1031 Regulatory Reform Legislation

Recently the topic of financial regulatory reform has been a hot item in the news. I recently became aware that there is a paper circulating in Washington with a proposed national regulatory bill concerning the Qualified Intermediary industry. The author of this proposal has been running moving around the Capital attempting to put provisions in place that, had they been in place, reportedly would have "prevented the loss of over $770 million of exchangers' funds that has occurred at the hands of QIs which currently operate in an environment that is subject to little or no regulation and oversight at the state level."

Seven states, thus far, have adopted 1031 legislation in an attempt to protect consumers. Those provisions, if adopted by all states, or at the national level, would have, perhaps, prevented or reduced many losses from unscrupulous Qualified Intermediaries. It should be said that, like many laws, people that are crooks will break the law.

One of the provisions that the author of this latest proposal is suggesting, though, is detrimental to the public. It would not allow a bank-owned Qualified Intermediary from depositing the exchange client proceeds into the parent bank. The proposal says that the "depository bank, escrow holder, or trustee holding exchange funds must unrelated to, and independent of, the QI". The pitch is that the bank which owns or controls the QI could then "place its financial interests above those of the exchanger".

This proposal would have the effect of eliminating banks (and their exchange facilitator affiliates) from the exchange facilitator business. This requirement would also negatively impact title insurance company-affiliated exchange facilitators who may wish to use a related escrow or trust company to provide qualified escrow or qualified trust services to provide greater protection to taxpayers.

Despite the fact that banks are already regulated by a state or federal financial regulator (and are subject to more oversight and controls than non-bank exchange facilitators), this proposal seeks to eliminate some of the safest and financially strongest exchange facilitators from the industry. Given that not a single loss has occurred as a result of bank failure, and there has never been any loss of exchange funds that were held in a bank-related QI, there is no history that would warrant this provision.

The national trade association of Qualified Intermediaries, the FEA, has been a strong supporter of federal regulation of its industry to require prudent funds management standards and other protections for its clients. In 2007, the FEA petitioned the FTC for regulatory oversight and submitted to it a comprehensive draft regulation. The FTC denied the petition, saying that the burdens of regulation outweighed the need, and that there was no evidence of pervasive fraud throughout the industry.

The FEA has since been actively involved in passing state legislation to regulate exchange facilitators. The FEA is supportive of legislation or regulations which provide protections for all taxpayers utilizing exchange facilitators and which do not competitively disadvantage any legitimate business model. It is my personal opinion that working with the FEA, and not against its efforts, would best serve the consumer and the industry as a whole.

For the record, 1031 Corporation is owned by FirstBank. We also individually segregate accounts. Please visit our website for a free exchange manual or contact us at 888-367-1031.