

UNCLAIMED FUNDS AUDIT RECOMMENDATIONS The following is a compilation of recommendations the Ohio Chamber of Commerce is making to the Ohio Department of Commerce regarding the conduct of audits for unclaimed funds authorized under Chapter 169 of the Ohio Revised Code. While not intended to be totally comprehensive, we hope these recommendations provide useful guidelines as to the business community's perspective as a Holder which, in turn, the Department will consider and incorporate into its draft rules. We trust this submission begins a productive dialogue between the Department and the business community all the way through to approval of the new rules by the Joint Committee On Agency Rule Review (JCARR). Since late 1998, the issue of audits for unclaimed funds has assumed a heightened level of importance to our members, what with the 1997 statutory change allowing the Department of Commerce to outsource these audits and other developments since then. In fact, a number of our members are major multistate corporations engaged in interstate and international commerce. Further, as Ohio corporate citizens and taxpayers, they support the most efficient and prudent use of state taxpayer dollars. However, we also want to make it clear that while these recommendations attempt to address some of the issues raised by the use of third party contingent fee auditors, we make no concession on this issue as a matter of public policy. Therefore, we feel obliged to reiterate that we dispute any notion that the 1997 budget bill outsourcing language allows the state to delegate its authority to audit for unclaimed funds to so-called third party, independent auditors, whose compensation is based on the amount they deem to be owed by a Holder. But we have other concerns besides contingent fee audits, although such audits have been a major subject of previous discussions between the business community and the Department. While the issue of unclaimed property does not involve the actual levy of a "tax," the lack of specific guidelines for administering and complying with the state's unclaimed property statutes have generated significant concerns among our members. Chief among those concerns is the fact that ordinary unclaimed funds audits, even those done by state employees, raise many due process issues besides those primarily attributable to contingent fee audits (see Attachment A). Business to Business Exclusion An issue closely aligned with the fate of contingent fee audits is the business-to-business exclusion. We believe that, historically, unclaimed funds tended to be funds due solely to individuals, such as unclaimed payroll checks, stock certificates and/or stock dividends. However, particularly with the advent of contingent fee auditors, the practice of broadening the scope of the audit to include business to business transactions has evolved. In speaking to a number of our members and from other sources, a certain pattern has unfolded. Under normal circumstances, a contingent fee auditor identifies a payment appearing to be due to a supplier or other company with whom the Holder has done business. If the corresponding journal entry cannot be identified showing actual payment of the debt, the funds are classified as "unclaimed" and are then subject to escheat by the state. But in reality, these funds are not "unclaimed" but rather are funds that "cannot be cross-referenced." The problem arises primarily from the sheer volume and number of individual transactions for many large, multinational companies and the difficulty in noting on the ledger how multiple, interrelated transactions have been reconciled. Often one payment is made for multiple transactions. While the applicable GAAP or FASB accounting principles have been followed, company controllers generally have not been concerned with cross-referencing these journal entries in the past. The extensive time, manpower, and administrative costs associated with reviewing these business transactions in such detail for multiple past years and matching them to the appropriate account entries is unrealistic and burdensome. While these are some of the reasons we cite as justification for a business to business exclusion, we believe Ohio law already provides for such an exclusion, as contained in Section 169.01 (B) (6) Ohio Revised Code, even though its parameters are undefined. We recognize, however, that a more detailed definition of the business to business exclusion should be included in permanent law, as well as the administrative code. Consequently, here is possible language proposed at the beginning of Section 169.02 Ohio Revised Code that attempts to more specifically define a business-to-business transaction: "Subject to division (B) of section 169.01 of the Revised Code AND EXCEPT FOR ANY INTANGIBLE PROPERTY DUE OR OWED, INCLUDING BUT NOT LIMITED TO OUTSTANDING CREDIT BALANCES, CHECKS OR MEMORANDUMS, OVERPAYMENTS FOR GOODS OR SERVICES, UNIDENTIFIED REMITTANCES, UNREFUNDED OVERCHARGES, ACCOUNTS RECEIVABLE, DISCOUNTS, REFUNDS, REBATES OR ANY OTHER TRANSACTION WITH A VENDOR OR COMMERCIAL CUSTOMER FROM A VENDOR RESULTING FROM A TRANSACTION OCCURRING IN THE NORMAL AND ORDINARY COURSE OF BUSINESS, the following constitute unclaimed funds." In particular, including credit balances resulting from transactions between business entities within the definition of "unclaimed property" is contrary to the truism that businesses do not, under normal circumstances, abandon property in the ordinary course of business. Credit balances are frequently not property due a creditor, do not require the "protection" of the State, and are so common in commercial transactions that requiring such items to be turned over to the State unnecessarily increases the cost of doing business. Unlike most individuals, businesses have standardized accounting systems to track accounts, and hire bookkeepers, accountants and attorneys to monitor their finances. Accordingly, if a business does not pursue a credit balance on another business' books, it is highly likely that the credit discrepancy was already paid or resolved, or never existed in the first place. Errors such as recording duplicate or incorrect amounts, calculating improper exchange rates or posting amounts to incorrect accounts often result in unresolved credit balances. Further, many credit balances are only promised discounts premised on future purchases, which remain uncollected if such purchases aren't made. For these reasons, credit balances between businesses should appropriately be excluded from the definition of unclaimed property. Such a rule thereby places the recordkeeping burden on the appropriate