Client Trust Accounting Controls

Client Trust Accounting Controls Including Revised Rules Effective 1/1/04 K. Jennie Kinnevy Neil Scullion (888) 875-9770 www.fdcpa.com

Agenda Introduction and Presentation Overview Client Trust Accounting Controls What is a Client Trust Account? Summary of Lawyer s Responsibility Basics of Trust Account Management Detailed Controls vs. Supervisory Controls Summary of Revised Rule 1.15 Improving Trust Account Internal Controls to Reduce Risk of Loss Tax Compliance Implementing a Program and Monitoring Compliance Questions and Answers

What is a Client Trust Account? Trust Property - Property of clients or third parties in an attorney s possession Trust Funds - Trust property in the form of funds Trust Account - An account with a financial institution in which the funds are deposited Trust funds must be held in a trust account In Massachusetts, advances for costs and expense may be held in a business account.

What is a Client Trust Account? Trust Account Escrow Account Client Funds Account Conveyancing Account IOLTA Account or similar words indicating fiduciary nature of account

Two types of Interest Bearing Accounts Individual Trust Accounts IOLTA Accounts On individual accounts, the interest goes directly to the individual, client or third party who funds are in the account.

What is an IOLTA account? I Interest O On L Lawyer s T Trust A Accounts Nominal amounts or funds being held for a short period of time Interest gets remitted to IOLTA committee on at least a quarterly basis. Funds go 67% to Mass Legal Assistance and 33% to other charitable organizations.

Summary of Lawyer s Responsibilities 1. Trust Account responsibility for any client matters actively managed; 2. If others in the firm manage Trust Accounts intentionally negligently then you are all financially and professionally liable.

Summary of Lawyer s Responsibilities Are the attorneys aware of their trust account responsibilities? It is part of the ABA Model Code of Professional Conduct. It is part of Massachusetts Rule of Professional conduct 1.15. Boston Bar of Overseers proposed amendments (Lawyers Weekly July, 2001). Revised Amendments effective January 1, 2004

Summary of Lawyer s Responsibilities How good are Trust Account controls and procedures? How often are the Trust Accounts reconciled? Who signs Trust Account checks? All partners have a responsibility to ensure the firm s Trust Accounting procedures are sufficient.

Basics of Trust Account Management Taken from The ABA Guide to Lawyer Trust Accounts by Jay G. Foonberg ($79.95 published by the ABA) The Ten Commandments of Good Trust Accounts 1. Have a Trust Account 2. Never let anyone else sign your trust account 3. Obtain and understand the IOLTA rules

Basics of Trust Account Management The Ten Commandments of Good Trust Accounts 4. Immediately notify the client every time something is added to the client s account balance and every time something is taken from the account balance. (Should be tracked on T&B system) 5. Unearned fees and unexpected costs belong in the trust account until earned or spent. 6. Do not commingle your funds with the client funds in the trust account.

Basics of Trust Account Management The Ten Commandments of Good Trust Accounts 7. Be sure you understand the exact nature of the item deposited or credited to the trust account. 8. Reconcile the bank trust account monthly. (at least every 60 days per 1.15) 9. Reconcile and examine the individual client trust account balances monthly, and do not delay giving the clients their money. 10. Be alert to third-party claims. (Are their any liens against the account?)

Detailed Controls vs Supervisory Controls Examples of good detailed internal controls:- Monthly bank reconciliation (and review by lawyers) of all Trust Accounts (required in Mass at least every 60 days under new rules - increased from at least annually); Statements to clients on monthly basis; Check Requisitions required for all Trust Account checks; If Check is to firm for Fees and costs attach copy of bill (Bill first, Transfer second); All checks should be pre-numbered;

Detailed Controls vs Supervisory Controls Examples of good detailed internal controls:- All checks should be signed by two partners. One must be the responsible lawyer for the client. Check signatures should be real do not use rubber stamps. Cut-up ATM cards on Trust Accounts. All withdrawals should be via check. For individual trust accounts two accounts should be set-up on the General Ledger:- Liability: Trust Fund Asset: Trust Bank Account # 42423312 Name of Client Client

Detailed Controls vs Supervisory Controls Examples of good detailed internal controls:- The purpose of each receipt should be determined and agreed with the client. (e.g. Engagement Letter) Once Fees are Earned (ie billed) they must be paid out of the Trust Account because otherwise you will be commingling client and lawyer funds.

