1031 Specialists sets the standard for how Qualified Intermediaries should protect client funds during their 1031 exchange period. This article details how we safeguard client funds with insured escrow accounts and gold standard security protocols.
First and foremost, it’s important to understand the various ways any Exchangor could potentially lose money during their exchange period. It’s equally critical to evaluate those risks against the probability of such an event happening. Let’s begin with the highest category of risk an Exchangor faces, and review how 1031 Specialists mitigates those risks for its clients.
Highest Risk Category
Highest Risk #1: Misappropriation of Money
Any Exchangor should be concerned that monies received by their Qualified Intermediary (QI) are held for the benefit of the Exchangor, not misappropriated by their QI. Written differently, a QI could steal a client’s money and use it for themselves without the proper safeguards in place.
The 1031 Specialists Way
This risk is completely mitigated by 1031 Specialists because of the type of account we set up for each client. For every client exchange, 1031 Specialists opens a separate, segregated escrow account at an FDIC insured bank. This qualified escrow account is bound by a three-way agreement between the client, the bank, and 1031 Specialists; it states that no money can be moved anywhere or to anyone without the express, written authorization by the client. With 1031 Specialists, it is not possible for us to send any money out of an account without the client’s sign-off. This is the gold standard for how a Qualified Intermediary should operate.
Additionally, while it’s not necessary given the qualified escrow account structure we employ, we maintain errors and omissions coverage that provides additional protection for each client.
Highest Risk #2: Money is Invested into Risky Assets
There are no regulations or limitations on how an Exchangor’s funds are managed by a Qualified Intermediary. Some QIs are willing to invest client funds into volatile assets that may incur losses during their exchange period. There have been multiple stories of Exchangors learning their funds are worth less than what the QI was originally sent; the QI speculated with client money and lost.
The 1031 Specialists Way
Client funds are never invested into volatile assets. All client funds are held in money market deposits at a regulated, FDIC insured financial institution. Importantly, no gyrations in the stock or bond markets can ever change the value of the money held on a client’s behalf. Furthermore, we offer complete transparency; clients may view their fund balance at any time.
Highest Risk #3: Cyber fraud
There are constant threats from bad actors against firms who move a lot of money around, including Qualified Intermediaries. Thieves are always on the lookout for how to trick companies into sending large wires to the wrong counterparty.
The 1031 Specialists Way
The founders of 1031 Specialists have spent decades managing billions of dollars of capital. With their backgrounds as money managers, in investment banking, as CPAs, amongst other broad finance experience, 1031 Specialists has put an immense amount of focus on this risk. We believe we operate with the most robust anti-fraud protocols in the industry. The controls we have in place ensure the correct amount of money is sent to the correct recipient every time. Of note:
- Client money cannot be moved without client review and authorization per our three-way escrow agreement.
- No money is moved without 2 separate sign-offs and authorizations internally at 1031 Specialists.
- We confirm all bank instructions independently via phone with independently validated telephone numbers.
- Our bank instructions are always delivered via encrypted messages, not email.
Remote Risk
Remote Risk: Loss of Money Due to Bank Failure
Virtually all Qualified Intermediaries partner with banks to hold client funds during the exchange period. In the past few years, there has been increased discussion around the risk of customer deposits at banks, particularly given the challenges that banks like Signature Bank and Silicon Valley Bank have experienced. It is reasonable for clients to want to understand the risks associated with the financial institutions their QI is partnered with.
The risk of loss due to a bank failure is an extremely remote risk. While it is theoretically possible for Exchangors to lose money over the $250,000 FDIC insurance maximum, in reality there has not been a single depositor in the USA to lose a penny in over a generation, a period that includes the Great Financial Crisis. Even in one of the most significant periods of bank failures in history, depositors were made whole.
In a recent example, when Silicon Valley Bank failed, all depositors maintained their full balances and liquidity. The point being: just because there may be some challenges at some banks, deposits at troubled banks – which 1031 Specialists does not partner with – have a very remote probability of ever incurring a loss.
The 1031 Specialists Way
Even though the risk of a partner bank failing is remote, 1031 Specialists actively addresses this risk in the following ways:
- All 1031 Specialists partner banks carry FDIC insurance.
- All 1031 Specialists partner banks are regulated institutions that are required to maintain strong capital positions.
- 1031 Specialists maintains multiple banking relationships to mitigate single bank risk and ensure flexibility in an adverse scenario.
- 1031 Specialists reviews the financial statements of our partner banks and we constantly evaluate the credit worthiness of each partner. We receive reports on capital ratios, loan losses, and other data. As an example, one of our partner banks recently received significant equity investment from very notable investors, ensuring balance sheet strength and access to capital.
If any client would like to mitigate this risk even further, upon request 1031 Specialists can obtain additional deposit insurance in excess of the $250,000 FDIC insured deposit limit. This option does come with notable tradeoffs, however, such as the inability to have the qualified escrow account structure mentioned in the first section of this document. So, while greater deposit insurance coverage may mitigate the very remote risk of an impairment from the unlikely failure of a partner bank, it introduces other, higher probability risks. In our view, the tradeoff isn’t worth it.
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