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Unclaimed Property Examination Requires Controller to Meet “Reason to Believe” Standard

Unclaimed Property Examination Requires Controller to Meet “Reason to Believe” Standard

The California Court of Appeals held that the Controller must meet a statutory "reason to believe" standard with respect to examining records for purposes of California's Unclaimed Property Law (UPL).

By Leighton M. Anderson

Bewley, Lassleben & Miller, LLP counsels clients regarding the laws and regulations related to unclaimed property in California.

Financial institutions, retailers and many others commonly file reports with the Controller of the State of California regarding dormant accounts, gift cards and other forms of unclaimed property.  These reports are filed as part of a legislative scheme for reuniting owners with lost property – and permitting the property to be held by the State (the “escheat” power) under the Unclaimed Property Law (“UPL”), Civ. Proc. Code § 1500 et seq.  California’s UPL is modeled after a uniform statute (prepared for adoption by multiple states and designed to achieve harmony between the laws of different states) first published in 1958 and updated at various times since then.

Those same financial, retail and other businesses are subject to having their books and records audited by the Controller, who will look for unreported assets.  The law states that the Controller’s audit right (Civ. Proc. Code § 1571(a)) can only be exercised if the Controller has “reason to believe” that a person has failed to report unclaimed property.  That requirement can limit the Controller’s ability to conduct audits, depending on how that threshold requirement is interpreted by the courts.

Very recently, in Yee v. American National Ins. Co., 235 Cal. App. 4th 453 (3rd App. Dist., Mar. 24, 2015), the court stated:

[T]he standard of “reason to believe” in section 1571(a) means specific articulable facts that would justify a belief by a reasonable person, knowledgeable in the field of unclaimed property, that an entity was not reporting property as the UPL requires (and one way in which this standard can be met is if the suspected holder of unreported property has been chosen for record examination pursuant to a general administrative plan to enforce the UPL that is based on specific neutral sources).

The Yee court's analysis closely mirrors the conclusions reached by our firm prior to the ruling, as presented in a detailed memorandum.  The full text of the memorandum is presented here.

Questions Presented

1.         Does Code of Civil Procedure section 1571(a) require a threshold factual finding to be made by the Controller as a precondition for an examination of the books and records of a potential “holder” of unclaimed property within the scope of the Unclaimed Property Law (“UPL”), Civ. Proc. Code § 1500 et seq.?

2.         If the answer to the above question is yes, what threshold factual finding is required?

3.         Does Code of Civil Procedure section 1571 provide authority for the delegation of examinations under section 1571(a) to third parties without such a threshold finding or regulations governing the conduct of the third-party audit procedures?

Answers

1.         The statutory provision that the Controller “may . . .  examine the records of any person if the Controller has reason to believe that the person is a holder who has failed to report property that should have been reported . . .” imposes a predicate threshold for the examination or audit of records under the UPL.

2.         At a minimum, the “reason to believe” threshold requires a rational, good faith belief that the person whose records are to be examined has failed to report unclaimed property in the person’s possession.  Among other indicia, this can include a failure to file the necessary report for the questioned periods.

3.         The Controller’s practice of designating an agent for the examination of the records of holders of California residents’ unclaimed property at offices and locations outside of California for the purpose of on-demand audits, if unsupported by a rational, good faith belief that the person whose records are to be examined has failed to report unclaimed property in the person’s possession, exceeds the audit authority granted by the UPL in section 1571(a).

Analysis

            1.         Legislative history.

This memo primarily concerns Code of Civil Procedure section 1571(a), which provides as follows:[1]

The Controller may at reasonable times and upon reasonable notice examine the records of any person if the Controller has reason to believe that the person is a holder who has failed to report property that should have been reported pursuant to this chapter.

As enacted in 1959, Assembly Bill 16 (Miller) (“AB 16”) added Code of Civil Procedure sections 1500 – 1527 related to unclaimed property, and amended and repealed related provisions.  AB 16 was proposed, and subsequently enacted, as a modified version of the Uniform Disposition of Unclaimed Property Act.[2]  The modifications are not analyzed in this memo but a contemporary analysis in the Journal of the State Bar of California (Sept. – Oct. 1959) cited changes relating to traveler’s checks; corporate stock; exclusion of listed securities from public sale provisions; the deposit and use of funds in the custody of the state; a service charge on allowed claims; and procedures for review of the Controller’s rulings on claims, among other departures from the uniform act.