Detailed Controls vs Supervisory Controls Examples of good supervisory controls:- The Firm Culture Firm s Code of Conduct and Policy Manuals dictate what is acceptable ethical behavior. Supervision of activities For example A/R write-offs should be authorized by the Managing Partner. Otherwise money could disappear with an A/R write-off covering the trail. HR Policies Vacation should be mandatory for all employees. If an employee rarely takes vacation then is that employee hiding something? All employees should have job descriptions.

Detailed Controls vs Supervisory Controls Examples of good supervisory controls:- Segregation of Duties Person who opens mail should not be the same person who does the banking or the person who applies cash on the accounting system. In a smaller firm have the Bank Statements opened by the Managing Partner only and all other mail sorted and/or opened by the receptionist. Segregation of Duties will not prevent collusion.

Key Features of Revised Rule 1.15 Provide a clear description of what RECORDS need to be MAINTAINED with respect to Lawyer s Trust Accounts Detail OPERATIONAL REQUIREMENTS Effective January 1, 2004 Comply with or EXCEED requirements of Rules

Summary of Revised Rule 1.15 Segregate Trust Property Don t commingle Trust funds and attorney funds Attorney may and should contribute necessary funds to pay bank charges if not covered under agreement with client (avoid bouncing checks for NSF)

Summary of Revised Rule 1.15 - Continued Full accounting Required upon final distribution of funds Upon request of owner of funds On or before funds for attorney s fees are withdrawn Itemized bill of services rendered Amount and date of withdrawal Statement of balance after withdrawal

Mandatory Accounting Records of Rule 1.15 1. Account documentation (create a form) Name, address of bank Account number, title Opening and closing date Indicate type of account (IOLTA or individual)

Mandatory Accounting Records - Continued 2. Check Register Chronological order of Date and amount so all deposits Date, check number or transaction number, amount, payee of all disbursements Identify client name and matter Current balance in account

Mandatory Accounting Records Continued 3. Individual Client Records Record for client or third party Identify client matter Balance held Never distribute funds that would create a negative balance 4. Bank Fees and Charges Maintenance of a ledger with fees attorney deposited to cover bank fees and charges and use thereof.

Mandatory Accounting Records Continued 5. Reconciliation Reports No less frequent than every 60 days Reconcile bank balance to balance in check register as of report date Start with Balance per bank Add: deposits in transit, outstanding credits Less: outstanding checks, outstanding credits Balance per client matter Sum all client matters = Balance per Client Trust Account Sum of all Client Trust Accounts = Balance per Pooled Account Bank charges and fees are an individual client record No balance can be negative

Mandatory Accounting Records Continued 6. Account Documentation (Records Retention) Bank statements All transaction records Cancelled checks Records of electronic transfers Listing of all deposits List each deposits separately For each client or third person for whom deposit is made

Mandatory Accounting Records Continued 7. Electronic Record Retention ALL required records must be able to be reproduced in HARD COPY. Check registers Client ledgers Reconciliation reports All electronic records must be backed-up by appropriate storage device 8. Trust Property other than funds Must maintain appropriate records

Operational Requirements of Rule 1.15 Must Maintain Trust Account in state where attorney s office is located All IOLTA accounts must be maintained in MASS Trust Accounts name must indicate that it is a trust account: Trust Account Escrow Account Client Funds Account Conveyancing Account IOLTA Account or similar words indicating fiduciary nature of account

Operational Requirements - Continued Lawyers must notify the banks the purpose of the account Checks MUST be pre-numbered No ATM withdrawals or checks mad out to cash or bearer. Payee must identify the recipient All withdrawals for attorney fees must be made to the attorney or law firm Mandatory dishonored check notification Board of Overseers published list of financial institution you can set up accounts with and who have agreed to the dishonored check program Bank must remit funds at least quarterly and identify law firm name, amount, interest rate, interest calculation method

Improving Trust Account Internal Controls to Reduce Risk of Loss The Next Step. 1. Consider forming a committee of partners from those who have Trust Accounts, along with the firm CFO, controller or office manager depending on the size of the firm. Decide how to implement the procedures outlined above. 2. Develop an Accounting Policies and Procedures Manual for the Firm Start with how client engagement letter or retainer agreement addresses the need for a client trust account End with what to do when you want to close a client trust account, but you can no longer locate the client. 3. Does your computer software handle Trust Accounting? Some software packages provide fully integrated accounting. Trust Account balances should be reconciled to the balances on client ledgers.

