State got your bling?

The courts are poised to decide if California’s methods for handling $5 billion in unclaimed property are legal

Illustration By K.J. Pargeter

More than a decade ago, an SN&R investigation exposed how California was using its citizens’ unclaimed property as a sort of secret stash to balance its budget. Now, 11 years after that exposé, the state controller’s methods for handling unclaimed property again are being called into question.

Today, California’s Bureau of Unclaimed Property holds $5 billion worth of property—money left idle in bank accounts, inactive stocks, contents of abandoned safe-deposit boxes—belonging to 8 million individuals. The idea is for the state to hold the property for safekeeping until it can be returned to its owners. Since only about 20 percent of these people ever claim their property, the program provides a significant source of revenue for the state, funneling hundreds of millions of dollars each year into the general fund that the state spends freely.

State and federal courts are poised to rule on lawsuits that charge mismanagement by the California controller’s office has cheated plaintiffs out of tens of thousands—even hundreds of thousands—of dollars owed for unclaimed property. State Controller Steve Westly and other government officials estimate that these lawsuits, if successful, ultimately could cost California between $500 million and $1.5 billion.

SN&R reviewed hundreds of pages of court documents, court-hearing recordings and additional records obtained using California public-records law to tell the inside story about a brewing scandal that the mainstream media virtually has ignored.

A bad day in May
In May, as Westly campaigned across California in hopes of securing the Democratic nomination for the higher office of governor in the June 6 primary, the wheels were coming off a major division of his current state office.

On May 16, Westly’s campaign “Rally Blog” boasted that “over 10,000 people have joined the campaign in the last month—that’s a lot—and more and more join us each day. They are ready to take on the Schwarzenegger $120-million machine, and know that Steve is the guy who can lead the charge.”

That same day, Sacramento Superior Court Judge Shelleyanne Chang issued her own charge against Westly and the chief counsel of his office, Richard Chivaro. In a damning ruling, in a lawsuit in which Westly and Chivaro were named as defendants, Chang found that the controller’s Bureau of Unclaimed Property had violated state law and essentially cheated the plaintiff in the case, Trust Realty Partners, out of roughly $200,000.

“The Court finds defendants acted unlawfully with respect to the Unclaimed Property Law,” Chang formally declared. The judge said that Westly and Chivaro did not provide Trust Realty with an effective way to retrieve more than $500,000 worth of its own ostensibly “lost” property that the state had taken, did not effectively notify Trust Realty that the state had its property, and did not pay the interest required by law on the property, which it held and used for more than four years. The judge ordered the controller to recalculate what it owed Trust Realty, in principal and interest, and pay up within 15 days.

Not only that, but she also ordered Westly and Chivaro to dramatically change how their office obtains, holds and returns unclaimed property to the public. If upheld on appeal, Chang’s decision could paralyze the controller’s unclaimed-property division until the changes are made, jeopardizing the more than $300 million in yearly income the program currently generates for the state.

The Trust Realty case, however, may be only the proverbial tip of the iceberg. Two and one-half months after Chang issued her ruling, a similar but unrelated case reached, for a second time, the highest level of the federal judicial system, short of the Supreme Court of the United States. On July 31, the 9th Circuit Court of Appeals heard oral arguments in Taylor v. Westly, a lawsuit originally filed against Westly’s predecessor, Kathleen Connell. Six plaintiffs so far have joined in the class-action case, and thousands more are expected, since the litigation covers anyone who had property confiscated and sold by the controller since 1989. One plaintiff is Chris Taylor. California’s controller’s office seized Taylor’s shares of Intel stock that allegedly were “lost.” Taylor, who resides in England and has never lived in California, contends that his stock was not lost and that the state had no right to take and sell it. The state sold Taylor’s shares for about $200,000 in the 1990s. Years later, those same shares were worth up to $4 million, according to court records. Understandably, Taylor believes California’s controller owes him the difference.

