Client Trust Accounting Controls Including Revised Rules Effective 1/1/04 December 2, 2003

(617)742-7788 www.fdcpa.com Client Trust Accounting Controls Including Revised Rules Effective 1/1/04 December 2, 2003 Presented by:

Sponsors and Presenters FleetBoston Financial Deborah J. Lawrence deborah_lawrence@fleet.com 617-434-4560 Gayle Rosenfeld gayle_rosenfeld@fleet.com 617-434-8455 Feeley & Driscoll, P.C. K. Jennie Kinnevy Jenniek@fdcpa.com 617-456-2407 Neil F. Scullion Neils@fdcpa.com 617-456-2475 2

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 3

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. 4

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 Any client account with check writing capabilities 5

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. 6

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. 7

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. 8

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. Board of Bar Overseers proposed amendments (Lawyers Weekly July, 2001). Revised Amendments effective January 1, 2004 9

Summary of Lawyer s Responsibilities How good are your 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. 10

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 11

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. 12

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?) 13

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; 14

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:- Asset: Trust Bank Account # 42423312 Liability: Name of Client Client Trust Fund 15

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. 16

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. 17

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. 18

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 19

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) 20

Summary of Revised Rule 1.15 - Continued Full accounting Required upon final distribution of funds Upon request of owner of funds (Clients don t remember) 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 21

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) 22

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 23

Mandatory Accounting Records Continued 3. Individual Client Records Record for client or third party Identify client matter Balance held after each transaction Never distribute funds that would create a negative balance What type of transaction each was: Credit Debit Electronic transfer 4. Bank Fees and Charges Maintenance of a ledger with fees attorney deposited to cover bank fees and charges and use thereof. 24

Mandatory Accounting Records Continued 5. Reconciliation Reports No less frequent than every 60 days Bank reconciliation Ledger of client accounts Ledger of bank charges 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 Equal balance per check register 25

Mandatory Accounting Records Continued 5. Reconciliation Reports - continued Reconcile Check register to sum of ledger of individual client accounts and ledger of bank charges Ledger of Individual Client Trust Accounts Sum all client matters = Balance per a client Trust Account Sum of all Client Trust Accounts = Balance per Pooled Account No balance can be negative in total or for a client subledger Iolta comprise various client accounts The sum needs to agree to each client s ledger Master account at a bank may have subledger accounts. For pooled accounts, do not forget to transfer from subledger account accounts to master account before check writing. 26

Mandatory Accounting Records Continued 6. Account Documentation (Records Retention) Some are created by bank Some are created by lawyer 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 27

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 9. How many years do you retain records? 6 years after termination of responsibility and funds paid out 28

Operational Requirements of Rule 1.15 Must Maintain Trust Account in state where attorney s office is located unless client consents otherwise 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 29

Operational Requirements - Continued Lawyers must notify the banks the purpose of the account Checks MUST be pre-numbered No ATM withdrawals or checks made out to cash or bearer. Payee on check must identify the recipient All withdrawals for attorney fees must be made to the attorney or law firm Multiple notifications Monthly notification not good enough Can t bypass firm and make out for firm expenses or personal expenses 30

Operational Requirements - Continued Mandatory dishonored check notification If you bounce a check, the Board of Bar Overseers get notified and starts an investigation Board of Bar 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 31

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 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. 32

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. 33

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 payments received by other attorneys. 34

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. 35

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) 36

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 37

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. February 25, 2004 FEELEY & DRISCOLL, P.C. Certified Public Accountants Business Consultants 38

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) Records for Other People s Money Daniel C. Crane 39