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New SEC "Lost Securityholder" and "Paying Agent" Rules May Add to Compliance Costs

(The following post originally appeared on ONSecurities, a top Minnesota legal blog founded by Martin Rosenbaum to address securities, governance and compensation issues facing public companies.)

January 10, 2013

On December 21, 2012, the SEC issued new rules requiring broker-dealers to search for holders of securities with whom they have lost contact. The new rules also require broker-dealers and other “paying agents” to provide notice to persons who have not negotiated checks received on account of securities they beneficially own. The new rules may make it easier as a practical matter for states to lay claim to “unclaimed property” held by broker-dealers and paying agents. In addition, the rules may make it more attractive (i.e., profitable) for states to focus their unclaimed property collection efforts on securities and securities-related property in general. As described below, this could drive up compliance costs for public companies and their service providers.

New SEC Rules. Broker-dealers will be required to comply with the revised “lost securityholder” rules (Rule 17Ad-17) in the next year or so. Similar to existing transfer agent requirements, broker-dealers will be now obligated to conduct at least two database searches (using at least one database service) for “lost securityholders” - securityholders whose mail is returned as undeliverable. The first search must be conducted between three and 12 months of a person first becoming a “lost securityholder,” and the second search must be conducted between six and 12 months after the first search. Exclusions will apply for a securityholder (i) for whom the broker-dealer (or transfer agent) has documentation indicating the securityholder is deceased, (ii) whose aggregate value of assets is less than $25, or (iii) who is not a natural person.

Also, “paying agents” (including certain issuers, broker-dealers, transfer agents, and other entities) will be required to notify each “unresponsive payee” within seven months of the date on which an unnegotiated check is sent. An “unresponsive payee” is someone to whom a check is sent by the paying agent and the check is not negotiated (i.e., cashed) before the earlier of the paying agent’s sending the next regularly scheduled check or the lapse of six months after the sending of the unnegotiated check. Here too, an exclusion applies if the value of the unnegotiated check is less than $25.

Effects on State Unclaimed Property Laws. Although the new SEC paying agent rules in particular contain a statement that those rules “shall have no effect on state escheatment laws,” the rules may nonetheless affect the collection of unclaimed property in significant ways. For example, the new and revised rules will make it easier for state inspectors to find and obtain evidence of a lack of “dominion and control” by securityholders over their investment property, a finding that can trigger unclaimed property proceedings. Furthermore, some state laws require a second finding, that the owner of property be “lost,” prior to the commencement of what is commonly referred to as the “dormancy period” (generally three to seven years for securities). In sum, the new and revised SEC rules will make lost or inactive accounts more easily indentifiable by state investigators, and the rules may offer additional evidence for state investigators to assert that the owner is “lost”, if relevant.

Unclaimed Property on the States’ Radar. While unclaimed property and escheat law is complex, the importance of escheatment and unclaimed property is not lost upon state legislators attempting to balance state books. As indicated in this comprehensive academic review of unclaimed property laws in the Michigan Law Review in 2011 (PDF), only approximately 30% of unclaimed property is eventually reclaimed by a rightful owner or heir. And state efforts have been effective. The Delaware Office of Economic and Advisory Council estimated Delaware’s 2012 revenue from unclaimed property at $475 million, a figure that approaches 50% of all revenue raised from personal income taxes in that state. According to the Minnesota Department of Commerce website, in 2011, Minnesota received nearly $57 million in unclaimed property.

The significance of revenue derived from unclaimed property is a major reason why states will continue to pursue the property aggressively. For example, as Broc Romanek recently reported in Blog, many states have shortened the statutorily defined “dormancy period” after which they can take possession of such property, and embarked upon various “voluntary reporting” programs practically designed to speed the process by which the state takes possession of property.

Comment. As described above, the SEC rules may help states track down unclaimed property and provide them with additional evidence. Therefore, the biggest beneficiaries of these new rules may in fact be the states and their balance sheets. Quite a nice holiday gift for the states. A thank-you note to the SEC may be in order. Broker-dealers, paying agents and ultimately issuers may not be so grateful if their compliance costs are increased by the SEC rules and the states’ increased activity.


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