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Avoiding Ethical Concerns with Client Funds

12/1/2016 - By Zachary Farrington

An unsettling number of disciplinary actions against law firms are based on this simple fact: Somehow, an attorney has mismanaged a client’s funds or property. 

It could be lax trust or escrow account procedures that result in commingling of client funds. Or it could be weak internal controls that lead to money being diverted. Even an unintentional accounting error could potentially create allegations of a trust account violation.

Sometimes, actual damage doesn’t have to occur for disciplinary action to be triggered. For example, in some zero-tolerance jurisdictions, commingling funds becomes an ethics violation even if no injury results.

The Big Three

Consider these three all-too-common ways attorneys get in trouble when managing funds held in trust: 

1. “Borrowing” client funds — Tapping into a retainer to cover payroll or overhead costs when those funds have actually been set aside for a client’s specific matter can trigger an ethics violation — even if you plan on paying the money back “ASAP”. 

Defense: If you are not entitled to use of the money, don’t take it out of the trust account. Ditto for taking funds out before you have actually earned them. If this is occurring at your practice, stop immediately and make the account whole.

2. Commingling client funds — Client A’s funds cannot be used to cover Client B’s obligations. Ethically, you are required to establish distinct trust accounts for each of your clients. 

Defense: Go through your records and make sure you can account for each and every client's balance. If you have commingled funds, separate them immediately. 

3. Theft of client funds — Attorneys have a personal, fiduciary obligation to protect funds held in trust accounts. This responsibility cannot be delegated. In the case of a sticky-fingered paralegal or bookkeeper, you may still be held responsible.

Defense: Develop a solid system of internal controls to protect against theft and embezzlement. Also consider a commercial crime insurance policy to cover against employee theft, forgery or alteration, and theft of money or securities. Be sure to promptly notify police, clients and forensic accountants if theft is suspected. 

Safekeeping Best Practices

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:

Put it in writing. Develop a written trust fund policy and have it reviewed by your accountant. Then, walk clients through your trust accounting procedures and ethical requirements during initial client meetings. Also make all employees aware of policies and monitor compliance, and train staff about potential red flags and what to look for. Fraud is most often detected through internal tips. 

Limit signers. Strengthen the approval process by restricting the number of authorized signers. At the same time, make certain that no disbursement can be made without two signatures, or at least a contemporaneous review by a second person.

Document requisitions. Institute a system of check requisitioning that creates a clear paper trail designed to assure that no client trust account checks can be negotiated without sufficient documentation. 

Restrict online banking privileges. In cases where electronic banking is utilized, create a list that documents 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.

Reconcile and review. Review all client trust fund account reconciliations at the end of each month, looking for appropriate signatures, payees and endorsements. Be on the lookout for unusual items and large debits or credits. For the strongest control, have the bank statement delivered unopened to the reviewing attorney. 

Just One More Responsibility

Overseeing the details of a client trust account is just one more critical duty attorneys have to their clients. The best defense against violating this obligation is a good offense.

 Establish proper accounting records and internal controls to ensure that trust funds are properly safeguarded. Then, consider having a third-party consultant test your internal policies and procedures to ensure that adequate controls are in place and duties are properly segregated.

From in-depth accounting to third-party testing, our accounting professionals have the knowledge to help you safely manage client funds. Contact Saltmarsh to learn more.


Handling Fee Disputes

How you handle funds held in trust becomes important when a dispute arises over fees. The ABA suggests that any undisputed portion of the funds payable to the client should first be disbursed from the client trust account (CTA). Only then should any undisputed portion of fees and expenses payable to a lawyer and third parties be paid out of the CTA. 

Note that if a third party’s entitlement to funds is impacted by the dispute, the lawyer should notify the third party of the dispute. In cases where the dispute cannot be resolved in a timely manner, state law may permit the lawyer to interplead the funds. 


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