There's a lot of talk among accountants and ProAdvisors about becoming “Trusted Advisors”, and one area of interest maybe to provide service specialization to law firms. No matter what the size of a law firm, lawyers frequently have a need for a trusted advisor to help them with software selection/implementation, establishing operational policies, and implementing practices to insure they are compliant with the legal and ethical requirements of the practice of law.
In part 1 of this series we discussed the importance of ‘Law Firm Trusted Advisors’ having a thorough understanding of ‘the business of law’ as it relates to their attorney clients. Sole practitioner attorneys, and large corporate law firms, along with every law firm in between must all follow the rules established within the state in which they practice law. They are not only looking for someone knowledgeable about the ‘accounting methods’ or ‘technology requirements’, but a trusted advisor who understands how law must be practiced. As a ‘Law Firm Trusted Advisor’ you will be expected to have mastery of these five essentials:
- The importance of trust accounting and IOLTA requirements, as well as other requirements imposed by the state bar association and/or state judiciary, as to how to do the accounting correctly. There can be a substantial difference, and extra requirements, in some states not found in other states.
- Understanding how law firms perform their billing, including alternative fee arrangements, and making sure they are using a solution that helps them perform billing efficiently and effectively. Develop an expertise in multiple billing solutions that provide different billing alternatives.
- Understanding the ways law firms needs to track and account for advanced client costs and the difference between hard costs and soft costs. A criminal law firm might very well 'cover' the expense of costs associated with court transcripts or similar court costs as simply an expense associated with their lump-sum fee. On the other hand, a civil plaintiff's firm may bear the cost of expenses associated with depositions and transcripts, but then deduct those costs from any settlement or judgement prior to calculating their 'fee split' as part of the recovery. Other firm members may be compensated based on fees collected for work done, or on a percentage of fees, based on work done in connection with a specific attorney or client, regardless of the actual individual performing the work.
- Understanding the measurements that are important to law firms including how they choose to compensate the members of the firm (both lawyers and staff). Some firm members may be paid a salary, some maybe paid a draw against earnings, and some paid an hourly wage.
- Understanding how law firms 'manage' the areas of case load, scheduling, staff assignments, etc. You need to develop an expertise in a variety of legal case management software products that meet the needs of not only differing sized law firms, but law firms with differing work flows.
This series will examine each of these five critical skills and knowledge areas. In this 2nd series installment we will look at the responsibilities surrounding Client Trust and IOLTA Trust requirements.
If it is one thing I know about ‘law firm’ client trust and IOLTA accounts, no matter they be the accounts of sole practitioner lawyer, or a huge legal corporation, the quickest way for any lawyer to not only find themselves disbarred, but in jail, is to improperly handle the funds in these accounts. In fact, just this morning, the headlines in our local newspaper read, “Former Lincoln County Judge sentenced to prison for five years for embezzlement of his legal client’s funds.” A former judge, who had gone back into the private practice of law, was convicted of embezzling more than ½-million-dollars in funds belonging to his clients.
There are instances of lawyers being charged for professional misconduct, including perjury and witness tampering, and still they are not disbarred. But let them ‘convert’ as little as $1,000 in client trust funds for their own use, and ‘wallop’ the gavel hits the bar and they find themselves busted and disbarred from the practice. Even though this responsibility to ‘hold in trust’ the funds of their clients, and to administer that fiduciary responsibility properly, the number one reason why lawyers are disbarred, in every state in the US, has to be ‘stealing from their clients, usually by improper conversion of funds from client trust accounts.’
While law schools may not ‘teach’ the mechanics of trust fund accounting, they certainly ‘preach’ the code of ethics, professional responsibilities, and fiduciary duties of every lawyer to administer these funds properly, or insure the funds are properly administered by their staff. Because when it comes to client trust funds ‘the buck, stops with the lawyer’, even if the thief is a staff member and not the lawyer themselves.
Trust and IOLTA accounts are critical for lawyers and their firms. While some use the terms interchangeably, there are some subtle differences.
Trust Accounts / Client Trust Accounts – Generally speaking a Trust Account (aka: Client Trust Account) is an account belonging to a specific entity - a trust, an individual, an estate, etc. There will generally be significant money that will be held long enough to earn meaningful interest. The American Bar Association (ABA) has this to say about these funds.
American Bar Association - Model Rules of Professional Conduct
ABA Code of Conduct - Trust Funds
While these are ‘Model rules’ promulgated by the American Bar Association, each State Bar Association will implement them in exact, or even more stringent fashion. In addition, they will promulgate specific enactments and exacting requirements that may actually boil down to the specific methodology of accounting required, including mandatory reporting in specific formats. It is essential that all such practices and rules be followed exactly in order to avoid disciplinary action.