The Taylor case, which began in Sacramento, was dismissed in 2003 by U.S. District Judge Frank Damrell. But, in 2005, the case was reinstated by the 9th Circuit court, which said that the taking of Taylor’s stock, and the stock of the other defendants, was illegal, if proven to be true in further proceedings. “California did not and could not authorize its officer to take people’s property without notice and in the absence of any connection to the state of California,” the 9th Circuit court ruled. Like in the Trust Realty case, this court found problems with the state’s process for seizing and selling off unclaimed property. Indeed, if the process is truly as described in the lawsuit, the appellate court declared it would violate the U.S. Constitution.

When the case returned in July for the 9th Circuit court to consider a lower court’s refusal to order an injunction against the controller’s office, the appellate court clearly was annoyed that California had not altered its procedures in the intervening year. “I thought our last decision was clear enough so that you would work out a constitutional procedure,” one member of the three-judge panel told Westly’s attorney, Robin Johansen, during oral arguments, according to the official recording of the session. “And when I read this stuff, I wonder whether somebody was going to have to go to jail before you did.”

Now that he is safely retired, former Bureau of Unclaimed Property Chief Auditor Daniel McKinley has turned whistleblower against his former employer. McKinley says the controller broke the law by seizing and selling off millions in supposedly unclaimed property.

Photo By Larry Dalton

A ruling on the Taylor-case injunction is expected within weeks, and, meanwhile, a third major class-action case against Westly, Chivaro and the controller’s office is pending in U.S. District Court in San Jose.

These cases now are accelerating into high gear as rulings are expected that may send them, finally, to trial. The cases could cost California taxpayers between $500 million and $1.5 billion. That’s bound to cause Westly a few sleepless nights. So, too, is the fact that the star witness against Westly and the Bureau of Unclaimed Property is a former veteran employee of that organization, now turned whistleblower.

California’s cash machine
California’s unclaimed-property program originally was designed to function as a lost-and-found, reuniting owners or their heirs with lost or forgotten property. The legal term for the process is escheat: the transfer of unclaimed or lost property from the holder of the property—such as a bank—to the government, for safekeeping, until the property is claimed by the owner or the owner’s heir.

Last year, the state took custody of almost $900 million in property and paid out about $240 million in claims. The state currently holds about 8 million accounts worth more than $5 billion. Of the $5 billion, the state keeps only about $20 million on hand to pay unclaimed-property owners, if and when they are able to figure out that the state has their assets, but the rest of the money is transferred to the general fund and spent. The 2006 governor’s budget estimated that the general fund would receive $300 million from unclaimed property.

The low ratio of property that is returned relative to property that is taken means that the program is a cash cow for the state. Since nearly all unclaimed property is converted to cash by the state, even if the cash eventually is claimed, the state gets to use the money in the interim. This dynamic means that the state has a strong, albeit tacit, incentive to take as much property as possible and to return as little as possible.

The most common types of unclaimed property are checking and savings accounts; the contents of safe-deposit boxes; securities such as stocks, mutual funds, bonds and dividends; matured or terminated insurance policies; estates; mineral interests and royalty payments; and escrow accounts. Most securities are sold within 30 days of the state taking possession, and the contents of safe-deposit boxes of value, such as family-heirloom jewelry, wedding rings and rare coins, are auctioned off. Other safe-deposit-box items, such as almost anything in paper form (a will, a marriage certificate or treasured family photos) is shredded.

Years ago, the controller was required by law to wait 16 years before taking possession of unclaimed property. But the Legislature repeatedly has changed the law, speeding up the process so California can get its hands on the money quicker. The 16-year waiting period was reduced to seven, then to five, and, since 1995, the state only has to wait three years to take property for which the owner supposedly is missing. (The Legislature has tried, unsuccessfully, to reduce the waiting period to one year.) Not surprisingly, the timing of the law changes generally correspond to the state’s cyclical budget problems.

