BILL ANALYSIS �
SENATE BANKING & FINANCIAL INSTITUTIONS COMMITTEE
Senator Lou Correa, Chair
2013-2014 Regular Session
SB 139 (Hill) Hearing Date: April 3, 2013
As Introduced: January 29, 2013
Fiscal: No
Urgency: No
SUMMARY Would delete the January 1, 2014 sunset date on
provisions of California law that regulate persons engaging in
business as exchange facilitators, as defined.
EXISTING LAW provides for all of the following, through December
31, 2013:
1. Defines an exchange facilitator (EF) as a person who does
any of the following:
a. Facilitates, for a fee, an exchange of like-kind
property, through an agreement with a taxpayer to:
i. Sell a taxpayer's property that is being
relinquished in this state;
ii. Take title to a property in this state on
behalf of a taxpayer as an exchange accommodation
titleholder (EAT); or
iii. Act as a qualified trustee or qualified
escrow holder, as specified.
b. Maintains an office in this state for the purpose of
soliciting business as an EF; or
c. Holds himself, herself, or itself out as an EF by
advertising services or soliciting customers through
various means.
2. States that an EF is not any of the following:
a. The taxpayer or a disqualified person as those terms
are defined under specified Treasury regulations;
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b. A financial institution that is not facilitating
exchanges, but is acting as a depository for exchange
funds or is acting solely as a qualified escrow holder or
qualified trustee, as those terms are defined under
specified Treasury regulations;
c. A title insurance company or escrow company that is
not facilitating exchanges, but is acting solely as a
qualified escrow holder or qualified trustee, as defined;
d. A person that teaches professionals about
tax-deferred exchanges or trains them to act as EFs;
e. A qualified intermediary (QI) who holds exchange
funds from the disposition of relinquished property
located outside this state; or
f. An entity in which an EAT has a 100% ownership
interest and which is used by the EAT to take title to a
property in this state.
3. Requires an EF to comply with one or more of the following
at all times, to provide a source of funds for persons who
sustain damage as a result of a violation of Division 20.5
of the Financial Code by an EF:
a. Maintain a fidelity bond or bonds of at least $1
million, executed by an insurer admitted to do business
in California. This requirement is satisfied if the EF
is named as a listed insured on one or more fidelity
bonds totaling at least $1 million;
b. Deposit an amount of cash or securities or
irrevocable letters of credit of at least $1 million in
an interest-bearing account or money market account with
the financial institution of the EF's choice;
c. Deposit all exchange funds in a qualified escrow or
qualified trust, as those terms are defined in Treasury
regulations, and provide that any withdrawals from those
accounts require the client's and the EF's written
authorization.
4. Requires an EF to comply with one or more of the following
at all times:
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a. Maintain a policy of errors and omissions insurance
of at least $250,000, executed by an insurer admitted to
do business in California. This requirement is satisfied
if the EF is named as a listed insured on one or more
policies of errors and omissions totaling at least
$250,000;
b. Deposit an amount of cash or securities or
irrevocable letters of credit of at least $250,000 in an
interest-bearing account or money market account with the
financial institution of the EF's choice.
5. Requires an EF to notify its clients in writing within ten
days of the effective date of any change in control, as
defined, of the EF.
6. Requires an EF to act as a custodian for all exchange
funds, as specified, to invest exchange funds in investments
that meet a prudent person standard, and satisfy investment
goals of liquidity and preservation of principal. For
purposes of existing law, a prudent person standard is
violated if any of the following occurs:
a. Exchange funds are knowingly commingled by the EF
with the EF's operating accounts;
b. Exchange funds are loaned or otherwise transferred
to any person or entity affiliated with or related to the
EF;
c. Exchange funds are invested in a manner that does
not provide sufficient liquidity to meet the EF's
contractual obligations to its clients and does not
preserve the principal of the exchange funds.
7. Provides that exchange funds are not subject to execution
or attachment on any claim against an EF.
8. Prohibits an EF from knowingly keeping or causing to be
kept any money in any bank, credit union, or other financial
institution under a name designating the money as belonging
to a client of the EF, unless the money does belong to that
client and was actually entrusted to the EF by that client.
9. Prohibits an EF from doing any of the following:
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a. Making any material misrepresentations that are
intended to mislead, concerning any like-kind exchange
transactions;
b. Pursuing a continued or flagrant course of
misrepresentation or making false statements;
c. Failing, within a reasonable time, to account for
any moneys or property belonging to others that may be in
the possession of or under the control of the EF;
d. Engaging in any conduct constituting fraudulent or
dishonest dealings;
e. Committing any crime involving fraud,
misrepresentation, deceit, embezzlement, misappropriation
of funds, robbery, or theft; or
f. Materially failing to fulfill its contractual duties
to the client to deliver property or funds, unless such
failure is due to circumstances beyond the control of the
EF.