AB 16 was approved by the Governor on July 11, 1959, and filed with the Secretary of State on July 13, 1959, as “the Uniform Disposition of Unclaimed Property Act,” Civ. Proc. Code § 1500 et seq.  Section 1523 of the Act consisted of two unnumbered paragraphs, the first of which provided as follows:[3]

The State Controller may at reasonable times and on reasonable notice examine the records of any person if he has reason to believe that such person has failed to report property that should have been reported pursuant to this chapter.

Former section 1522 was recodified as current section 1571 in 1968 (chapter 356).  The paragraph quoted was recodified as subsection (a) with no change to the language.  Section 1571(a) was amended again in 1996 (ch. 1064), with the title of “State Controller” changed to “Controller,” and the term “the Controller” was inserted in place of the masculine pronoun.  In 1998, the subsection was amended again (ch. 1029) to the current language.

Although there is an extensive legislative history of the original enactment, little if any elaboration can be found in the legislative file regarding limitations on the Controller’s right to examine books and records under former section 1522.

In general, the Act was presented as a revenue measure as well as a means of compelling corporate holders of third-party property to account to the owners for lost or forgotten assets.  The Report of the Escheat Subcommittee of the (Assembly) Committee on Judiciary (January, 1959) (“Committee Report”) described the benefit to the State in these terms:

The State of California has an opportunity to establish a continuing source of revenue requiring no new taxation.  An estimated 30 to 100 million dollars could be realized through enactment of a comprehensive abandoned property statute.

Committee Report at 8.

References in the legislative history to the administration of the law generally restated the plain import of the text of the specific provisions.  For example, the Report issued by the Office of Legislative Counsel, dated June 29, 1959, regarding AB 16 observed that:

The Controller may, when reasonable to do so, examine the records of holders who are suspected of possessing property not reported, may bring actions to force delivery from persons who refuse to do so, and may make regulations governing the reporting procedure.

Leg. Counsel, Report on Assembly Bill No. 16, June 29, 1959, at 2.

The above summary accordingly reflects a legislative understanding that (as-then) section 1522 concerned circumstances of reasonable suspicion of a holder’s unlawful retention of unclaimed or abandoned property, as distinguished from a random or automatic audit of any holder’s accounts.

2.         Statutory interpretation – plain meaning.

The plain meaning of current section 1571(a) supports an interpretation that some factual predicate must be established by the Controller for the examination of the books and records of a “person [whom] the Controller has reason to believe . . . has failed to report property that should have been reported . . . .”  The “person” whose books and records are to be examined must be in the category of those persons whom the Controller has the requisite reasonable belief.  Moreover, the statute uses the conditional term, “if” to define the circumstances in which the review is permissible:  the Controller may examine the books and records of the person if the Controller has the necessary reason to believe the person is withholding the required report.

“It is a cardinal rule of statutory interpretation that, in the process of determining legislative intent, resort first be had to the language of the statute itself.”  Butler v. County of Los Angeles, 116 Cal. App. 3d 633, 639 (1981).  “Courts have established a process of statutory interpretation to determine legislative intent that may involve up to three steps.”  Alejo v. Torlakson, 212 Cal. App. 4th 768, 786-787 (2013).  The first step in that process “looks to the words of the statute themselves.”  Alejo, 212 Cal. App. 4th at 787, citing Delaney v. Superior Court, 50 Cal. 3d 785, 798 (1990).  “The Legislature's chosen language is the most reliable indicator of its intent because ‘“‘it is the language of the statute itself that has successfully braved the legislative gauntlet.”’” MacIsaac v. Waste Management Collection & Recycling, Inc., 134 Cal. App. 4th 1076, 1082 (2005), quoting California School Employees Assn. v. Governing Board, 8 Cal. 4th 333, 338 (1994).  Thus, “[i]t is axiomatic that in the interpretation of a statute where the language is clear, its plain meaning should be followed.” Great Lakes Properties, Inc. v. El Segundo, 19 Cal. 3d 152, 155 (1977).

“Ordinarily, if the statutory language is clear and unambiguous, there is no need for judicial construction.”  California School Employees Assn., 8 Cal. 4th at 340.  But if necessary, the second step in the process (Alejo, 212 Cal. App. 4th at 787) is to consider maxims of statutory interpretation and legislative history as guides to the interpretation of the statute.  See, e.g.Dyna-Med, Inc. v. Fair Employment & Housing Com., 43 Cal. 3d 1379, 1387 (1987).  The maxims include the guidance that “significance should be given to every word, phrase, sentence and part of an act in pursuance of the legislative purpose.”  Cannon v. American Hydrocarbon Corp., 4 Cal. App. 3d 639, 648 (1970).