In the past, the law also required the state to pay interest on the money it held for unclaimed-property owners. But that law also was changed, and, since 2003, the state does not pay interest on the money it uses primarily to help run the government. And the state made the new zero-interest rate retroactive, which Chang said was illegal. A 9th Circuit judge expressed his own thoughts on the interest-rate change, and what the state does with unclaimed-property cash proceeds, at the July hearing. “You’re using somebody else’s money for free. You’re not going to use my money for free. You’ll pay interest if I give you anything,” he said, incredulously. “You use [unclaimed-property cash proceeds] to pay your debt or to reduce costs of government or use it to pave roads or whatever you want; that’s where it goes.”

In addition, the effort the state expends, and must expend by law, to notify people whose property it has seized has taken a similar path of change. The methods used to notify individuals that the Bureau of Unclaimed Property has taken their property have landed Westly and others on his staff in court, facing millions in damages. For example, in July, a 9th Circuit judge became irate when Westly’s state attorney, Robin Johansen, argued that the controller’s often-publicized searchable Web site of lost property satisfied the state and federal laws that require the agency to try to find lost owners. “Wait a minute, wait. Through a Web site?” the judge asked. “I don’t care about California law; what I care about is federal constitutional law.” One judge on the three-judge panel also pointed out that property only is listed on the Web site after it is sold by the state, leaving citizens virtually no opportunity to claim their property, in its original form, before it is sold.

As plaintiffs in one of the lawsuits, Richard and Jo-Ann Seitzinger have first-hand knowledge of the problem. The Seitzingers owned three batches of General Electric stock, which they bought when Richard worked for GE in the 1980s. Statements, and other correspondence related to the stock from GE, all were sent to the same address, where they had lived for more than 30 years. About five years ago, however, the Seitzingers were dumbfounded when their son called from Kentucky to say he’d seen their name listed on the Internet as having the cash proceeds of a stock sale listed as unclaimed property with the state of California. Jo-Ann contacted the controller’s office to try to find out how the state ended up with their stock.

“I wrote them a letter in August 2000 because I was so upset about all this, and they just ignored us,” Jo-Ann told SN&R. “They wouldn’t send us the stock. They said they had sold it. They never contacted us—we were never notified—and they knew exactly where we lived. They knew we had been filing income-tax returns in the state of California for over 30 years, and all they had to do was call the Franchise Tax Board to find out where we were.”

Attorney William Palmer (left) is suing California Controller Steve Westly on behalf of Johnstone Whitley and Lynn Keith. Whitley says the Bureau of Unclaimed Property refuses to help him claim money that belongs to him.

Photo By Larry Dalton

Like thousands of stockholders throughout California, the United States and even other countries, the Seitzingers have learned that stock owners can be declared “lost” if they fail to cash a dividend check, respond to a proxy or voting statement, or simply have mail sent to them returned to the company that holds the stock for them. A 9th Circuit judge angrily summarized the problem at the July hearing:

“Look, if I buy a stock, and it doesn’t pay me dividends, and I don’t vote my shares, and it’s maybe something like Microsoft—for years they didn’t pay dividends—I’d lose it,” he said. “I haven’t changed my address in 32 years, and a lot of my stocks don’t pay dividends, and I never bother with proxies because I don’t know or I don’t care. And boy, if any of my property has a California nexus, it’s gone.”

At the same court hearing, Johansen triggered even more animosity from the three-judge panel when she admitted that, after the state takes the stock, it makes no attempt to contact the owner unless the owners’ address it received from the company that holds the stock is different from the stock owners’ address on file with the state Franchise Tax Board. In the Seitzingers’ case, and in thousands of similar cases, it wasn’t.

The Seitzingers ultimately received a $1,318 check in payment for the stock that the controller’s office sold in the 1990s. But they contend that the amount is significantly less than the stock would be worth today had it not been sold. And that’s why they’re suing.

Former auditor blows the whistle
The most damning information on how the state’s current process for handling unclaimed property has been changed over the years to work against property owners, like the Seitzingers, and serve to line the state’s coffers is coming from a sworn court statement provided in the Taylor case by Daniel McKinley. McKinley’s the former chief auditor of the controller’s Bureau of Unclaimed Property, and he recounted his first-hand experience of how that process evolved over 25 years until he retired in 2005. During those years, he wrote, the process changed from one that passively took possession of lost property and tried to find lost owners to one that aggressively seeks out lost property and makes a less-than-diligent effort to reunite it with its rightful owners.

