A lawsuit before Delaware's Chancery Court could have broad implications for state finances around the country and for foreign shareholders who hold more than $6 trillion of stock in U.S. corporations.
Two French scientists are suing the state of Delaware for seizing and selling their stock without their knowledge, depriving them of millions of dollars in gains.
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French scientists Dr. Gilles Gosselin and Dr. Jean Louis Imbach allege that Delaware officials wrongfully seized their shares in Idenix Pharmaceuticals Inc. and sold the stock for $1.7 million to pad the state budget in 2009.
After Merck & Co. acquired Idenix in 2014, the scientists learned they no longer had stock in the company and couldn't collect on a $13.7 million windfall from the deal because Delaware officials had sold their shares five years earlier. Unable to return the stock, officials only reimbursed the money the state received, leaving the two investors out some $12 million.
In a court filing at the end of July, the plaintiffs called the state's actions "tortious and unconstitutional." In an earlier filing, they alleged Delaware "willfully, recklessly and negligently" failed to act as custodians of their property and violated the U.S. Constitution's takings and due process clauses, among other claims.
Delaware officials declined to comment on the case beyond the court filings. In those, the state argued it followed its law to the letter.
The suit calls into question Delaware's execution of a law that allows it to take unclaimed assets such as dormant bank accounts, uncashed checks and securities from companies incorporated in the state. Although the owners can recover the property or its equivalent value at any time, officials can sell the property and use the proceeds for state programs if they can't find the rightful owners. Such seizures represented more than 10% of the state's $4 billion 2017 fiscal-year budget, ended on June 30.
More than half of all publicly traded companies in the country are incorporated in Delaware, so most U.S. companies are vulnerable to the rule.
Under the law, shareholders must show an active interest in their stock to prove they haven't abandoned it. They can do this by voting in an annual election, signing into an online brokerage account or cashing a dividend check.
If they don't establish contact for three consecutive years, the law triggers a series of events that can lead to the state taking custody of the unclaimed shares. Under the law, companies must inform shareholders of the rules, but lawyers and securities advocates fear that foreign shareholders who don't understand them and aren't in touch with U.S. advisers could be surprised to learn they no longer hold the securities they purchased.
Delaware exploited foreign shareholders to bolster an important revenue source, said Ethan Millar, a lawyer for the plaintiffs at Alston & Bird LLP. Many foreign investors have put their holdings in long-term accounts and don't realize their investments may no longer be there.
"Most investors are buy-and-hold," he said. "This is a rule that really hurts people."
The law is meant to ensure companies don't hold onto unclaimed goods and securities that don't belong to them, said David Gregor, the state official responsible for administering the unclaimed property law. If the state can't find the rightful owners, it should use the property for the public good, he added.
"The companies shouldn't benefit from poor bookkeeping," he said.
Although every state has a similar unclaimed property law on its books, Delaware has been the most aggressive enforcer. The state collected $607.1 million from gross unclaimed property receipts during its 2017 fiscal year ending on June 30, making it the state's third largest revenue source.
Stock taken into custody accounted for $248 million of the gross total, according to the most recent state estimates, a 21% increase from 2016. The amounts collected from stock sales are naturally volatile, and some of the increase in 2017 was due to a rising stock market that boosted values, said Mr. Gregor.
Delaware isn't alone. States around the country are targeting foreign-owned shares for extra revenue, said Jennifer Borden, a lawyer who has represented securities industry groups trying to stop state seizure programs. Illinois, South Dakota and Tennessee have made it easier this year for officials to seize and sell securities they deem abandoned. That's putting an undue burden on foreign shareholders to protect their investments, said Ms. Borden.
The French scientists were unlucky, but Delaware's decision to sell the shares upon seizure could also have benefitted them if Idenix's stock price had fallen instead, said Patrick Reynolds, senior tax counsel for the Council on State Taxation, a nonprofit trade association. Still, the state's underlying attitude towards seized property is worrisome, he added.
"This is one more time that the state is viewing the unclaimed property laws as a way, not to reunite the property with owners, but as a revenue source," he said. "Once you do that, it becomes a troubling issue."
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(END) Dow Jones Newswires
August 18, 2017 07:14 ET (11:14 GMT)