party in the business transaction - the party with the financial incentive to collect legitimate outstanding debts. The cost to those businesses that enter into millions of transactions of tracing such items and proving that they are not abandoned property far exceeds the societal benefits of turning over the relatively few accounts that are legitimately owed and unclaimed. In sum, our intention in proposing this language is to exclude banking transactions and confine the exemption to the mercantile business marketplace. The concept is to only include the payment/purchase of goods or services in the normal course of business, merchant to merchant. Looked at from the point of view of the Holder¹s customer, therefore, the transaction is seen merely as an accounts payable function. Consequently, the only subsections of Section 169.02 that would have to be amended due to this language are subsections (N) and (P). General Comments Any set of new rules governing third party contractors or other individuals or organizations performing unclaimed funds audits should include the following general areas: scope of the contract between the State and the Contractor; qualifications of the Contractor; Contractor's scope of authority; entrance conference with the Holder; audit examination by the Contractor; Contractor's reporting requirements; confidentiality of information; and dispute resolution. The current rules fail to address many of the business community's concerns regarding the conduct of an audit by a Department employee, much less a third party. As a result, they need to be greatly expanded to protect Holders from potentially abusive practices or Contractors. Scope of Contract Between State and Contractor Our focus in this regard is disclosure to the Holder of the details of the contractual arrangement between the State and the Contractor. In particular, we would ask for disclosure of the following pieces of information before commencement of an audit: Time period of the contract Payment terms/consideration with the Contractor, including: percentage of collection calculation or flat fee ceilings (either on a per examination or entire contract basis) Events which would terminate the contract Terms of the contract that may limit the liability of either party Contractor's required compliance with applicable state and federal law Contractor's obligation, if any, to indemnify the State or Holder based on the Contractor's negligence or other malfeasance Copy of the contract itself. Qualifications of the Contractor Our objective in this regard is that there be minimum standards/qualifications a third party auditor or Contractor must meet and thereafter certify in order to conduct a State-authorized audit examination. In using the term "Contractor", we also include the contract auditor's employees or subcontractors hired by or working for the contract auditor. In this regard, we believe the minimum qualification standards should include: Statement that the Contractor is familiar with the State's unclaimed property laws, regulations, case law and reporting requirements Identification of the number of years each Contract Auditor has been working in the subject area and the level of education completed by each Auditor Completion of a NAUPA-supported training program that contains both technical and Holder-interaction aspects once the program is developed and made available to Contractors Participation in any peer review programs established by the State or its designees (including NAUPA) State having the right to reject any Subcontractor based on qualifications or performance. Contractor's Scope of Authority To Conduct Unclaimed Property Audits While much of the discussion between the Department and the Chamber has revolved around what we perceive to be the inherent conflicts of interest contingent fee auditors face in performing the actual audit examination, there are other potential conflicts of interest that ought to be specifically addressed, if not prohibited. As a general policy statement, we believe that third party auditors shall not participate in examinations in which such participation could be construed as a conflict-of-interest. Some common examples are: Contractor entering into an agreement with or having an existing obligation to the Holder; Contractor signing a confidentiality statement purporting to preserve the Holder's interest; and, Contractor maintaining a file of confidentiality statements and promising to provide such statements to the State upon request. The above situations are obvious conflicts of interest and should be prohibited to have a fair and independent audit program. However, more needs to be done and we would recommend the following additional requirements: Contractor must disclose the signed confidentiality statement to the Holder Establish penalties on the Contractor and remedies for the injured party (Holder, State) if the Contractor violates the conflict-of-interest rules, possibly including a fine, damages to the Holder, loss of contract, loss of fees? Ironclad prohibition against a Contractor (and/or its affiliates or subsidiaries) contracting with the State to perform audits and using information gleaned from the examination to solicit would-be claimants from such examination If the Contractor has provided processing or consulting services regarding the Holder's unclaimed property within the past three (3) years, then the Contractor should be prohibited from auditing the Holder. We also submit the following recommendations related to the Contractor's scope of authority: Disclosure of the extent of the Contractor's right to examine records, request and receive records from a Holder (types of records needed such as bank reconciliation statements, asset logs, etc. and over what period of time) Only state officials can authorize "legal action" (i.e., issue assessments, initiate litigation, start collection proceedings) Disclosure of the Contractor's obligation to consult with State officials regarding choice of companies for audit and interpretations of law and policy Contractor must utilize its best efforts to schedule the audit so as to mitigate the demands placed on the Holder Contractor must have specific authorization, in writing, from a State Unclaimed Funds Division official to engage in an audit examination and this writing must identify the entities to be audited Contractor and the State are jointly responsible for ensuring that any Subcontractor used during the audit complies with all administrative rules. Entrance Conference To facilitate clear channels of communication, we believe the Contractor must schedule an entrance conference with the