When McKinley started working for the unclaimed-property division under Kenneth Cory, who was controller from 1975 to 1987, in 1979, he was told by his boss that the philosophy of the office was known as “fair play.” Back then, that meant that the controller’s office did not use its governmental power to force companies to turn over “unclaimed property” until a company had verified that a property owner was truly lost and unknown. “And second, but most important, the objective was to protect the rights of the owners, so we went to great lengths to provide forms of direct mailing and publication notice to the owners and used the locator unit,” McKinley attests in his affidavit. The now-defunct locator unit had full-time employees who tried to find lost property owners.

Stock certificates, in particular, were handled differently than they are today. SN&R obtained an internal memo that the controller’s office has twice fought to suppress in court. That memo reveals that in the past, the unclaimed-property division held—rather than sold—most stock certificates until lost owners could be tracked down or came forward. The internal memo explains: “The rationale for this policy was due to the fluctuation of the stock market, and by paying in certificate form, owners were not exposed to the situation where we may have sold their stock for $100.00 per share (for example), and when they came to claim, the stock had appreciated to $500.00 per share.”

That’s no longer the case. The concern-for-the-lost-shareholder policy was replaced with its extreme opposite: selling all stock shares within 30 days of taking possession and putting the proceeds in the state’s general fund to be spent.

According to McKinley, the turnaround accelerated when Gray Davis took over as controller in 1987. First, Davis cut back, and eventually disbanded, the locator unit. Davis, who was controller until 1995, also changed how the office attempted to find lost-property owners through newspaper ads. The law required that the controller place ads listing the names of each individual unclaimed-property owner in newspapers throughout the state. The controller also was required to publish ads in the counties of the last known address of the owners. Instead, Davis began running generic ads that just said the state had lost property and listed a toll-free number for people to call if they thought they had lost property. The office also stopped providing direct-mail notification to stockowners, as required by law under Davis’ tenure, according to McKinley.

“At the time, we knew that the [ad and direct-mail change were] illegal and would harm property owners, because they would have no way to claim their property before it was sold,” McKinley wrote. “The [controller] recognized that if proper direct mail and publication notice was not provided to the owner, the ‘revenue’ or the secondary purpose of the law would increase.”

Johnstone Whitley—a plaintiff in one class-action suit against the controller—suspects that the state controller’s office still is increasing revenues by not making a good-faith effort to reunite owners with their “lost” property. “According to what I’m hearing, they want to keep the money in the state, and then they can use it for whatever they want to do with it,” he told SN&R. “They should be open to giving it to whose it is.”

The long-retired Whitley, who lives at the Eskaton Village senior community in Carmichael, has been trying, with his daughter’s help, to obtain copies of trust records from the controller’s office, which the office acknowledges it has. Whitley contends that the records will show that real estate he owned was sold and the proceeds were delivered to the state. But the task of getting help from the controller has been daunting. Whitley’s daughter, Lynn Keith, reports her shock at being told by the controller’s employees that if she wanted to look at any public records, she needed to hire an attorney.

Illustration By K.J. Pargeter

“When I went there with my husband, two supervisors I talked to at the counter were not like, ‘Well, this is your asset. We’ll help you.’ It was like, ‘I don’t think you’re getting this—go get an attorney,’” she said. “I didn’t know you needed an attorney to see public records.”

They’re now suing to get money they believe Whitley deserves from the sale of his property.

David vs. Goliath
Westly and Chivaro, the two key defendants being sued by the stock and property holders who contend they were wronged by the controller’s office, are backed up by the deep pockets and massive resources of the state. For example, in the Trust Realty case, the defendant’s appeal brief lists four attorneys from the attorney general’s office who worked on the defense of Westly and Chivaro, including a “senior assistant attorney general,” a “supervising attorney general” and two “deputy attorney generals.” On the other side of the battlefield in that case and the other two cases, is just one man, local attorney William Palmer. To learn more about the man who has taken on the controller’s office in these complicated lawsuits, SN&R sat down with Palmer at his Sacramento home office.