Improving Trust Account Internal Controls to Reduce Risk of Loss 4. Consider how your internal controls and procedures can be strengthened. Operational Reviews provide recommendations as to modifications that should be made. 5. Do those handling Trust Accounts have proper oversight? Make the time to review and supervise. 6. Consider having a surprise audit of procedures and practices if Trust Accounts are significant. 7. Review all handouts for ideas that you may apply at your Firm.

Tax Compliance Payer who makes payments of $600 or more to an attorney must issue a Form 1099 to that attorney. The 1099 must be furnished to the attorney before January 31 of the following calendar year. Joint Payees Delivered to Payee: The attorney who receives the check should also receive a Form 1099. Delivered to non-payee or non-attorney Form 1099 should be issued to first attorney payee on check. Attorney to Attorney payments A Form 1099 should be issued to an attorney for

Tax Compliance Exceptions A Form 1099 is not required with respect to payments for the following: Wages or other compensation. Payment of profits earned to partners by a partnership who provides legal services. Payment of dividends or corporate earnings to shareholders by a corporation who provides legal services. Payments to non-residents of U.S., foreign partnerships or foreign corporations that do not engage in business in the U.S. or perform any labor or personal services. Payment to an attorney as the person responsible for closing a transaction for sale or exchange of ownership interest in real estate.

Implementing a Program and Monitoring Compliance Document and distribute Firm policies and procedures Educate all employees lawyers, bookkeepers, secretaries - anyone who may come in contact with Client Funds Make sure employees have proper skills to handle their responsibilities Proper segregation of duties don t give anyone total control (authorization, recording, reconciliations, resolving disputes)

Implementing a Program and Monitoring Compliance Create and Distribute Firm Policies Related to All Types of Client Trust Accounts. Provide link annually via e-mail Distribute to all new hires Do an internal audit Never make exceptions Distribute and Maintain on the Firm s Intranet Rule 1.15. Lawyers must certify their compliance with Rule 1.15 as required by SJC Rule 4:02. Distribute Related Articles and Findings Periodically

Handouts Rule 1.15 Safe Keeping Property as included in Rule 3:07 Massachusetts Rules of Professional Conduct (to be e-mailed) Tax compliance 1099 examples Guidance on client ledgers (The Massachusetts IOLTA Committee-Guidelines for Client Funds Accounts-In process of being updated)

True or False 1. The prohibition against commingling client trust funds and attorney funds is found in the 1909 American Bar Association Canons of Ethics, the 1970 American Bar Association s Model Code of Professional Responsibility, and the 1983 American Bar Association s Model Code of Professional Conduct. 2. In the event of a conflict between state bar rules and ABA principles, the ABA principles are controlling. A. False 3. IOLTA is an acronym for Interest on Lawyers Trust Accounts 4. An intervening third-party criminal act, such as a bookkeeper embezzling funds, relieves the lawyer of financial responsibility for trust account monies. A. False 5. It is permissible for the lawyer s fees to remain in the trust account after they are earned as long as the clients timely get their money. A. False 6. Using rubber-stamp signatures for trust account checks is a preferred trust account procedure because it saves the lawyer the time and bother

True or False 7. The term retainer fee has different meanings in different jurisdictions and in different situations, resulting in differing rules as to whether or not a retainer fee must or must not be deposited to the trust account. 8. Retainer fees can be deposited to the office account if the retainer fee is earned in full by the act of accepting the client or matter and is not refundable. 9. A law firm may properly combine cash in the client trust account with the cash in its other bank accounts on the financial statements of the firm as long as an appropriate footnote is included in the financial statements. A. False 10. Assume a client gives a law firm a check with instructions to deposit the check to the trust account and await further instructions. The client subsequently instructs the lawyer to send a series of checks for $950 each to a political campaign fund and to identify the source of the funds as anonymous. The lawyer knows (or should know) that it is a violation of state election law for one person do donate more than $1,000 to a single campaign fund. Possible violation of the election law is of concern to the client and is no concern of the lawyer.

