Contingency fee audits conducted by third-party audit firms continue to remain at the forefront of any unclaimed property discussion. While the holder community continues to express its concerns over the objectivity of such auditors and certain practices and methodologies they employ, many states opt to contract with third party auditors to conduct unclaimed property examinations due to time and/or financial resource constraints.
As with most other aspects of unclaimed property law, there is no such thing as uniformity. Recent legislation in Delaware, Illinois, Massachusetts, South Carolina, and Wisconsin continues to reflect the opposing state viewpoints on the use of third-party contingency fee auditors.
Editors Note: This post, originally posted on February 28, 2018, has been updated based on activity pertaining to the legislation detailed below.
Massachusetts: Prohibits Contingency Fee Based Audits
Originally introduced on January 23, 2017 and still pending in the Massachusetts Senate, S 1755 would prohibit the department of revenue, state treasurer and any other state agency from contracting with or employing any person, agent or firm on a contingent fee basis. State agencies and constitutional officers would be barred from renewing contingency fee based audit contracts after July 1, 2017.
For any contracts entered into prior to July 1, 2017, state agencies would be prohibited from assigning further audits on a contingency fee basis to auditing firms if the contract would be considered prohibited under the new proposal and the contract allows the assignment of audits on a discretionary basis by the state agency or constitutional officer.
MA S 1755 would become effective on July 1, 2018 and would apply to audits, determinations of liability, assessments, and the services of a tax expert contracted for on or after that date.
Delaware: Authorizes the Use of Third-Party Contingency Fee Based Audits
While both Massachusetts and Wisconsin (see below) seek to ban contingency fee based agreements from being made during third party unclaimed property audits, Delaware seeks to grant such authority to the Secretary of Finance with the introduction of DE S 145 on January 25, 2018.
As Delaware maintains such a prominent presence within the unclaimed property community and has been the subject of several lawsuits specifically over the use of third-party contingency fee auditors, this bill will surely attract the attention of many interested parties.
Michigan: Senate Bill to Authorize the Use of Contingent Fee Audits
Introduced on February 27, 2018, and amended on May 3, 2018, Michigan S 855 seeks to authorize the use of contingent fee audits. Under the provisions of the bill, the Department of Treasury is authorized to contract with private auditing firms to audit for and collect unclaimed property, so long as the amounts necessary to fund auditing and collection costs and fees do not exceed 12% of the collections, or a lesser amount as prescribed by the contract.
MI S 855 has not yet passed, but if passed the effective date would be 90 days after the legislature adjourns, which is projected to be on December 31, 2018.
South Carolina: No Contingency Fee Based Audits Unless in Multi-State Contingency Fee Based Audit
On January 16, 2018, South Carolina enacted H 3720, which bars the Treasurer from expending funds to retain a third party, private sector auditor, or auditing firm to fulfill his duties pursuant to the unclaimed property law on any basis other than an hourly basis.
However, the Treasurer may join other states in multi-state contingent fee auditors’ examinations, unless the companies under audit have a parent company headquartered or incorporated in South Carolina and there is reason to believe that those companies are holding funds belonging to South Carolina citizens.
Illinois: Allows Use of Contingency Fee Audits Unless Company Under Audit is a Financial Organization
Introduced on February 16, 2018, Illinois S 3229 would provide that if an administrator contracts with another party to conduct an examination, the contract may provide for compensation based on a fixed fee, hourly fee, or contingent fee.
However, if the organization under examination is a financial organization, compensation must be based upon a fixed fee or hourly fee.
Introduced on February 14, 2018, IL 2901 includes a provision that would amend Illinois Unclaimed Property Law to prohibit the administrator from entering into contingency fee based audit agreements in their entirety. The Illinois treasurer has publicly commented that he opposes the bill and that audits are critical to ensuring all companies follow the law.
Proponents of the bill stated that, “Chamber initiative, SB 2901, allows all types of audits except for those funded on a contingency basis,” … “That is those audits conducted by an outside firm where the firm is compensated based on how much revenue they can extract from businesses. Contingency firms typically are only compensated by the amount of revenue they identify creating a tremendous incentive that puts businesses at a disadvantage.”
Wisconsin: Senate Bill Prohibits All Contingent Fee Based Audits, but Assembly Bill Allows a Select Few
Update: On March 28, 2018, Wisconsin Senate Bill 645 failed to pass. This bill would have prohibited the use of contingency fee based audits.
Wisconsin Senate Bill 645, introduced on December 21, 2017 and Wisconsin Assembly Bill 773, introduced on December 19, 2017 and last amended on February 19, 2018, would both prohibit the secretary of revenue from entering into agreements to allow persons to engage in an audit on a contingent fee basis to administer the unclaimed property laws or to purchase information arising from the audit, except for information received by the federal government.
However, WI A 773 goes further to state that if the person whose documents or records are audited is not domiciled in this state, the secretary may enter into such a contingent fee agreement if the amount of the contingent fee does not exceed 12% of the total amount of unclaimed property that is disclosed by the audit.
The secretary of revenue is prohibited from entering into an agreement as part of an effort to administer the unclaimed property law that allows a person engaging in an audit of another person’s documents or records to use statistical sampling to estimate the liability of that person unless that person consents to the use of an estimate. WI A 773 would be effective on July 1, 2018.
Holder Concerns Regarding Contingency Fee Unclaimed Property Audits
Over the years, the holder community has expressed its displeasure with certain practices and methodologies used by contingent fee based auditors, questioning whether such auditors are acting in good faith when the auditors are paid a percentage based upon the amount of unclaimed property found in the audit.
Past cases have highlighted how third-party auditors have used this platform to often inflate their unclaimed property estimations to bolster their own compensation.
Regardless of how an audit firm is compensated, holders should ensure that they are following unclaimed property reporting best practices and have policies and procedures in place to ensure compliance with the laws of each jurisdiction, and be prepared to act, should they find themselves under audit.
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