Law Firms: Avoid the 6 Most Common Trust Accounting Pitfalls

This is part one of a two-part blog series. Part two can be found here.

The Florida Supreme Court has recently disciplined hundreds of attorneys for violating Florida Bar rules. Several of those sanctioned had committed trust account violations.

Your firm may hire outside individuals to oversee and reconcile your trust accounting, but that does not shift the trust accounting responsibility. Avoid common pitfalls and reduce the risk of trust accounting improprieties and errors by implementing proper controls, educating attorneys and staff in your practice, and keeping accurate records.

The following are six of the most common trust accounting pitfalls and some ways to avoid them.

1. Commingling of client funds

Commingling of client funds is one of the most common mistakes a law firm makes regarding trust accounting. According to The Florida Bar’s rules regulating trust accounts, “a lawyer must hold in trust, separate from other lawyer’s own property, funds and property of clients or third persons that are in a lawyer’s possession in connection with their representation.”
Trust accounts must be maintained in the state where a lawyer’s office is situated, or elsewhere with the consent of the client or third person, and clearly labeled and designated as a trust account.

A lawyer may maintain funds belonging to the lawyer in their trust account as long as the amount is no more than an amount reasonably sufficient to cover necessary bank fees related to the trust account.

Large or long-term deposits of client funds are generally required to be held in separate bank accounts that are clearly labeled and designated as trust accounts and have the potential to earn interest for the client. The client’s name is typically included in the account name, and the account is set up using the client’s federal ID number.

2. Improper record-keeping and tracking of client funds

Trust account violations sometimes stem from a failure to maintain trust account records in compliance with bar rules. Maintaining adequate records is imperative for helping your firm avoid these types of violations and for providing an audit trail for the tracking of client funds. This is especially important at large firms with multiple locations, where record-keeping can be complex.

The best way to encourage adherence to trust accounting best practices at your firm is to establish a clear set of policies and provide a procedures manual that includes guidance on the handling of trust accounts. Creating a firm culture in which all attorneys take responsibility for their accounts is crucial to proper trust accounting.

Another way to encourage personal responsibility in trust accounting record-keeping is to ask each attorney to review or sign off on the accuracy of the information reflected on their detailed trust account activity reports on a monthly basis. Attorneys should be prepared to provide supporting documentation if any disbursements or deposits raise questions and need additional review.

3. Untimely trust account reconciliations

Your firm should perform trust account reconciliations on a monthly basis. Another good practice is to verify that the total sub-ledger balances agree with the general ledger balances and the related bank reconciliations. In addition to the monthly reconciliations, someone besides the person who oversees the monthly process should review reconciliations, unannounced, at least once a year.

If your law firm is not frequently reviewing and reconciling trust accounts, it will be much more difficult down the line to identify inaccuracies and trace back any errors.

4. Improper trust disbursements.

Improper “borrowing” from trust accounts can occur when you don’t require adequate authorization and fail to adhere to strict authorization policies and procedures. This may come in the form of disbursing fees from the trust account before there are adequate funds in the account — or even outright theft.

Many law firms do not have a clear policy that is consistently applied regarding the payment of client costs. To maximize cash flow and minimize risk, you may want to review your firm’s policies regarding the disbursement of client costs and clearly indicate in your policies and procedures manual, and in client engagement letters, how client costs will be funded.

An effective way to prevent improper authorization for trust disbursements is to require dual signatures on trust checks over a certain amount, as well as on the bank forms needed to complete a wire transfer. In some cases, banks may also require phone or written confirmation for disbursements, which adds another layer of control to the process. The authorizing party should receive supporting documentation that they can use to determine if the disbursement is appropriate.

5. Lack of segregation of duties

To reduce the risk of fraud and error, the performance of critical functions should be separated among more than one individual. No one person at the firm should be the sole individual responsible for more than one of the following functions in the same process:

• Authorization of movement of assets
• Custody of assets
• Record-keeping for trust accounting purposes
• Reconciliation of trust accounts

It’s also a good idea to rotate employees who hold these key responsibilities on a periodic basis and make sure key people take vacation and have trained back-ups.

6. Unmanageable number of accounts

Large firms tend to have several attorneys requesting to open trust accounts across various locations. The volume of accounts and the number of signers on each account can create complex administrative challenges, making it more difficult to verify that attorneys are adhering to trust account policies.

Implementing a formal process for requesting and approving new trust accounts can help make this situation more manageable. Management or its designee should have the ultimate approval over who can open and close trust accounts.

Small firms with fewer trust accounts and locations may have an easier time managing trust account activity, but no matter the size of your firm, it’s imperative to implement proper, documented internal controls related to the establishment of client trust accounts.

Trust accounting could become a headache – and moreover, a significant risk – if law firms don’t take the necessary steps to set up proper oversight and controls of the trust accounts. Even if you feel confident about your policies and procedures around your trust accounting, it may be beneficial to enlist a qualified accounting firm or other third-party consultant to evaluate your firm’s internal controls and test internal policies and procedures to confirm that adequate controls are in place.

Remember, even if you hire an independent outside party, ultimate responsibility for your firm’s internal controls and trust accounting compliance still lies with you.

In the second part of this blog, we will discuss what questions you should ask yourself and your firm to determine whether it’s time to take a detailed look at your trust accounting policies and procedures.