True or False 11. A client asks a lawyer to bill the client s company for services rendered with no further description and to put the payment into the trust account to await further instructions. The lawyer need not be concerned with the client s tax treatment of the payment of the invoice as deductibility or non-deductibility of the payment by the company is the concern of the client and not of the lawyer. A. False 12. After reconciling the trust account bank statement to the trust account records and being satisfied that all balances are correct, the lawyer may then trash the reconciliation and supporting data used to make the reconciliation. A. False 13. On receipt of service of process seeking financial information the lawyer should notify all clients whose financial and legal affairs would be disclosed to third parties to determine if the clients wish to assert appropriate privileges. 14. On receipt of process to obtain information from a client s trust account, a lawyer should consider taking appropriate action to seek judicial review of the process and a protective or limiting order to protect clients confidences.

True or False 15. Whether or not it is required, it is good practice to physically segregate client trust account bank statements, cancelled checks, reconciliations and other documents from other banking records. 16. A lawyer has satisfied ethical trust account obligations by delegating trust account maintenance to a CPA and then not being further involved except to sign trust account checks prepared by the CPA. A. False 17. It is ethically permissible to contract with a client to charge the client for the performance of trust account maintenance such as preparing checks, deposits, reconciliations etc. 18. The term retainer fee has different meanings in different jurisdictions and different fact situations. 19. If a lawyer s trust account records are subpoenaed by disciplinary authorities, the lawyer should have copies of all records turned over in case the lawyer needs them for malpractice or tax or other purposes as the lawyer may not be able to conveniently get access to the records or copies of the records after they are delivered.

True or False 20. It is permissible to use a general office account as a trust account as long as no client loses money. A. False 21. Paying annual bar dues with a trust account check is aggressive stupidity. 22. When a lawyer receives a settlement draft or check with permission to deposit the check upon execution of a document, it is permissible to deposit the check and distribute the proceeds before getting the required signatures on the document in order to save time. A. False 23. A lawyer may endorse a client s signature to a settlement check or draft if the lawyer has appropriate written authority to do so, but a lawyer should not execute a settlement agreement by signing a client s signature if it can be avoided. 24. Generally, all unearned fees must be placed in the trust account until earned. 25. A lawyer generally may ethically provide for a lien on the client s cause of action or recovery or funds in the trust account to protect the lawyer from thirdparty claims.

True or False 26. A lawyer can delegate trust account responsibility to a professional office manager or a Certified Public Accountant and not be disciplined for trust account mistakes made by the paralegal or the office manager. A. False 27. In a large firm with a managing partner and a chief financial officer and an in-house CPA, a lawyer will still have personal disciplinary responsibility or financial responsibility for trust account negligence, mistakes, and irregularities on those cases under the lawyer s control or supervision. 28. In large firms it is an acceptable practice for each lawyer who has case responsibility to have his or her own client trust account in addition to the firm s client trust account. 29. It is permissible for a lawyer to borrow funds from the trust account for short periods of time as long as the clients get their money in a reasonable prompt time. A. False 30. A lawyer may remove fees as earned from a client trust account without prior approval as to the amount of the fees if the fee

True or False 31. If a lawyer removes earned fees from a client trust account in accordance with the fee agreement, and the client subsequently objects to the amount of the fees, the lawyer must immediately return the fees to the trust account until the dispute is resolved. 32. A lawyer who keeps trust account records in a computer can be disciplined for failure to keep proper records if the computer crashes and no monthly hard copies were prepared. 33. In some states an auditor will audit all transactions on a trust account for three years, even if the bank bounced a check through a bank computer error and the lawyer did nothing wrong. 34. Only client funds have to go into the trust account. Funds paid by one non-client to another non-client incident to representation of a client can be deposited to the office account or to an interest bearing account with interest going to the lawyer. A. False 35. If the client s money or a third party s money is likely to be with the lawyer long enough to earn significant interest, the lawyer should not put the money into an IOLTA account, but rather should open a special trust account whereby the interest can be credited or given to the person ultimately entitled to the interest. 36. The interest earned on IOLTA accounts is normally used for charitable purpose