Holder before beginning the audit. This will serve several purposes: Identify the types of property that will be the subject of the audit, the time period covered by the audit, and the dormancy periods for each type of property under audit Explain the types of audit methods employed by the Contractor *** Because we believe there are insufficient constitutional safeguards for Holders, we are opposed to statistical sampling and urge that it be prohibited, unless the Holder and Contractor agree to its use and specific sampling methods. While some companies and the Contractor may prefer a statistical audit because it can be completed quicker and less intrusively, it is only the actual records themselves that can give an accurate accounting of the Holder's compliance. *** Explain the types and number of prior years' records the Contractor expects to request during the examination Scheduled commencement and anticipated date of completion of the audit List the State employee(s) who can be contacted regarding the audit. We also recommend that within ten (10) business days after completion of the entrance conference, the Contractor must provide the Holder with an Entrance Conference Letter summarizing the items discussed during the Conference, including the types of property under audit and the time period. Audit Examination By the Contractor The Contractor should be required to prepare working papers that serve as documentary evidence of the work performed during the examination. This level of detail is beneficial to the Holder and will ensure greater efficiency in the audit. We would also request that at least thirty (30) business days notice be given by the Contractor prior to the audit. If the time selected for an audit is in conflict with critical business activities of the Holder (i.e., month end close, merger/acquisition), the Contractor should make every effort to reschedule at a time convenient to the Holder within a reasonable period. Contractor's Reporting Requirements The emphasis here is that regular, timely reports by the Contractor to the State should be submitted periodically. These reports should show the detailed status of each examination and be available to the Holder as it relates to the steps in the audit plan as identified in the Entrance Conference and Entrance Conference Letter. In addition: Contractor should provide the Holder and the State a Closing Conference Letter containing its preliminary findings and workpapers within ten (10) business days after conclusion of field work Any proposed assessment must be explained in detail, including the types of property generating any underpayment After all material issues associated with the audit have been resolved and the Holder and Contractor have agreed to a final assessment, if any, the Contractor will provide the Holder and the State an Audit Report summarizing the ultimate conclusions of the audit, any payment between a Holder and the State, and a statement that the audit is closed. Confidentiality of Information The Contractor during an audit is reviewing highly sensitive, proprietary material such as customer lists, financial statements and business plans in preparing its report. Because of this, and the Contractor's legitimate need to analyze such information, there is no way to prevent the Contractor from encountering confidential information that is ultimately disclosed to the State. Therefore, we believe severe penalties must be established (whether in rule or statute) to sanction Contractors who abuse their positions of trust. Finally, we believe the Contractor must acknowledge that it is prohibited from disclosing information obtained during the audit to third parties and the Holder should be entitled to damages if this duty of confidentiality is breached. Dispute Resolution The opportunity for Holders to have an informal hearing to raise objections to the examination is very important. Ideally, an independent hearing board is preferred, but an appeals procedure within the Department would be a good starting point. At a minimum, however, there are three prerequisites we would bring to your attention: State should arrange for a hearing at a mutually convenient time Establish a minimum number of days after receipt of the appeal request that the hearing must be held unless waived by the Holder Any administrative hearing board should not allow or require a contractor representative to be a member. One last suggestion our members support is that the filing of a good faith report by a Holder should start the running of the statute of limitations for an audit. This would require amending Section 169.03 (F). ATTACHMENT "A" Procedural Due Process Details To Be Resolved In connection with the rulemaking process, a number of due process details should be discussed and addressed. If we fail to resolve such issues, there is a strong likelihood that the courts will be making those rules in future cases, a prospect providing ample incentive for both sides. This list assumes we are writing on a clean slate and is not intended as either a supplement to or substitute for the Recommendations made in the accompanying document. In other words, these are general questions or issues regarding the many aspects of unclaimed funds audits our members would like to see resolved in the final administrative rules. Will unclaimed funds dispute proceedings be open to the public? Will Holders have an unclaimed funds "bill of rights" similar to the taxpayers' bill of rights contained in R.C. 5703.50-.54? Will special pleading be required, or will notice pleading be sufficient? Will the rules be liberally construed in similar fashion to the rules of civil procedure? What will be the appeal venue? Common Pleas Court, Court of Appeals, Franklin County Court of Appeals, Board of Tax Appeals, or other quasi-judicial body? Will Holders be entitled to an appeal as of right to the Ohio Supreme Court? Will Holders be permitted to amend original notices of appeal? If so, when and how often? Will Owners have the same appeal and discovery rights as Holders? Will Holders and Owners be entitled to discovery from Auditors? How will discovery be supervised? What will be the standards of review at the various levels of adjudication? Can notices that are deficient in some respect be cured or amended? How will principles of estoppel, laches, res judicata, etc., be applied? Under what circumstances will costs and attorneys' fees be awarded? What constitutes valid service of pleadings and notices of appeal and to whom? Can the Holder withhold payment until a dispute has been resolved at a certain level? Can additional evidence be introduced at appellate levels?