BILL ANALYSIS
SENATE COMMITTEE ON BANKING, FINANCE,
AND INSURANCE
Senator Ronald Calderon, Chair
SB 204 (Benoit) Hearing Date: September 8, 2009
As Amended: September 2, 2009
Fiscal: Yes
Urgency: No
SUMMARY Would clarify the rules that apply to fidelity bonds
and errors and omissions insurance required to be obtained by
exchange facilitators, as specified.
DIGEST
Existing law
1. Prescribes rules for exchange facilitators (persons who act as
custodians for money or property involved in Section 1031
exchanges), as specified (Financial Code Section 51000 et seq.).
Among those rules, exchange facilitators must at all times do
one of the following:
a. Maintain a fidelity bond or bonds in an amount not less
than $1 million, executed by an insurer authorized to do
business in this state; deposit cash, securities, or
irrevocable letters of credit in an amount not less than $1
million in a financial institution; or deposit all exchange
funds in a qualified escrow or qualified trust account, as
defined, and require both the exchange facilitator's and the
client's signature before any withdrawal may be made from
that account (Section 51003); and,
b. Maintain a policy of errors and omissions insurance in
an amount not less than $250,000, executed by an insurer
authorized to do business in this state, or deposit cash,
securities, or irrevocable letters of credit in an amount not
less than $250,000 in a financial institution (Section
51007);
2. States that any person claiming to have sustained damage by
reason of the failure of a person engaging in business as an
exchange facilitator to comply with the exchange facilitator law
SB 204 (Benoit), Page 2
may file a claim on the bonds, deposits, or letters of credit
described in Section 51003 to recover the damages (Section
51005).
This bill
1. Would clarify that exchange facilitators may obtain
fidelity bonds and errors and omissions insurance from an
eligible surplus lines insurer that is on the list of such
insurers maintained by the Insurance Commissioner, as
specified;
2. Would require the amount of any bond, deposit, or letter of
credit held by an exchange facilitator pursuant to Section
51003 to be reduced to the extent of any payment made (and
thus clarify that the $1 million coverage is aggregate
coverage, not per occurrence coverage).
COMMENTS
1. Purpose of the bill To allow exchange facilitators to
obtain fidelity bonds and errors and omissions insurance, as
required by existing law.
2. Background SB 1007(Machado), Chapter 708, Statutes of 2008,
enacted rules that specified, for the first time ever in
California law, acceptable and prohibited behavior by
persons who help facilitate Section 1031 exchanges (i.e.,
exchange facilitators).
The name "Section 1031 exchange" refers to the Internal Revenue
Code (IRC) section that governs these transactions. Under
IRC Section 1031, no gain or loss is recognized for tax
purposes when property held for productive use in a trade or
business or for investment is exchanged for like-kind
property that will be held for productive use in a trade or
business or for investment. In other words, instead of
selling an investment or business property and being taxed
on the sales proceeds, a property owner may exchange that
property for like-kind property and defer the tax liability
into the future.
SB 1007 was introduced, in response to reports of increasing
malfeasance by exchange facilitators, and out of concern
that an industry which oversees several hundred billion
SB 204 (Benoit), Page 3
dollars worth of assets annually is unregulated at either
the state or federal level.
SB 1007 put a series of requirements in place, intended to
ensure that exchange facilitators do not abscond with their
clients' money, and that they have sufficient financial
assets with which to provide redress to clients who have
suffered losses at the hands of exchange facilitators. As
noted above, two of the financial requirements codified by
SB 1007 require these entities to obtain fidelity bonds and
errors and omissions insurance.
Recently, exchange facilitators have encountered trouble meeting
these requirements. The one insurer who would otherwise be
willing to issue fidelity bonds has balked, out of concern
that Financial Code Section 51005 does not limit the
insurer's liability to the $1 million face amount of the
bond. The insurer is concerned that the existing wording of
Section 51005 could allow each claimant on a bond to claim
the full $1 million, rather than splitting the $1 million
coverage across all claimants.
The Federation of Exchange Accommodators (FEA; the trade
association that represents exchange facilitators) is
requesting that Section 51005 be clarified to ensure that
the maximum liability of an insurance company that issues a
fidelity bond to an exchange facilitator is the face amount
of the bond.
FEA is also seeking clarification that "eligible surplus lines
insurers" recognized by the California Department of
Insurance may issue fidelity bonds and errors and omissions
insurance to exchange facilitators, in accordance with
Section 51003 and 51007. There is currently some question
as to whether an eligible surplus lines insurer meets the
Section 51003 and 51007 definitions of an "insurer
authorized to do business in this state." The proposed
language would make such a clarification.
3. Support . Both FEA and the Escrow Institute of California
(EIC) support the measure for the reasons stated immediately
above. EIC is interested in the measure, because some of
its members act as exchange facilitators.
4. Opposition None received.
SB 204 (Benoit), Page 4
5. Prior Legislation
a. SB 1007 (Machado), Chapter 708, Statutes of
2008: Enacted requirements to regulate exchange
facilitators operating in California, as specified.
Sunsets on January 1, 2014.
POSITIONS
Support
Escrow Institute of California (sponsor)
Federation of Exchange Accommodators
Oppose
None received
Consultant: Eileen Newhall (916) 651-4102