Palmer’s office is adorned with awards and photographs that seem to document his career and reveal something about who he is. On one wall is a framed photo of former California Governor George Deukmejian. Across the office, a low bookcase covered with various awards also holds a book autographed by Rosa Parks, which Palmer said he was given as a thank you for his pro-bono legal work on behalf of Sacramento community leader and minority bookstore owner Carol McNeal. Above the bookcase hangs a framed letter from the former prime minister of Israel, Benjamin Netanyahu, thanking the home-grown advocate for his pro bono work on the Holocaust insurance-reparations law, which returned assets to Jews around the world. “Due in no small measure to the work of your office, those unable for so long to have their claims honored may now look forward to finally obtaining what is rightfully theirs,” Netanyahu wrote.

Palmer also enjoys showing a stack of snapshots from a two-month tour of duty he did in Iraq earlier this year, doing legal work at the request of the federal government. In the photos, the attorney looks uncomfortable in the flak vest he had to wear while traveling in the tumultuous country.

SN&R asked Palmer why he believes California effectively has turned its unclaimed-property program into an ATM for the state government.

In his soft-spoken style, Palmer attributed the alleged misconduct of the controller’s office to the seemingly endless financial problems of the state: “They have cash-flow problems, and this is one way that they resolve it. They have figured out that this unclaimed property is basically a profit center.” He senses that the economic condition of California is essentially a house of cards, ready to topple. “Things are a lot worse than people think they are,” he said. “Everything is kind of glossed over. It’s an election year, and they downplay the deficits, and they basically have tapped out every fund that there is to spend. That’s where things are.”

Naturally, each controller in the recent succession has blamed his or her predecessor for problems with the unclaimed-property program. But Palmer alleged that unclaimed-property seizures have increased dramatically during Westly’s tenure, even though he knew the methods being used to bring in more property were illegal.

“He didn’t just continue the misconduct. He doubled-down,” Palmer said. “He not only inherited a problem, but he increased it twofold.” The attorney charges that Westly ignored internal reports, audits and court rulings that described the collection methods as improper, and let them continue, which is why he and Chivaro are being held accountable by the courts. “In the face of all these stop signs and warning lights, they just charged forward,” Palmer contended.

Westly did not respond to SN&R’s phone, e-mail and fax requests for an interview. Westly’s spokesman, Russ Lopez, said that he couldn’t talk about any of the pending litigation.

But as these cases appear to be moving closer to trial, the office, in the meantime, has changed several of its policies on how it handles unclaimed property. And Lopez described the changes to SN&R. For one, the procedure of immediately selling off seized stock as soon as it comes in the door has ended for the time being. “That is on hold right now,” Lopez said. “We’re not doing that anymore. … We’re just holding on to the [stock] certificates.”

The office also has changed its notification policy and now will mail notices to stock and other property holders, even if the address associated with the stock or property records is the same as the one on file at the Franchise Tax Board. “We’re changing our procedure. We’re going to send out notices whether we find a new address or whether it’s the same address,” Lopez said. He emphasized that notices only will be sent out when the controller’s office receives property—after that, lost-property owners are on their own. “Once it’s in the system, by statute we can’t go out and aggressively start calling people and letting people know they have money [in the unclaimed-property fund],” he said.

Lopez also said that the online auctions of safe-deposit-box contents, and other assets that the controller holds, temporarily are suspended. “We’re holding off until we have resolution on some of these court cases,” he said.

Chivaro takes issue with whistleblower McKinley’s characterization of the controller’s past and current policies. “We don’t believe that he’s correct in his analysis, and a lot of what he says is pure hearsay,” he said. When asked to specify inaccuracies in McKinley’s sworn statement, Chivaro punted: “I am not going to go into all of the areas at this time, as that would reveal litigation strategy. Suffice to say that it is based on hearsay, opinion and speculation, rather than fact, and will, in all likelihood, be disregarded by the court as such.”