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Tuesday, October 31, 2017

Trust Account Violations: How Simple Mistakes Can Put Your Firm at Risk


Earlier this year, a California lawyer was charged by the state bar with multiple counts of misconduct, including three counts of failing to maintain client funds in a client trust account and three counts of misappropriation, in addition to failing to promptly release her client’s file and commingling. The amount in question was $966.88. Admitting that her poor accounting skills resulted in disparities between her ledger balance and the actual client trust account balance, the lawyer faced two years of suspension plus three years of probation.

What’s shocking about this is not the small amount of funds involved or the serious consequences levied for what amounts to sloppy accounting. What’s shocking is that this situation is far from unusual. Browse any state bar discipline report or legal journal, and you’ll find many instances of client trust account negligence, misconduct, commingling and other violations.

The reason? Lawyers and their firms are not taking appropriate steps to make sure that the rules for proper accounting for client trust accounts are being followed. As a lawyer, it’s your job to act as a fiduciary of client funds. This means you are ultimately responsible, even if your accounting staff fails to scrupulously adhere to state bar rules for client trust accounts.

Accountants are not lawyers, and vice versa

Chances are you didn’t go into law because you were interested in accounting. And it’s highly unlikely that your accounting staff and/or certified public accountants are legal industry experts. Therein lies the problem with client trust accounts: Lawyers don’t want to be accountants, and accountants aren’t familiar with the minutiae of state bar regulations. For instance, the California State Bar handbook on client trust accounts is more than 100 pages long. That’s why proper procedures may not be in place to prevent trust account violations. Lawyers and accounting staff often don’t understand that client trust accounts must be treated differently than other business accounts. Even the bank you use may not understand all the rules that apply to trust accounts and Interest on Lawyers Trust Accounts (IOLTAs).

Common accounting mistakes

When an attorney or his or her accounting staff doesn’t understand all the rules, and there is insufficient knowledgeable oversight, innocent mistakes or incorrect accounting processes can easily happen. Some common mistakes are:
  • Lack of detailed records for each client: Your firm must be able to track every client transaction using both bank-created records, such as statements and cancelled checks, and your records of all deposits and payments. These records must account for how much money every client has in your trust account at any given time.
  • Failure to properly reconcile trust accounts: Unlike a regular business account, with a client trust account, your firm needs to reconcile individual client balances against the overall account balance. You need to confirm that the bank balance reconciles with the balance in your trust liability account on your balance sheet. If there’s a shortage or leftover funds that are unaccounted for, that’s a violation.
  • Failure to disburse or remove funds in a timely manner: Delaying the removal of legal fees after they have been earned or not promptly disbursing funds to clients can both be violations. Your accounting staff may not understand that money can’t be left in the account once cases are settled.
  • Improper adjustments: Unlike accounting for a regular bank account, making adjustments to reconcile the balance can be a violation. For example, say your firm has a $4 million trust account, and after a bank reconciliation, you or your accounting staff makes a $12,000 adjustment, thinking that it wasn’t a material adjustment. This is a violation, because every penny must be accounted for and reconciled for each client with funds in the trust account.
Don’t wait for the state bar to call

Lawyers—and their firms—who fail to strictly adhere to the rules regulating the handling of client trust accounts risk being disciplined by their state bar association, including suspension and even disbarment. Clearly the stakes are high, which is why making assumptions about whether or not your firm is properly complying with client trust account regulations is a dangerous gamble.

To avoid mistakes, have an independent third party with legal industry expertise and specific knowledge of accounting requirements for law firms conduct a review of your trust accounts and related accounting practices. Based on the findings, you can then correct any errors or omissions in your current processes to make sure your firm is not in violation of client trust account regulations. This will help keep you off the disciplinary report and out of the legal journal news.

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