Here, the conditional permission granted to the Controller to examine books and records was expressly made subject to the Controller’s “reason to believe” that the records were held by a person who had failed to report accurately on the existence of unclaimed or abandoned property.  To argue that the Controller could engage in such an examination even without such reason to believe in the existence of unreported property would fail to give effect to the “if-then” logic of the statute, under which a reason to believe that the person had failed to report reportable property triggers the right of the Controller to conduct the specified review.  And as shown by the Legislative Counsel’s summary, the Legislators voting on the measure presumably understood that the provision allowed the Controller, “when reasonable to do so,” to “examine the records of holders who are suspected of possessing property not reported.”

“[T]he third and final step in the interpretive process” (MacIsaac v. Waste Management Collection & Recycling, Inc., 134 Cal. App. 4th 1076, 1084 (2005)) is for the court, if necessary to resolve any remaining ambiguity, to consider whether “practicality and common sense” support a different construction.  Halbert's Lumber, Inc. v. Lucky Stores, Inc., 6 Cal. App. 4th 1233, 1239 (1992).  But the court may only undertake this step “cautiously” (MacIsaac) and “only . . . when the first two steps have failed to reveal clear meaning” (Halbert’s).  Not only should this step be regarded as unnecessary and therefore inappropriate here, but there is no reason to imagine that considerations of practicality, common sense or the overarching statutory purposes would warrant a disregard for the specific balancing of a potentially invasive audit right against the prior requirement of reasonable grounds for suspicion of a non-reporting violation, as carefully provided by the Legislature in section 1571.

3.         Judicial construction – California courts.

Prior to the Yee case (see introduction), only one reported California case referred to section 1571(a), State of California ex rel. Bowen v. Bank of America Corp., 126 Cal. App. 4th 225 (2005).  While that case did not present any disputed issue under the provision of interest in this memo, the court’s general summary of the UPL supports the interpretation being advanced:

The Controller is responsible for enforcing the UPL and may investigate suspected violations. “The Controller or an authorized licensing or regulating agency may, at reasonable times and on reasonable notice, examine the records of any person whom the Controller reasonably believes to have failed to report escheated property. ([Code Civ. Proc., §] 1571.) An action may be brought to enforce the duty to permit this examination, or to obtain a judicial determination that property is subject to escheat. ([Code Civ. Proc., §] 1572[, subd.] (a)(1), (2).) And criminal penalties are prescribed for willful failure to report. ([Code Civ. Proc., §] 1576[, subd.] (a).)” (4 Witkin, Summary of Cal. Law (9th ed. 1987) Personal Property, § 32, p. 35.)

Bowen, 126 Cal. App. 4th at 235 (emphasis added).

In addition, multiple California statutes invoke a “reason to believe” test for administrative enforcement or sanctions, and these statutes have uniformly been interpreted to require an articulable basis for the authorized next step.  For example, Education Code § 1241.5 provides an audit right for the county superintendent of schools, as follows:

At any time during a fiscal year, the county superintendent may review or audit the expenditures and internal controls of any school district in his or her county if he or she has reason to believe that fraud, misappropriation of funds, or other illegal fiscal practices have occurred that merit examination.

Ed. Code § 1241.5 (emphasis added).  In Polster v. Sacramento County Office of Education, 180 Cal. App. 4th 649 (2009), the court construed that provision and related provisions as imposing express limitations on the audit power:

All of these statutes evince a legislative intent to vest the county superintendent of schools with general oversight powers and, specifically, the authority to act as watchdog for each school district's fiscal affairs. However, a superintendent's regular duties do not include making managerial decisions on the expenditure of funds. He or she may intervene only where there is reason to suspect fraud, misappropriation of funds, or illegality in fiscal practices.

Polster, 180 Cal. App. 4th at 660-661 (emphasis added).

Similarly, Penal Code § 1305.1 provides that even if a criminal defendant has failed to appear for an arraignment, trial or other proceeding, the court may continue the case in circumstances where “the court has reason to believe that sufficient excuse may exist for the failure to appear.”  Id. (emphasis added).  Although the courts have typically have “liberally relied on [the] representations” of defense counsel regarding reasons for a defendant’s failure to appear, People v. Amwest Surety Ins. Co., 56 Cal. App. 4th 915, 922 (1997), concerned the question, among others, of “[w]hat showing must be made to the court of sufficient excuse for nonappearance . . . ?”  By analogy to similar setting involving the forfeiture of bail (People v. United Bonding Ins. Co., 5 Cal. 3d 898, 906 (1971) (the failure to declare an immediate forfeiture “can be justified only where there is some rational basis for a belief at the time of his nonappearance that there exists a sufficient excuse”)), the court in Amwest held that the “reason to believe” standard in Penal Code § 1305.1 meant that “[i]n order for the court to have reason to believe that sufficient excuse may exist, . .  there must be ‘some rational basis’ for belief at the time of defendant's nonappearance that sufficient excuse may exist.”  Amwest, 56 Cal. App. 4th at 923.

