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Sunday, March 23, 2014

Managing Client Trust Accounts


January 14, 2014, front page of the Daily Journal – Several members of the State Bar’s Board of Trustees endorsed the idea to “Begin to Audit Lawyers’ Client Trust Accounts.”

Trustee Heather Linn Rosing said, “This is a big issue” and “we believe there probably are problems, ranging from accounting errors to theft.” Rosing said the Board may begin exploring the audit idea as soon as its March 6th meeting.

Malpractice defense attorney, John Sheller, of Hinshaw Culbertson LLP was also quoted saying, “random audits are a good idea,” and “I think any big operation needs to do statistical sampling. How is anybody going to get compliance if they don’t ask questions?”

John Montevideo, a former President of the Consumer Attorneys of California, said, “Attorneys should not fear the audits…it’s all for the protection of the clients.”

State Bar Executive Director, Joseph Dunn, who supports the proposal, said they’re “after compliance, not discipline.” Of course, they’re after compliance! What a wonderful world this would be if everyone just complied. But, how do you get compliance if not by discipline, or at least, the threat of discipline?

The real question is not whether these State bar audits are going to happen, but rather, will you and your firm be ready for a Client Trust Account Compliance Audit from the State Bar?

In my 30 years of practice, I’ve had the privilege of working with some of the best law firms and lawyers in California. One commonality between them is they are responsible for properly maintaining their client trust accounts. And, the vast majority knows very little about accounting, especially trust accounting. Unfortunately, when it comes to client trust accounting, a lawyer cannot delegate the fiduciary responsibility of safeguarding the assets of a client to anyone else—not a trusted office manager, controller or bookkeeper. When you agree to hold money in trust for a client, you take on the non-delegable, personal fiduciary responsibility to account for every penny, as long as the funds remain in your possession.

Managing your Client Trust Account has always been a serious obligation. With the State Bar looking to audit these trust accounts, it’s now time to take stock of your firm’s processes. Here’s a list of many of the procedures required by the State Bar. Check if your firm is following any or all of these procedures and, remember, a passing grade is 100%. Anything less would be a violation subject to disciplinary actions (up to suspension).

  • All funds held for a client must be maintained in a bank account separate from the firm’s general funds that must be clearly identified as a client trust bank account.
  • Generally, all client trust bank accounts must be maintained in California.
  • Upon receipt of money or property on behalf of a client, you must promptly notify the client.
  • You may not deposit any of the firm’s money into a client trust account.
  • Attorneys’ fees must be taken out of the client trust account as they are earned.
  • When clients request money or properties you are holding for them, you must promptly deliver it to them.
  • When clients ask how much money you are holding for them, or what you’ve done with their money, you must tell them.
  • When the State Bar asks how much money you’re holding for the client, or what you’ve done with it, you must tell them.
  • You must wait until checks that have been deposited into the account have cleared the bank before you disburse funds.

The mandatory minimum recordkeeping that is required to be kept for at least five years is:

  • Client Ledger. A detailed record of every transaction, including a running balance, on behalf of each client.
  • Summary Account Journal. A listing of the money going in and out of the Client Trust Account. The monthly ending balance should agree with the bank statement.
  • Bank Statements and Cancelled Checks. You must keep a record (even if it’s online) of both the bank statements and the cancelled checks for at least five years.
  • Bank Reconciliations. You must reconcile the client trust bank accounts monthly to the client ledger and the account journal.
  • Journal of Other Properties. A detailed listing of any non-monetary property received or held on behalf of a client.

These recordkeeping requirements are intended to ensure that you are able to fulfill the purpose of client trust accounting. That is, to make sure you know exactly how much of the money you are holding for your clients belongs to each individual client at any given time.

The bottom line is we know the State Bar will bring more scrutiny to the compliance of Client Trust accounting. It is important that you know what procedures are in place at your firm and whether or not your firm is in compliance with State Bar requirements. No matter who handles your bookkeeping and accounting, you are ultimately responsible for these funds and their accounting.

If you have any questions or concerns about firm compliance, consult the Handbook on Client Trust Accounting for California Attorneys which can be found on the State Bar website.

Tax Reform Update: Law Firms

  • Cash basis accounting would be eliminated for Law Firms with more than $10M per year in gross revenue, forcing those Firms to use accrual accounting.
  • For partnerships, the Camp Act would repeal the rules on guaranteed payments to partners so payments received would be either part of their distributive shares or independent third party payments.

The Camp Act would also repeal the rule treating certain liquidating payments to deceased or retiring partners as guaranteed payments.

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