Regulations issued by the U.S. Treasury Department in 1991 require the use of a facilitator in an exchange. They can’t be a disqualified person within a two year period of the exchange, hence your employee, attorney, accountant, investment banker, real estate agent or broker can’t be used.

Therefore a new class of professionals has become established over the last 15 years. They are known by several names:

1. Exchange Accommodators
2. Exchange Coordinators
3. Exchange Facilitators
4. Qualified Intermediaries

We will use the term qualified intermediary or QI throughout the rest of this paper.

The same treasury regulations also specify that the exchanger cannot take actual or constructive receipt of the cash proceeds during the exchange. Funds must be held by the qualified intermediary. Regulations do not specify how the funds are to be held and kept secure, therefore each exchanger should at least ask the following security questions of any prospective Qualified Intermediary they are considering:

1. Do you have a current Fidelity Bond?
2. Do you have a current Errors & Omissions Liability Policy?
3. What is your Investment Policy?
4. Where do you Keep Trust Funds?

The purpose of this paper is to help illustrate what the answers to these 4 questions should look like. We have used our firm’s answers as the illustration.

1. Do you have a current Fidelity Bond? Every reputable qualified intermediary should have such a bond. The Fidelity Bond insures against losses resulting from dishonest acts, such as embezzlement, conversion, fraud, etc. of the insured’s employees against the insured, as well as the insured’s employees, partners and owners against the insured’s clients. A sample of what an evidence of insurance certificate for a Fidelity Bond looks like is on the next page.
   
   
   
   Note the following when reviewing a Fidelity Bond Program certificate.
   Insured’s Name: Make sure it is the actual or d.b.a. name of your QI.
   Effective Period: Fidelity Bonds are only good for one year & must be renewed.
   Amount of Coverage: The amount of coverage is per occurrence per employee.
   The amount should be appropriate for the general size of your transactions.
   
   To obtain this type of insurance the qualified intermediary must answer a series of questions on the application that ask about such things as: bank account segregation, facilitation agreements, discrepancies, and other internal controls. The purpose of such a bond is transfer the risk of fraud away from the exchanger to the financial strength of an A-rated insurance carrier.
   
   
2. Do you have a current Errors & Omissions Liability Policy? This is another important insurance policy for qualified intermediaries. It is different and in addition to the Fidelity Bond. Every reputable qualified intermediary should have such insurance which defends and pays valid claims alleging negligent acts, errors or omissions in the provision of, or failure to provide, professional services involving or related to 1031 exchange transactions, subject to the terms and conditions of the policy.
   
   
   
   Note that the Errors & Omissions Liability policy is also an annual policy that must be renewed each year with a series of questions asking about business volume, proceeds, regulatory action, and claims history. The purpose of this type of liability policy is again to transfer the risk of negligence away from the exchanger to the financial strength of an A-rated insurance carrier.
   
   
3. What is your Investment Policy? Although a formal investment policy statement is not required it would be prudent for an exchanger to know how their funds may be invested.
   
   
   
   
4. Where do you keep Trust Funds? After determining how trust funds are invested, the related questions to ask are – where are they invested and why? There are no regulations that specify answers to these questions.
   Where? We invest 100% of trust funds into Frontier Bank, unless directed otherwise for extraordinary and rare reasons by a client. www.frontierbank.com
   Why? This answer is more elaborate, but helps prospective clients understand the value of a solid a banking relationship.
   
   
   
   

Summary

These four questions are not meant to be the only questions that should be asked when selecting a Qualified Intermediary, but they are some fundamental ones that tend to give a glimpse into the security of your exchange funds. In addition to these critical questions an exchanger should seek referrals from their trusted tax, legal and financial advisors who have dealt with the 1031 exchange firm before and know of their competence and integrity in financial matters. Selecting a QI is an important step in a successful exchange transaction. Exchange coordination is a very specialized financial and tax service designed to insure smooth and successful exchange transactions and perhaps, more importantly, provide security for the exchange funds. Your Qualified Intermediary should be a partner you can trust in an exchange transaction.

If we can help you understand any more about security of exchange funds and how to protect them, please give us a call. We would be happy to assist you any way that we can.