Maine Adds 1031 Exchange Intermediary Regulation

The state of Maine recently added it's name to a growing number of states instituting 1031 exchange Qualified Intermediary (QI) regulation. Maine Public Law, Regulation of Exchange Facilitators, was enacted by the Maine Legislature in April and will go into effect on Sept 12, 2009.

The new law utilized much of the language we've seen from a number of western states that have been early in adopting new 1031 regulation. Like other states, the Maine law prohibits commingling of exchange funds with operating funds of the QI, but does not require the segregation of each client exchange account (which we strongly support). The new law prohibits any loans to the QI or affiliated person or entity, and requires that exchange funds be invested in a manner that will ensure liquidity and preservation of the principal. Similar to the recently passed QI bills out west, the Maine law also requires ten day notice of any change in control of the QI.

It does require a lower fidelity bonding and errors and ommissions (E &O) insurance coverage that we've seen in other states. The fidelity bonding threshold is $250,000. The Maine act allows the QI, in lieu of bonding, cash deposits or irrevocable letter of credit in that amount or the use of a qualified trust or escrow account. E&O coverage of $100,000 is required (or in lieu thereof cash deposits or irrevocable letter of credit in that amount).

The Maine law does differ in that it requires annual licensure of any person acting as QI for relinquished property in the state. We've written previously about other state licensure provisions being passed. While licensure may allow the state to keep track of those that are acting as QIs in the state, it does little to protect a consumer against fraud until it is too late.

As we've seen in other failed QI cases, having minimal fidelity bonding and E & O insurance doesn't provide as much security to the client as one would think. Bonding and/or insurance protects the firm, not clients of the QI firm. In addition, each act of fraud is not necessarily considered a "per occurance" event so the bonding may fall considerably short of protecting exchange clients.

While each state has, thus far, adopted segregation of client funds from operating funds, we've yet to see a state adopt segregation of each individual client escrow account. This is a recurring issue in the bankruptcies and subsequent legal procedings that have occured in the 1031 Tax Group and the LandAmerica Exchange cases. Clients of failed QIs that do not segregate - and distinctly identify the segregation of funds in their exchange agreement - will, unfortunately, learn that their interest is pooled together in a bankruptcy case as just another unsecured creditor. Since the funds are commonly "pooled" for greater investment returns, individual client funds are not protected as clearly being 'in trust for' a specific client.

Only segregated accounts and an exchange agreement that clearly makes use of segregation language can ultimately provide protection for clients of Qualified Intermediaries that sell. Of course, due diligence should be performed to make sure you know the financial condition of the QI you chose. Publically available financial statements, forthcoming answers to questions of segregation and investment policy/practices and a solid exchange agreement should all be provided.

If you've interest in discussing provisions of this new state law, or any other pending or passed exchange facilitator regulation, the Federation of Exchange Accommodators is working hard to balance the interests of clients and industry member firms to maximize protection of clients while minimizing the regulatory burden/costs and would be happy to answer many of the questions. We at 1031 Corporation would be happy to answer any questions you might have in selecting a Qualified Intermediary or information specific on how we protect our client funds. Give us a call today at 888-367-1031.