Likewise in a criminal law context, Penal Code 1203.2(a) provides for the revocation of probation if the court “has reason to believe from the report of the probation or parole officer or otherwise that the person has violated any of the conditions of his or her supervision.”  (Emphasis added.)  In People v. Harrison, 199 Cal. App. 3d 803, 809 (1988), the court noted that “[t]he standard of proof for misconduct that would justify revocation of probation is lower than the 'beyond a reasonable doubt' test,” and that “[a] 'clear and convincing' showing’ will suffice.”

In summary, case law applying similar language in varying contexts uniformly requires some factual basis for suspicion, at the least, before the “reason to believe” standard can be met.

4.         Judicial construction – state courts applying the model act.

As noted above, the adoption of the UPL in 1959 was explicitly the adoption of the Uniform Disposition of Unclaimed Property Act.  The legislative history materials for AB 16 include a copy of the uniform act as it existed at that time.  Section 23 of the Act as adopted by the Uniform Law Commission in 1956 is identical to the original section 1522, except that the bracketed placeholder term “[State Treasurer]” appeared in the uniform Act rather than “State Controller” as enacted in California.

Since that time, the Commissioners’ uniform law has been revised in 1966, 1981 and 1995:

The problem of “lucrative silence” motivated the Uniform Law Commission (ULC) to promulgate the Uniform Disposition of Unclaimed Property Act in 1954.  It was amended in 1966 and then was wholly revised in 1981 to become the Uniform Unclaimed Property Act (UUPA).  In 1995, the Uniform Law Commission once again revised the UUPA.  It updates UUPA (1981) and should greatly assist the States in dealing with the unclaimed intangible personal property problem.

Unclaimed Property Act Summary, The National Conference of Commissioners on Uniform State Laws (2015).[4]

Despite California’s original intention to adopt the then-existing uniform law with modifications, California does not appear to have kept pace through the adoption of the subsequent revisions.  While the legislative history obtained for section 1571 does not permit a comparison between (i) any subsequent revisions of the uniform act and (ii) all subsequent amendments to California’s UPL, it is clear that the provision at issue here – the “reason to believe” requirement for audit rights under Civ. Proc. Code § 1571(a) – has remained unaffected since the original enactment, with only the minor changes in related language noted in section 1 of this memo.  The absence of any material amendment is of interest because the 1995 revision of the model act omits the “reason to believe” requirement, leaving the issue of administrative review substantially to the discretion of the administering officer.[5]

The provision in the 1956 uniform act allowing examination of records based on reason to believe that the person has failed to report reportable unclaimed property has resulted in a handful of published cases from other jurisdictions which are of interest for the purposes of this memo. In Fryzel v. Chicago Title & Trust Co., 173 Ill. App. 3d 788, 794, 527 N.E.2d 1025 (Ill. App. 1st Dist. 1988), the issue indirectly concerned the “reason to believe” limitation on the audit right for unclaimed property under section 23 of the Illinois Uniform Disposition of Unclaimed Property Act, Ill. Rev. Stat. 1983, ch. 141, par. 123.   In that case, the Illinois Department of Financial Institutions sought by declaratory relief to establish its right to examine defendant Chicago Title & Trust Co.'s (“CT&T”) records for reportable unclaimed property, in response to CT&T’s reliance on the exemption in the Act for property held by an express trust.  Reversing a trial court’s dismissal of the agency’s declaratory-relief complaint, the appeals court held that CT&T’s reliance on the express-trust exemption constituted sufficient “reason to believe” for audit purposes, since the agency would otherwise be forced to accept CT&T’s own determination that the unreported accounts were exempt.  Fryzel, 173 Ill. App. 3d at 796 (“Barring a proper investigation by the Director here would remove a holder of property from the scope of the Act solely on the basis of his own assertions . . .”).  The court determined:

Whether a trust company holds property as a trustee of an active express trust requires an examination of the terms of any existing trust deed. Such an analysis is a threshold task. Here, we are only concerned with this first step in the process of determining whether the funds in question are covered by or exempt from the Act. Clearly, the legislature has authorized the Director to take that first step by examining records he has reason to believe may involve unclaimed property under the Act which has not been properly reported.