IOLTA, stands for Interest on Lawyers Trust Accounts, and has become an integral part of the legal profession. In every state, statutes and/or rules allow lawyers or law firms to deposit client funds in an IOLTA account unless the funds can otherwise earn income for the client in excess of the costs incurred to secure such income. In those cases, the client, and not the IOLTA program, receives the interest if the funds are large enough or will be held for a long enough period of time to generate net interest that is sufficient to allocate directly to the client. The result is a lot of ‘accounting’ to properly determine IOLTA funds and interest, contrasted with Non-IOLTA Client Trust funds.
Every state, along with the District of Columbia and the Virgin Islands, has established IOLTA related legislation and/or court rules. Forty-four jurisdictions have mandatory IOLTA programs (requiring attorneys to participate). Six jurisdictions maintain opt-out IOLTA programs. Participation is voluntary in two other jurisdictions. Each state has its own set of rules and/or statutes that govern when, where, and how to establish and maintain an IOLTA account. Obviously the fact that 52 sets of regulations exist, and that it is easy to see not all of those regulations are the same even on their face, is indicative of the fact that law firms in each state need to be aware of the specific requirements of their own state. Further, law firms practicing in more than one state, even if they are operated under the same ‘holding corporation’, may very well find that they need to comply with several different IOLTA regulation requirements, depending upon jurisdictional considerations.
IOLTA was designed to provide a way to increase access to civil justice for low income individuals. Under IOLTA the interest earned on funds deposited into the IOLTA account, together with state and federal appropriations, provide non-profit legal aid providers with the economic resources to help low-income people with civil legal matters.
In most cases, an IOLTA account is an account that combines the funds of multiple entities or individuals. The funds belonging to each entity or client are not significant enough or being held long enough to earn significant interest, so lawyers are allowed to combine the funds into a single account. The interest earned on this account is transferred back to the state entity specified under state statutes or court rules.
Even though these funds are combined within the IOLTA account, and all of the interest earned is surrendered to the state, the attorney must be able to account for all funds in the IOLTA account in terms of who the funds belong to and what any funds were used for. Either the Bar Association or state mandated IOLTA agency, in the state audits the funds and examines reports that show the funds by client and how the IOLTA ‘trust’ account ties to the funds in the IOLTA ‘bank’ account.
Here are a few specifics that generally apply:
- In an IOLTA client trust account, where the funds of more than one client are being held at any given time, it is important to remember that while funds are deposited into the same account the lawyer must know and account for each client’s funds as if each client had a totally separate account. One client’s funds should have absolutely nothing to do with another client. At no time should funds being held for one client be used, even momentarily, to satisfy the obligations of another client. Separation of the funds should be accounted for using a ledger system that exactly accounts for all monies received and/or paid-out on behalf of each and every client.
- The accounting records for these accounts, should always be prepared (manually or automated) and maintained for each separate client and/or matter and should always document the source of all funds, the date of every fund transaction, the names of the client(s) for whom the funds are held, along with the descriptions, amounts and pay-to-the-order-of identify for all charges or payments made from such client funds.
Client Trust Scales of Justice
- You can’t spend what you don’t have is a fundamental precept of client trust funds. All deposits should be verified as ‘cleared’ with sufficient time so as to preclude any instances of deposited instruments being returned as insufficient before they are distributed. Most states will have rules governing how long a law firm must wait to be ‘safe’, because bank polices may consider funds cleared only to reverse such a determination at a later time. Failure to abide by these practices can have serious repercussions because under most state rules governing ethical behavior, a lawyer who writes a check from client trust funds upon deposited monies, and the deposited funds bounce, or the checks issued bounce for reason of insufficiency, a ‘conversion’ is considered to have taken place even if the lawyer has no dishonest motive, and no client or other person is ultimately harmed. This necessitates having a thorough and complete understanding of the financial institution’s check clearing policies and procedures.
The authors have previously written articles on how to track trust funds in QuickBooks so we won't go into such details within this article. However, it is appropriate to once again emphasize the fact that since the money does not belong to the law firm, there should be a Trust/IOLTA liability account that exactly matches the value of each Trust/IOLTA bank account.
It is critical that those individuals desiring to become ‘Law Firm Trusted Advisors’ not only have a thorough understanding of the legal, ethical and accounting requirements for client funds, regardless of the nature of their deposit (Client Trust or IOLTA Trust) accounts. You should become fully competent in the specific state requirements in which you are going to render services, and always discuss any situations or transactions that may appear unclear or irregular with your client.