The past few months have been a busy time in the unclaimed property space. In addition to the normal fall reporting deadlines, there have been three major developments involving unclaimed property that impact holders.
First, the Michigan Supreme Court has remanded Dine Brands Global, Inc. v. Eubanks, a case that involves the interpretation of the statute of limitations for enforcing unclaimed property liability and that was decided in favor of the holder by the Michigan Court of Appeals.1
Second, the California Superior Court has held, in Investment Company Institute v. Cohen, that a security may be escheatable if a holder mails a due diligence notice and does not receive a response (even if the notice is not returned as undeliverable).2
While Dine Brands and Investment Company Institute address important questions and have the potential to impact a significant number of holders, neither case is final and both create additional ambiguities with respect to compliance.
Third, the Securities and Exchange Commission has entered a consent order in In re DST Asset Manager Solutions, Inc. that has the potential to impact best practices regarding escheatment for transfer agents and mutual funds.3 The DST consent order is not binding on third parties and drew a dissent from two of the SEC’s commissioners, but it nevertheless provides insight into the SEC’s approach to escheatment.
Michigan: Dine Brands remanded, creating uncertainty on the statute of limitations
Dine Brands involves the interpretation and application of MCL 567.250(2), which provides that “an action or proceeding shall not be commenced by the administrator with respect to any duty of a holder under this act more than 10 years… after the duty arose.” The Court of Appeals had concluded that an examination is not an action or proceeding and, thus, does not toll the statute of limitations to enforce an unclaimed property liability. In other words, unclaimed property reporting years can become barred from enforcement during the course of an ongoing audit.
The Michigan Treasurer appealed the Dine Brands decision to the Michigan Supreme Court on March 2, 2023.4 On September 15, 2023, the Michigan Supreme Court issued an order—not deciding whether or not to accept the case on appeal—but instead, remanding Dine Brands to the Court of Appeals to consider the specific questions.
The Michigan Supreme Court asked the Court of Appeals to consider the following: “assuming that an examination is a ‘proceeding’ for purposes of MCL 567.250(2): (1) whether the commencement of the examination tolled the statute of limitations in MCL 567.250(2); and (2) whether the Treasurer must still file a lawsuit within the applicable time frame to avoid the lawsuit being time-barred.” This question is important because MCL 567.250(2) does not contain an express provision that tolls the statute of limitations while an action or proceeding is pending, so it is possible that the Treasurer timely commenced an action or proceeding by starting an examination within ten years but that the Treasurer would still be barred from filing a subsequent action to enforce any liability discovered during that examination.
The Michigan Supreme Court’s September 15, 2023 order is not a decision on the merits, and does not actually decide that an examination is a proceeding for purposes of MCL 567.250. It is unclear if the Supreme Court intends to grant review with merits briefing and oral argument following the Court of Appeals’ revised decision or if it will instead issue a final decision without merits briefing or oral argument.5
Dine Brands has the potential to impact any holder with an outstanding Michigan audit or with potential unclaimed property exposure in Michigan. Several other states have statutes that are identical (or nearly identical) to Michigan’s, as well, so the outcome of Dine Brands could also have a knock-on effect in other states.
Thus, holders with pending unclaimed property audits in Michigan should consider how to view the statute of limitations period for their audits. To the extent the issue is material, holders at the end of their audits have an opportunity to engage with participating states to reach a mutually-agreeable resolution on the statute of limitations issue in light of the pending uncertainty.
California: Investment Company Institute’s motion for summary judgment denied, court holds securities could be escheatable if holder does not respond to a due diligence letter
Investment Company Institute addresses the question of when a security is presumed abandoned and reportable to the State pursuant to California Code of Civil Procedure 1516. Section 1516(b) provides that a security is escheatable “if (1) the [security] is owned by a person who for more than three years has neither claimed a dividend [or similar payment]. . . nor corresponded in writing with the [holder] or otherwise indicated an interest as evidenced by a memorandum or other record on file with the [holder], and (2) the [holder] does not know the location of the owner at the end of the three-year period.” (emphasis supplied). Section 1516(d) requires a holder to mail due diligence notices to owners six to twelve months before stock becomes escheatable to the state.
In 2020, the California Controller’s office issued a ruling letter that took the position that holders must send due diligence letters to owners for whom there has been no activity under subsection (1) of the rule. The Controller’s formal ruling letter interpreted Section 1516 as requiring “an affirmative determination by the holder that it knows the location of the owner based on the due diligence requirements.” If the due diligence letter was not returned by the shareholder, the Controller argued that subsection (2) of the rule had been met—the holder did not know the location of the owner.
Investment Company Institute (“ICI”) challenged the Controller’s interpretation of Section 1516 in California Superior Court, arguing that a security is escheatable only if a holder mails a due diligence notice to an owner and the notice is returned as undeliverable. ICI filed for summary judgment and raised three main arguments in favor of its interpretation of the statute. First, ICI argued that the plain language of Section 1516(b) does not provide that an owner’s address is unknown when the owner does not respond to due diligence, and that the Controller’s interpretation essentially flips the statute on its head by making a holder prove a negative. Second, ICI argued that even if Section 1516(b) is ambiguous, statutory construction principles and the legislative history of the statute support that there must be some indication that the owner was “lost” before a security could become presumed abandoned. Third, ICI argued that deeming a security abandoned after only three years of inactivity could violate due process, and that the statute should be interpreted as requiring returned mail to avoid a potential constitutional violation.6
On September 14, 2023, the Superior Court denied ICI’s motion for summary judgment. The court rejected each of ICI’s arguments and found that return mail is one way—but not the only way—for an owner’s location to be unknown. The court found that ICI’s proffered interpretation of Section 1516, that it required returned mail before the due diligence obligation is even triggered, “is incorrect and unsupported by the plain language of the statute,” and is also inconsistent with the legislative history.