Id. (citation omitted; emphasis added).

Lincoln Bank & Trust Co. v. Oklahoma Tax Comm'n, 1992 OK 22, 827 P.2d 1314 (Okla. 1992), similarly involved whether the state agency "had reason to believe" that a financial institution was holding unreported property presumed abandoned by the Oklahoma Uniform Disposition of Unclaimed Property Act, 60 O.S. 1981 § 651 et seq.  There, the Oklahoma Supreme Court expressly observed that “[a]ccording to the terms of [the Act], the Oklahoma Tax Commission must have ‘reason to believe that [a] . . . person has failed to report [abandoned] property’ before it may examine that person's records.”  Lincoln Bank & Trust, 827 P.2d at 1315 n. 2.  But the court then adopted an expansive interpretation of that language.

In the Oklahoma case, the plaintiff bank brought suit to quash an administrative subpoena issued after the bank had refused to produce records on demand.  Id. The tax commissioner’s pre-litigation letter to the bank cited “reason to believe” that the bank was holding unreported unclaimed property because (a) no reports were on file for 1978 and 1979, with negative reports filed for 1980 and 1981; (b) items reported consistently by other comparably sized banks had not been reported by the plaintiff ban; and (c) its reporting history was not consistent with other comparably sized banks.  Id.  While this may have sufficed as a predicate for purposes of the statute, the court’s opinion includes a broad definition of the audit right:

The standard to be applied for testing the underlying basis of the Commission's reason to believe (or reasonable belief) that any person has failed to comply with the Act is no stricter than that which the U.S. Supreme Court applies in cases where the administrative agency seeks a search warrant to inspect a regulated business for compliance with governing statutes and regulations. In Marshall v. Barlow's, Inc. [436 U.S. 307, 98 S.Ct. 1816, 56 L.Ed.2d 305 (1978)], the Court held that, after access is refused, the Occupational Safety and Health Administration must "secure a warrant or other process, with or without prior notice." Although the Commission need not obtain a warrant here, "entitlement to inspect . . . [does] not depend on . . . [a demonstration of] probable cause to believe that [the law has been violated]. . . . Probable cause in the criminal law sense is not required. For purposes of an administrative search . . . [, like that attempted by the Commission], probable cause . . . may be based not only on specific evidence of an existing violation but also on a showing that 'reasonable legislative or administrative standards for conducting an . . . inspection are satisfied. . . .'"  An inspection by the Commission is hence permissible and meets the statutory reasonable belief requirement when the suspected holder of unreported abandoned property has been chosen "on the basis of a general administrative plan for the enforcement of the Act derived from neutral sources."

Lincoln Bank & Trust, 827 P.2d at 1322 (footnote citations omitted; emphasis added).[6]

As further justification for the audit in the Oklahoma case, the court found the following grounds:

The evidence relevant to this inquiry consists of, for example, testimony by a witness for the Commission that "noncompliance" with the requirements of the Unclaimed Property Act is "widespread" among banks in this state. According to undisputed testimony an "audit" program began in 1982 when the legislature appropriated funds sufficient to boost the enforcement effort. Once the inspections started, the number of reporting banks tripled. Lincoln's own reporting history contributed to the need for examination. Of the reports that it had submitted, reference was made only to checking and savings accounts and, on occasion, to "interest checks," while reports from other banks referred to one or more of the following additional sources: cashiers' checks, certificates of deposit, safe deposit boxes, collateral and escrow accounts.

At the time of trial 42% of Oklahoma's banks did not submit any reports, and, of the 260 banks that did, 48 indicated an absence of unclaimed property. Out of the 75 banks that have been examined, all had unreported abandoned property. This is perhaps the strongest indication that the Commission's state wide inspection program is not tainted by any discriminatory enforcement criteria or motives.

Lincoln does not argue, and the record is devoid of any indication, that the Commission chose to investigate the Bank based on any non-neutral source. Moreover, the evidence considered today is undisputed. We conclude that the Commission had reason to believe Lincoln failed to comply with the Unclaimed Property Act. The burden of showing a neutral, nondiscriminatory pattern of enforcement has been met, and Lincoln's district court challenge to the pre-dispute inspection process in suit must hence fail.

Lincoln Bank & Trust, 827 P.2d at 1323 (footnotes omitted).

Hence, while the bank in that case itself contributed to the tax commissioner’s justification, the court chose to emphasize the fact that an audit program had revealed unreported assets, thereby justifying itself as providing reason to believe that unreported assets could be found.