True or False 37. A multi-state law firm may keep the client trust account and maintain the records in accordance with the laws of any state in which the firm has an office. A. False 38. A multi-state law firm should maintain a client trust account within the state where the responsible supervising lawyer for the matter is located and should follow the trust account and IOLTA rules for that state. 39. Misappropriation is a term commonly used to describe a variety of trust account rules violations 40. Failure to maintain and safeguard adequate hard copy records of computer records of trust account transactions and reconciliations can be a

True or False It is good office procedure and good law firm management to maintain separate bank accounts as follows: 41. A client s trust account for client and third-party funds. 42. A general office account for office expenses and to receive fee and other income. 43. A payroll account to receive gross payrolls and to segregate withheld employee taxes. 44. A client cost account to record client costs expended and recovered and where a cushion of lawyer funds belonging to the law firm may ethically maintained. 45. A personal bank account should be maintained for the lawyer s personal non-client-related expenditures.

True or False 46. A lawyer who is administratively challenged and unable to balance a personal checkbook should get assistance from a CPA or part-time bookkeepers as well as get some tutoring in basic checkbook maintenance 47. When funds in the trust account have been earned by the lawyer and must be removed, the lawyer may remove them by paying personal expenses and bills directly from the client trust account without the necessity of transferring the funds directly to the office general account where the income will be reflected. Such a practice would constitute permitted commingling A. False 48. The IRS claims that many lawyers underreport their income by writing checks from a trust account for personal use or personal savings without first transferring the funds to the office general account and subsequently drawing the money out for personal use.

True or False 49. When a lawyer represents one party in a transaction involving trust account funds and the other party is unrepresented by a lawyer, it is wise for the lawyer when disbursing money to the non-client to remind the non-client in writing that the lawyer represents only his or her clients and does not represent the non-client. 50. Third-party liens on settlement proceeds can be ignored if the client instructs the lawyer to pay the cash directly to the client and to leave it to the client to pay the lien amount or negotiate it down. A. False 51. A lawyer can be disciplined and held financially responsible for failure to honor contractual or statutory third-party liens on funds flowing through the trust account. 52. A lawyer may safely assume that the firm s insurance policies will fully protect and cover property that is owned by the client rather than the firm. A. False

True or False 53. Lawyers who represent and defend lawyers accused of trust account violations are commonly known as professional responsibility lawyers and many can be found as members of the Association of Professional Responsibility Lawyers (APRL) 54. The ABA and most state and local bar associations have some form of an ethics hotline which may be able to assist with trust account questions. 55. In many states, the IOLTA administrators may be able to assist with a trust account question. 56. Malpractice insurance carriers can often assist a lawyer with a trust account question.

Presented by: K. Jennie Kinnevy, CPA, MST is a Partner and the Director of the Law Firm Services Group at Feeley & Driscoll, P.C. She holds a BS in Economics from the Wharton School of Business at the University of Pennsylvania and a Masters of Taxation from Bentley College. She is a member of the Massachusetts Society of Certified Public Accountants (MSCPA) and the American Institute of Certified Public Accountants (AICPA). Ms. Kinnevy has over eighteen years of experience or servicing privately held clients specializing in law firm management, financial, tax and business consulting services and has published several articles on law firm management, issues and lectured at seminars to managing attorneys and firm administrators. Neil Scullion is a supervisor at Feeley & Driscoll, P.C., concentrating on Law Firms. Neil has more than seven years experience providing accounting, auditing and consulting services. He holds a BS in Accounting from University of East Anglia in the UK, and is a Chartered Accountant (the UK equivalent to the CPA). Neil is a member of the Institute of Chartered Accountants in England and Wales. For 30 years Feeley & Driscoll, P.C., CPAs has been serving as accountants and business advisors to privately owned companies throughout New England. We have earned a reputation with clients as well as bankers, attorneys and other professionals in the financial community for technical excellence and superior client service. Our 14 partners and 100-member professional staff are committed to providing our clients with the highest possible quality of service. A group of professionals within our firm is committed to maintaining our position on the vanguard of the law firm industry. FEELEY & DRISCOLL, P.C. Certified Public Accountants Business 48