However, the court also rejected the Controller’s motion for judgment on the pleadings on procedural grounds. As the Controller had not followed the proper procedure to put its construction of Section 1516 before the court, the court did not weigh in on whether the Controller’s construction (as laid out in the Controller’s 2020 ruling letter) is correct. As the court denied both parties’ motions, neither party can file an appeal, but they have several options to proceed with this case. One option would be for the parties to file cross-motions for summary judgment that raise alternative legal arguments. Another would be for the parties to conduct discovery to seek more information on the proper construction of Section 1516 and then file for summary judgment or proceed to trial once they have a more developed factual record. A third option would be for the parties to negotiate a resolution using the court’s ruling on ICI’s motion for summary judgment as guidance on the contours of Section 1516.
The decision in ICI has the potential to impact broker-dealer, mutual funds, issuers, and other holders with custody of securities. Although the decision in ICI is a non-precedential trial court decision and does not expressly endorse the position in Controller’s 2020 ruling letter, third-party auditors and states may try to point to the decision as authority for requiring holders to escheat securities even when mail has not been returned as undeliverable. In light of the court’s ruling, holders with custody of securities should consider re-evaluating their due diligence and escheatment procedures for California and any other states with statutes similar to Section 1516.
SEC: Transfer agent violated Rule 17Ad-17 by only contacting lost securityholders when it found a match based on both SSN and name (rather than just SSN); transfer agent ordered to work with its mutual fund clients to educate shareholders on the risk of escheatment.
The SEC has entered a consent order in In re DST Asset Manager Solutions, Inc. that discusses the interplay of Exchange Act Rule 17Ad-17, which governs the process for a transfer agent to locate a lost securityholder, and state escheatment law. The transfer agent in this order had a policy that it would only contact lost securityholders when it found a match based on both SSN and name, even though Rule 17Ad-17 provides that the securityholder’s name should only be used “when a SSN search is not reasonably likely to locate the securityholder.”
According to the order, the transfer agent’s failure to follow Rule 17Ad-17 caused harm to the securityholders because it resulted in about $651,000 of securities being escheated to the states. The order requires the transfer agent to take additional steps in the future to find lost securityholders and imposes a fine of $500,000.
Controversially, the order also requires the transfer agent to “[r]equest that its mutual fund clients periodically send out notifications to their client shareholder base informing them of the risk of escheatment and educating them on steps to take to avoid dormancy, including updating their addresses and otherwise establishing contact with the funds” or the transfer agent. Two of the SEC’s commissioners dissented from the order, and argue that the order’s requirement that the transfer agent request that its mutual fund clients send out notifications about escheatment is going to have the effect of a substantive rule that “implies that all mutual funds, with prompting from their transfer agents, should be sending periodic escheatment notices and conducting escheatment education for their shareholders.”7 According to the dissenters, to the extent that this type of requirement is desirable it should be accomplished through notice-and-comment rulemaking and should include detailed guidance on what would be adequate rather than just a vague statement in a consent order.
Although this order is not binding on third parties, it nevertheless provides insight into the SEC’s approach to lost securityholders and escheatment. Transfer agents and mutual funds should consider consulting with counsel to evaluate the impact of the SEC’s order in DST and whether it justifies a change in policy or best practices. The dissent may also provide a basis for the securities industry to petition the SEC for a rulemaking regarding the interaction of the lost securityholders rule and state escheatment law (a topic that the SEC expressly declined to address when it last revised the lost securityholders rule).8
- Order, Michigan Supreme Court Docket No. 165391 (Sept. 15, 2023).
- Minute Order, Sacramento Superior Court, 34-2021-00310039-CU-MC-GDS (Sept. 14, 2023).
- Administrative Proceeding File NO. 3-2156 (Aug. 17, 2023).
- The State also filed a motion for a stay of the Court of Appeals’ decision on March 28, 2023. The Michigan Supreme Court denied the Treasurer’s motion for a stay on April 21, 2023.
- The Michigan Supreme Court recently reversed a decision of the Michigan Court of Appeals in a major state tax case without granting review and without full merits briefing or oral argument. See Vectren Infrastructure Services Corp. v. Department of Treasury, Michigan Supreme Court Docket No. 163742 (July 31, 2023).
- ICI also pointed to communications from the Controller’s office during the litigation as supporting its interpretation of Section 1516 (or at least showing that Section 1516 is ambiguous). The Controller’s office objected to the use of these communications on the grounds that they were privileged settlement communications. The court’s decision in ICI did not address these communications, other than to note that it “need not reach” the Controller’s objections because “they are immaterial” to the ruling.
- UnRulemaking: Statement Regarding DST Asset Manager Solutions, Inc.
- In the previous rulemaking, the SEC declined to follow comments that suggested that the agency should “clarify in the adopting release how firms should apply the rule if a conflict should arise with state escheatment laws,” and instead stated that it would “consider how to address any such actual conflict at the time it is made aware that such a conflict exists.” 78 FR 4768, 4775 (Jan. 23, 2013).
In-depth 2023-247