A Maryland appeals court subsequently considered the “reason to believe” issue in light of Lincoln Bank and other cases in Goldstein v. PHH Corp., 123 Md. App. 214, 717 A. 2d 950 (Md. Ct. Spec. App. 1998), which arose under the Maryland Uniform Disposition of Abandoned Property Act, Md. Code § 17-301 et seq.  Section 17-322(a) of the Maryland law contained the uniform provision for examination of books and records based on “reason to believe that the person has failed to report property that should have been reported under this title.”  The case differs from the others considered above in that (i) the case concerned the use of private, third-party auditors, and (ii) the court’s ruling required that the enforcement agency “must be able to point to specific articulable facts that would justify a belief by a reasonable person, knowledgeable in the field of unclaimed property, that a person or business entity was not reporting abandoned property as required by the Act.”  Goldstein, 717 A.2d at 959.

In Goldstein, the defendant corporation[7] was sued by the Controller of the state for declaratory relief.  The defendant moved to dismiss the complaint on the grounds that the allegations failed to demonstrate the statutory requirement of reason to believe the defendant was holding and failing to report abandoned or unclaimed property.  Id., 717 A.2d at 954.  The trial court agreed with the defendant and dismissed the complaint.

On appeal, the court specifically addressed the question of what “reason to believe” means.  Id., 717 A.2d at 955.  In its analysis, the court addressed Lincoln Bank and the U.S. Supreme Court case, Marshall, on which Lincoln Bank heavily relied.  In that analysis, the Goldstein court cited an earlier Maryland case, Banach v. State Com. on Human Relations, 277 Md. 502, 507, 356 A. 2d 242, 246 (Md. 1976), for the related propositions that (i) the legislature may validly confer the power to compel information for preliminary investigation, and (ii) the court must look to the authorizing statute to determine if the legislature has done so.  Goldstein, 717 A.2d at 956.  Accordingly, the court observed:

Under the Act, the Comptroller has no right simply to search the records of a commercial enterprise that is suspected of failing to report abandoned property. If the operator of a business, after notice by the Comptroller, refuses to permit a search of the records, a subpoena to compel the production of records is issued, and if the subpoena is disobeyed, the disobedient party has a right to a hearing in circuit court to show cause why he/she failed to obey the subpoena. CL § 17-322. These provisions of the Act bring it within the class of statute, recognized and distinguished in Marshall, where the statute envisions court enforcement when entry into the commercial establishment is refused.

Id., 717 A.2d at 956 – 957.[8]

In an effort to formulate a bright line test for what circumstances would, and would not, provide “reason to believe” the auditee was withholding reportable assets, the Maryland court extensively considered Lincoln Bank and another, unpublished case from the State of Minnesota, First National Bank of Saint Paul v. Lord, No. 447350, District Court for the Second Judicial District of Minnesota (Ramsey County) (mem. op. April 20, 1982).  After that analysis, the court concluded:

Nothing in the Maryland Act suggests that in order for the Comptroller to have "a reason to believe" that a corporation or other entity has failed to report abandoned property, he must arrive necessarily at that belief based either on information that the subject of the audit has engaged in specific acts of wrongdoing or on a general plan for the enforcement of the Act derived from "neutral sources." It seems obvious that without such a "general plan" and without specific information as to wrongdoing, a person knowledgeable in the field of abandoned property could still have "reason to believe" that there had been a failure to report by other means. We adopt the view of the Lord Court and hold that to meet the "reason to believe" standard, the Comptroller must be able to point to specific articulable facts that would justify a belief by a reasonable person, knowledgeable in the field of unclaimed property, that a person or business entity was not reporting abandoned property as required by the Act.

Goldstein, 717 A.2d at 958-959 (emphasis added).

In other words, Goldstein rejected Lincoln Bank’s alternatives of either specific facts of wrongdoing or a “general plan” for enforcement, and instead announced a test of “specific articulable facts” that would justify a belief by a reasonable and knowledgeable person that the auditee was not reporting abandoned property as required by the Act.  This standard has the advantage of being closely related to the terms of the statute itself as adopted pursuant to the 1956 uniform law.[9]  While it may be possible to adopt a broader and less restrictive inspection regime without offending the Fourth Amendment in the process, that was among the purposes of subsequent amendments to the Act as proposed by the ULC, and it would be reasonable to suppose that any desire that the agency may have for a more perfect statute should be addressed to the Legislature in the first instance.  See, e.g.Pacific Tel. & Tel. Co. v. Public Utilities Com., 62 Cal. 2d 634, 655 (1965) (in rejecting agency’s argument for additional authority, court observes that if the Legislature believes there is a problem, “it may deal with those questions through appropriate legislation. So far, it has not done so”).

