The compliance burden of operating client and trust accounts place a heavy responsibility on practitioners – it’s easy to get it wrong.
The compliance burden of operating client and trust accounts place a heavy responsibility on practitioners – it’s easy to get it wrong. Many regulatory environments enforce self-reporting. For example, in England & Wales, the Compliance Officer for Finance and Administration has an active responsibility to report material transgressions to the Solicitors Regulation Authority. Lesser breaches might be noted but only disclosed annually within the Accountant’s Report. This article will discuss reporting and audit behavior in a different region.
CASE STUDY 1
In July 2017 the United States Attorney for the District of Vermont published a notice that a former attorney was sentenced to 14 months imprisonment for mail fraud. The circumstances were that the attorney was a trustee of a trust established by two clients. As trustee, he was required to disburse charitable contributions from the trust and did make them for a while. However substantial sums of money were also diverted to his law practice and used for personal reasons. The criminal behavior occurred within 12 months so easily escaped any attention under an annual audit. Where individuals are concerned, the safeguards are few.
CASE STUDY 2
In July 2018, the Law Society of New South Wales struck a solicitor off the roll permanently for causing a deficiency of funds in a trust account operated by her firm. This case was notable for several reasons: the lawyer had provided access and control over the account to her husband, who was not a lawyer and thus could not be authorized to transact on the account.
The husband had initiated EFT payments from the trust account to a personal account. Additionally, the lawyer herself attended a bank and made a cash withdrawal from trust – a method specifically disallowed by regulation.
Inadequate record keeping accompanied the transgressions and additional refusal to assist the Law Society with their investigation.
Law Societies worldwide often struggle to adequately administer their audit programs, generally due to the costs of servicing large numbers of law practices. Budgetary constraints make it impossible to review every firm on an annual basis. On average, a practice might expect a visit every four years. Firms who operate in certain areas of law, such as estates, are more likely to receive regular audit attention. To ensure continuous monitoring of law firm behavior, regulatory bodies rely on a system of self-reporting via mandatory engagement of external examiners to complete the accountant’s reports.
In New South Wales, the accountant’s report must be finalized and submitted to the Law Society by 31 May of each year. Practicing Certificates for the firm’s solicitors will not be issued unless the report is received. Similarly, in Queensland, 31 May is the deadline for submission. The object of the report is to “form a view, from analyzing internal controls and test checking transactions, as to whether the records have been kept per the legislative requirements and good accounting practices”. Auditors are often reminded that the doctrine of materiality does not apply when auditing trust accounts – a transgression of the rules applies regardless of whether the value is a solitary dollar or ten thousand.
All other states and territories in Australia require similar tests to be conducted and reported. Law societies provide checklists and guidance on the testing regime. For example, tests will be conducted to determine if invoices owed to the law practice were subject to 7-day waiting periods before the transfer of trust monies and that the correct notification was provided to clients, including within the initial cost agreements.
England & Wales
Within the existing Solicitors Regulation Authority Accounts Rules 2011 32A.1.a specifies a requirement that any firm that had held client money during an accounting period must obtain an accountant’s report no later than six months after that period ends. An exemption exists for balances of less than 10,000 (averaged). Typical tests performed include office receipts to assess if any client monies were intermixed; testing for ‘round sum’ client-to-office transfers without a specific connection to a sum or multiple sums based on actual invoice value; delays in banking monies and debit balances within the client account without adequate reason or rectification.
Section 26 of the Solicitors Accounts Regulations 2014 outline the duty to deliver an accountant’s report to the Law Society of Ireland. The examiner would be required to perform test checks of client ledger postings regarding original source records to establish that transactions relating to client monies are in accordance with those regulations. Of particular importance is the check that each bank reconciliation lists a closing cashbook balance equaling the client account trial balance. During an examination, the accountant might call for a review of an entire file. A solicitor may choose to only provide access to limited sections of the file if they believe it will breach their duty of confidentiality to their client.
The Law Society of Scotland requires law practices to submit Accounts Certificate 1 twice-annually. Topics attested to include that a firm has properly investigated any reconciling items appears on the bank reconciliation statement and that any client monies subject to no proper reason to continue the holding of have been returned to clients.
The Law Society of British Columbia maintains a ‘Trust Assurance Program’ to ensure lawyers who handle trust funds are subject to rigorous standards as per the Law Society Rules. The Law Society advises members they should expect an audit every six years. The chance of audit increases where firms fail to file their annual trust report or indicate a compliance issue which raises concerns. Area of practice, volume and size of transactions all play a part in determining how frequently a law practice might be targeted for a society-initiated audit.
Annual audits are a requirement for every BC lawyer or firm who has held trust funds for the period. There is a focus on viewing the report as an education tool rather than an administrative task. One cost-saving benefit available to the BC lawyer is the ability to self-file the report rather than being forced to engage an external auditor, however, the society may still direct that requirement. Typical reporting topics include a full list of all trust account signatories, detailed information on files in the estate area of law, a certification that monthly bank reconciliations were performed and an indication if any trust monies were handled on behalf of another lawyer (working outside of your practice).
In New Jersey, Rule of Professional Conduct 1:21-6 (h) Availability of Records specifies “any of the records required to be kept by this rule shall be produced in response to a subpoena deces tecus issued in connection with an ethics investigation or hearing, or shall be produced at the direction of the Disciplinary Review Board or Supreme Court.” New Jersey Courts maintain a Random Audit Committee with targeted firms chosen on a ‘truly random’ basis via a computer program. The claim is that every law firm regardless of size has an equal chance of being selected.
The safekeeping of client property and holding of trust and client monies requires substantial checks and balances so that the public may hold continued confidence in the business of law. Solicitors have a continual fiduciary duty to their clients, however, ownership and use of a client’s monies often intersect with the commercial necessity of providing invoices – thus introducing the risk that legal professionals may misuse funds. The ideal way to safeguard the process is by transparency – consistent reporting to both client and regulatory body accompanied by well-funded audit programs.