10. Provides that the aforementioned provisions may be enforced
via civil suit in a court of competent jurisdiction.
COMMENTS
1. Purpose: SB 139 is intended to ensure that consumer
protections enacted during 2008, to protect people who
entrust their money and property to California exchange
facilitators, do not sunset on January 1, 2014. SB 139 does
so by deleting the January 1, 2014 sunset date contained in
SB 1007, Machado, Chapter 708, Statutes of 2008.
2. Background: Exchange facilitators are persons who
facilitate tax-deferred transactions known as Section 1031
exchanges, after the Internal Revenue Code (IRC) section
that prescribes rules governing 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. Section 1031 allows a taxpayer
who wishes to dispose of an investment or business property
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to exchange it for like-kind property, and defer the tax
liability into the future.
Section 1031 allows a taxpayer to make as many tax-deferred
exchanges as he or she wants over his or her lifetime (thus,
Property A could be exchanged for B, B for C, C for D, and
so on, without the recognition of tax liability, as long as
the rules contained in IRC Section 1031 are followed).
However, these changes are tax-deferred, and not tax free.
Ultimately, when a taxpayer's replacement property is sold
(not exchanged), the taxpayer must pay tax on the sum of the
accumulated gains that were previously deferred.
An exchange facilitator is an independent third party, not
related to the taxpayer, who, for a fee, manages the
mechanics of a Section 1031 exchange, in accordance with IRC
Section 1031 and interpretive regulations issued by the
Internal Revenue Service (IRS). Exchange facilitators take
temporary custody of money and/or property, during the
period of time between a property owner's disposal of one
property and acquisition of new property, or, in a so-called
"reverse exchange", during the period of time between a
property owner's acquisition of new property and his or her
disposal of old property. Because IRC rules generally allow
180 days in which to complete an exchange, an exchange
facilitator can have custody of several million to several
tens of millions of dollars of money and/or property at any
given time.
Although the IRS and the United States Department of the
Treasury have issued several rules governing Section 1031
exchanges, all of those rules relate to the requirements
that must be satisfied in order for an exchange to qualify
for tax-preferred status. Neither the IRS nor the U.S.
Department of the Treasury has published any minimum
qualifications that must be met by an exchange facilitator,
in order to act in that capacity, nor has either entity
published any rules regarding the ways in which an exchange
facilitator may use the monies or properties entrusted to
them for safekeeping. Beginning in 2007, the Federation of
Exchange Accommodators (FEA; the trade association
representing exchange facilitators) petitioned the federal
government to enact rules of that sort. However, the FEA's
attempts to secure federal legislation and regulations in
this area have been rebuffed (initially by the Federal Trade
Commission and the IRS, and more recently by the Consumer
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Financial Protection Bureau).
Following several high-profile cases in which exchange
facilitators misappropriated their clients' funds, and in
response to the lack of any state or federal rules governing
acceptable and prohibited behavior by exchange facilitators,
California enacted SB 1007 in 2008. SB 1007 added Division
20.5 to the Financial Code (Financial Code Section 51000 et
seq.), to establish a set of allowable, required, and
prohibited behaviors by persons meeting the definition of an
exchange facilitator in California.
According to FEA, the rules established by SB 1007 have become a
national standard. Laws in Washington, Oregon, Colorado,
Maine, and Virginia are all based on California's law and on
FEA's Model Law.
3. Summary of Arguments in Support:
a. According to the author, "SB 1007 provides a clear
set of guidelines for those who wish to reputably and
ethically engage in the field of exchange facilitation in
California. While no law can prevent wrongdoing by people
who are intent on violating the law, there is great value
in establishing deterrents for those violations, and in
establishing minimum statutory standards for responsible
behavior in the exchange facilitation field. Retaining
California's law on our books is critical, as
California's housing market continues to recover, and
Section 1031 exchanges regain the popularity they held
before the economic downturn."
b. The Federation of Exchange Accommodators (FEA)
supported SB 1007, and supports the extension of its
consumer protections indefinitely. SB 139 will continue
prudent funds management and other good business
standards for the Section 1031 exchange accommodation
industry, and will provide significant consumer
protections for the clients of FEA members.
c. The Escrow Institute of California also supports SB
139, and believes that eliminating the sunset date added
by SB 1007 is an important consumer protection. "From
our vantage point and perspective the modest requirements
contained in the Machado legislation have been effective
in protecting consumer's exchange trust funds."
SB 139 (Hill), Page 7
4. Summary of Arguments in Opposition: None received.
5. Prior and Related Legislation:
a. SB 1007 (Machado), Chapter 708, Statutes of 2008:
Implemented the statutory framework for the regulation of
exchange facilitators, which this bill would continue
indefinitely.
LIST OF REGISTERED SUPPORT/OPPOSITION
Support
Escrow Institute of California
Federation of Exchange Accommodators
Opposition
None received
Consultant: Eileen Newhall (916) 651-4102