5.         Extensive extra-territorial compliance audits are far-removed from any requirement for “specific articulable facts.”

From the beginning of unclaimed-property regulation, and at various stages of the evolution of the uniform statute, constitutional issues have arisen concerning the extraterritorial reach of any State’s escheat powers.  See, e.g., National Conference of Commissioners on Uniform State Laws, Uniform Unclaimed Property Act (1981), at 3 (Commissioner’s Prefatory Note), citing Texas v. New Jersey, 379 U.S. 674, 85 S. Ct. 626, 13 L. Ed. 2d 596 (1965) (right to escheat defendant corporation's debts went to the state of the creditor's last known address, or where no address was known, to the state of the debtor's domicile).  While those issues have not been considered directly relevant to the subject matter of this memorandum, it is relevant to consider whether a mandate to a private third party auditor to use a California’s agency’s inspection power under section 1571(a) with respect to non-California “holders” of unclaimed property must be limited to the evident legislative purpose of requiring reason to believe the subject person is withholding reportable assets.

In that regard, it is noteworthy that Goldstein, the case considered above in which the court formulated the “specific articulable facts” requirement involved a third-party auditor such as now being used by the Controller.  As noted above (supra, n. 1), the UPL contains at least one other expressed limitation on the authority of the Controller to proceed in that fashion:  section 1571(b) requires that “the Controller shall adopt guidelines as to the policies and procedures governing the activity of third-party auditors who are hired by the Controller,” and that these guidelines be adopted “following a public hearing.”

No opinion is expressed in this memorandum concerning whether the Controller has held the required public hearing.  But it does seem evident that no such guidelines have ever been adopted either by rule or otherwise.  The regulations adopted by the Controller in the California Code of Regulations, title 2, chapter 2, subchapter 8 (Unclaimed Property Law) fail to disclose any such regulations.  While resort to the Controller’s website reveals a document entitled, “Guidelines for Requesting an Informal Review of an Unclaimed Property Examination (September 2003),” the pamphlet’s guidelines are in the nature of a sequential description of the audit process and advice to “holders” for disputing auditor findings (whether the auditors are employees of the Controller or of a third-party) and do not appear to provide “policies and procedures governing the activity of third-party auditors.”  In the absence of such policies and procedures, there does not appear to be any reliable or enforceable means of compelling adherence by the unregulated third parties to the Legislative determination that compliance audits should be limited only to cases in which the Controller or its designee “has reason to believe that the [auditee] is a holder who has failed to report property that should have been reported” pursuant to the UPL.

6.         Summary.

At a minimum, any unclaimed-property audit conducted pursuant to California’s enactment of the Uniform Disposition of Unclaimed Property Act should be supported by a prior finding of a reason to believe, based on “specific articulable facts,” that the auditee has not properly reported abandoned property of California residents or domiciliaries.  The Controller should adopt regulations consistent with that standard for the conduct of extraterritorial compliance reviews by third-party contractors.

While the above review was prepared ahead of the recent appellate decision in Yee v. American National Insurance Co., ___ Cal. App. 4th __, 2015 Cal. App. LEXIS 257 (3rd. Dist., March 24, 2015), the reasoning given  by the Court in that case closely tracks the views expressed here.


[1] Also of interest is subsection (c) of the same section: Following a public hearing, the Controller shall adopt guidelines as to the policies and procedures governing the activity of third-party auditors who are hired by the Controller. The above requirement is more fully examined in section 5 of this memorandum.

[2] The Uniform Law Commission promulgated the Uniform Disposition of Unclaimed Property Act in 1954.  Unclaimed Property Act Summary, The National Conference of Commissioners on Uniform State Laws (2015) (https://www.uniformlaws.org).  The Act was amended in 1966 and then was wholly revised in 1981 to become the Uniform Unclaimed Property Act (UUPA).  Id.  In 1995, the Uniform Law Commission once again revised the UUPA.  Id.

[3] The second paragraph of section 1522 provided for licensing agencies, such as the Superintendent of Banks and the Savings and Loan Commissioner, to examine the records of banks or savings and loan associations not organized under the laws of the State of California.

