Avoiding Ethical Concerns with Client Funds

Ethical Minefield

Trust (or escrow) account management is a potential ethical minefield for attorneys and law firms. Weak internal controls can lead to funds being diverted, and even an innocent accounting error could result in allegations of a trust account violation.

Ultimately, a fiduciary responsibility exists for attorneys in possession of client funds and property. As part of that duty, timely and complete accounting must be provided to the client, and all funds and property to which the client is entitled must be disbursed properly.

Accounting for It All

While no specific accounting system is required by court rule, a basic trust accounting system should include at least the following essentials:

  • Trust receipts journal
  • Trust disbursements journal
  • Trust ledger book containing individual ledger accounts for recording each financial transaction affecting that client’s funds

At a minimum, each client’s ledger account should reflect:

  •  The date, source and a description of each item of deposit
  • The date, payee and purpose of each withdrawal

Here, the accounting system could be as basic as a manual “one-write” or “pegboard” system, where the date, payee, purpose, check number, etc., are all automatically recorded in the journal when the check is written. Or, maintaining and monitoring client trust accounts can be automated using any number of software packages designed specifically for law office trust accounting, such as EasyTrust, i-trust and WinVantage 4.

Whatever method is used, it’s good business practice to prepare a monthly reconciliation of balances in the trust ledger book, the trust receipts and disbursements journals, the bank account checkbook, and bank statements.

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You’ll also want to consider reporting the trust’s bank and investment account transactions. Reporting is typically made to the Trustor and/or Trustees, and would only be for those accounts established for a single trust (vs. an account established to hold comingled client deposits, undisbursed litigation awards, real estate closing proceeds, etc.).

You Are Responsible

Because you are ultimately responsible for the security of these funds, the importance of strong internal controls cannot be overemphasized. Consider these steps for safeguarding client funds:

Use the correct tax ID. Obtain the client’s Social Security or federal tax identification number during the initial intake process and then use the number on the bank account to avoid unexpected tax problems for the lawyer.

 Limit the number of trust accounts. Avoid operational inefficiencies caused by having too many accounts. Establish criteria to determine whether new accounts should be opened (e.g., based on average account balance to be maintained, length of time balances will remain in account, etc.).

Create a paper trail. Institute a sys-tem of check requisitioning that creates a paper trail designed to assure no client trust account checks can be negotiated without sufficient documentation.

“Establishing thorough accounting records and internal controls helps ensure that trust funds are properly safeguarded.” 

 Restrict online banking privileges. In cases where electronic banking is utilized, create a list documenting computer privileges assigned to specific employees. This list should be authorized by management or an assigned designee who does not have the ability to set up user access privileges on the system.

 Require two signatures. Make certain no disbursement can be made without two signatures, or at least a contemporaneous review by a second person.

 Review account reconciliations. Review all client trust fund account reconciliations at the end of each month, looking for appropriate signatures, payees, endorsements, unusual items, and large debits or credits. For the strongest controls, deliver the bank statement to the reviewing attorney unopened.

How Do You Measure Up?

Establishing proper accounting records and internal controls helps ensure that trust funds are properly safeguarded. You can have assurance you’re doing your part when the following conditions are met:

 You’re up on your state and bar requirements. Make sure you know your responsibilities from both a bar and state law perspective.

 You communicate clearly. During initial client meetings, talk with clients about trust accounting procedures and your ethical requirements. For example, let clients know upfront that settlement proceeds will not be disbursed until the settlement check has cleared.

 You are properly insured. A Commercial Crime Policy may provide coverage against, among other things, employee theft, forgery or alteration, and theft of money or securities. Be sure to review policy limits annually.

 You have a written trust fund policy. Have the policy reviewed by your accountants and make all employees aware of its existence. Monitor compliance and update the policy as needed.

 You test your system. Have a third-party consultant test your internal policies and procedures to ensure that adequate controls are in place and duties are segregated properly.

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