[4] Source:  https://www.uniformlaws.org/ActSummary.aspx?title=Unclaimed%20Property%20Act

[5] See National Conference of Commissioners on Uniform State Laws, Uniform Unclaimed Property Act (1995) (“UUPA”), Section 20 and accompanying commentary.  Section 20(b) of the 1995 UUPA provides that “the administrator” (a generic term used for the constitutional officer in each State delegated to perform the functions of the UUPA) may, “at reasonable times and upon reasonable notice,” examine the records of “any person” to determine whether the person has complied with the UUPA, “even if the person believes it is not in possession of any property that must be reported . . . .”  The ULC Comment to section 20 observes that subsection (b) is “based on Section 30 of the 1981 Act,” which likewise provided in section 30(b) that “[t]he administrator may conduct the examination even if the person believes it is not in possession of any property reportable or deliverable under this Act.”  National Conference of Commissioners on Uniform State Laws, Uniform Unclaimed Property Act (1981) § 30(b).  The Comment to that section in the 1981 UUPA remarked, “To require as prerequisite for an examination that a state has reason to believe information has been withheld encourages litigation and imposes an unnecessary burden on the state.” Id. at 52 (Comment) (italics in original); see also, Note: Virginia’s Acquisition of Unclaimed and Abandoned Personal Property, 27 Wm. & Mary L. Rev. 409, at 424 n. 114 (Winter 1986) (the “reason to believe” test was dropped from the 1981 revision of the uniform act “because [the former language] generated excessive litigation and imposed an unreasonable burden on the state”).  At the time of the 1995 revision, the ULC Comment regarding section 20(b) states:  “Aside from the requirement that the administrator conduct the examination at reasonable times and upon reasonable notice, the only limitations on the administrator’s right to examine are constitutional limitations.”  In that regard, the Comment observes that the Fourth Amendment rights of corporations and business premises (which are not as protective as those recognized for natural persons in their homes) may limit “inspections of commercial property . . .  if they are not authorized by law or are unnecessary for the furtherance of a governmental interest,” citing Donovan v. Dewey, 452 U.S. 594, 599, 98 S. Ct. 1942, 56 L. Ed.2d 486 (1981).  While the reference to Donovan invoked the entire body of constitutional jurisprudence regarding warrantless searches of commercial property (a topic which extends beyond the scope of this memo), the ULC’s Comment explicitly relied on Donovan’s observation that warrantless inspections of commercial property “may be unreasonable if they are not authorized by law or are unnecessary for the furtherance of [governmental] interests.”  The negative implication is that a warrantless requirement to produce books and records may be considered constitutionally reasonable if authorized by law and if necessary in the furtherance of a governmental interest.  Citing Donovan’s dicta on that point, the ULC Comment regarding section 20(b) of the 1995 UUPA then asserted that the subsection “is deemed to meet that [constitutional] standard,” analogizing the administrator’s examination of records for unclaimed-property purposes to the familiar rule that taxpayers may constitutionally be required to produce their records for tax-audit purposes.

[6] Marshall v. Barlow's, Inc., held the federal OSHA statute unconstitutional to the extent that it would allow the Secretary of Labor to perform warrantless searches of regulated workplaces.  Marshall, 436 U.S. at 325.  As noted by the Oklahoma court, the Supreme Court ruled that the required warrants would not need to be supported by probable cause if issued by “a neutral officer” based on a finding “that the inspection is reasonable under the Constitution, is authorized by statute, and is pursuant to an administrative plan containing specific neutral criteria.”  Id.  It remains unclear why the Oklahoma court in Lincoln Bank would conclude that the Oklahoma statute’s reasonable-belief requirement would be satisfied based on a warrantless inspection in a case in which even inspection by warrant would be constitutional only if issued by a neutral officer based on a subject-neutral administrative plan.  As noted above with respect to the 1981 and 1995 revisions to the UUPA, the uniform act has been modified by the ULC (and, thereafter, in other states) to remove the “reason to believe” test, leaving underlying Fourth Amendment rights as the only remaining constraint on the exercise of an audit function.  Lincoln Bank seems to have anticipated that legislative revision through judicial construction, but it would be reasonable to question whether the court was justified by the then-existing Oklahoma statute in doing so.

[7] The court’s opinion does not specify the nature of the defendant corporation’s business as relevant to the unclaimed-property law; PHH is identified only by reference to an allegation of the complaint to the effect that PHH “is one of the largest corporations in the State of Maryland [and] engages in numerous business activities.”  Goldstein, 717 A.2d at 953.  Independent research indicates that PHH is engaged in secured real estate lending for residential and commercial clients.

[8] California’s statute has similar provisions.  See, e.g., Civ. Proc. Code § 1572.

[9] The standard is also more closely tied to the California cases cited in section 3 of this memorandum that have arisen from other California statues which have incorporated a “reason to believe” test for further administrative or judicial action.

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