Having a good working set of accounting records is an essential step toward the sensible management of client trust funds. It is also the first essential to avoiding theft.
However, it is only a first step. Without required records, the lawyer has not met the obligation to clients or to the Court. Moreover, the lawyer without proper records can be responsible for knowingly, or negligently invading clients’ trust funds. Equally important is the fact that the lawyer who has poor records is ripe for theft by partners, associates, bookkeepers, and secretarial employees.
Even when records are properly established, however, records alone do not satisfy the lawyer’s ethical obligations and do not serve as a defense against theft by others. In order to meet these challenges, one must: (a) maintain records in proper working order;
and (b) exercise control over these records by actively reviewing them in accordance with a regular oversight program. This chapter outlines some of the steps by which lawyers can control their client trust account and meet ethical obligations and minimize the possibilities of theft.
B. Diversification of Financial Functions
The cardinal rule in avoiding theft is to divide the monetary functions in a law office. This is particularly difficult for a small firm or sole practitioner. However, if one secretary, for example, is given authority and responsibility to handle the trust and business accounts, reconcile these accounts, handle bank statements and, occasionally, even sign checks, that one person can easily doctor the records to cover up a theft and avoid detection for a long period of time. The same is true where one lawyer in a firm has sole responsibility for accounts with no oversight. Either one could unilaterally steal the law firm blind.
Ideally, functions can be divided this way:
Only a lawyer may sign trust account checks.
Only one secretary or bookkeeper should have access to trust and business accounts records. Access by many secretaries makes it more difficult to pinpoint responsibility and increases opportunities for theft.
A separate staffer should open all mail and record all incoming checks, which should then be given to the secretary/bookkeeper responsible for maintaining the accounts.
All accounting records should be reconciled by the lawyer or by an independent accountant or bookkeeper on a monthly basis.
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The lawyer responsible should receive directly all monthly bank statement unopened or directly by electronic transmission.
An annual (or quarterly) audit should be done by an outside accountant.
This layered diversification of responsibility minimizes the opportunities for fraud, since successful theft in this system requires collusion between two or more persons.
C. Exercising Control of Records
Control is not a self-executing concept. It must be exercised. The following are positive steps that can be taken to exercise control over trust and business accounts funds:
(a) When the lawyer signs trust account checks, a review of the client’s ledger should be made to determine the validity of the checks drawn.
(b) A periodic review should be made of the reconciliation book prepared by the secretary/bookkeeper to determine its correctness.
(c) A perusal and inquiry of checks outstanding for an extended period of time should also be made periodically.
(d) Randomly, a review of the current balance on the general ledger/checkbook register and the balance of funds reflected on the client’s ledger should be undertaken when a disbursement is made to ensure that there are sufficient collected funds to accommodate the disbursement.
(e) The bank statement (with canceled checks) should be delivered unopened to the lawyer or directly by electronic transmission. The lawyer should then peruse the canceled checks for the following:
(1) Are the payees familiar?
(2) Are the clients who are named on the checks firm clients?
(3) Are endorsements made by the payee or by an employee in the law office?
(4) Are checks being cashed instead of being deposited? If so,
communicate with one or two payees to make sure they received the money?
(5) Are duplicate payments being made? If so, is one legitimate and the other being taken by an employee?
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(6) Is your signature on all checks authentic? DO NOT use signature stamps.
(f) Randomly review bank statements that are delivered to you unopened to make sure that none are missing. Personally obtain and review any
missing bank statements and also any checks that have been outstanding for a long time or which are missing.
D. Exercising Control Over Employees
1. Hiring
Just as a dispossess action is no substitute for finding a good tenant, so too a lawsuit or criminal action is not much solace for hiring a dishonest employee. There is no
substitute for hiring good, honest employees. While there are no guarantees on new employees, there are basic steps that should be taken. It is most important to do a thorough background review and to check references.
One law firm hired a bright, attractive secretary who had excellent skills. They later fired her for stealing $26,000 and only then inquired of her former employer to find out she had previously been fired from that firm and criminally prosecuted for theft.
2. Instruction
Lawyers are ethically obligated under Rule 43(b)(1)(B) to properly instruct and oversee employees to ensure that their actions are compatible with the lawyer’s professional obligations. This is particularly true of those employees who will be involved with the handling of clients’ and firm funds. Give them a copy of the Rules and this manual and make sure they understand the basics. Then follow up periodically and check their compliance.
3. Supervision
Sometimes employees seem too good to be true. Consider these signs carefully if you believe there could be theft or fraud by an employee:
• Does the employee come in early (usually before the boss) and stay later than necessary (usually after the boss has left)?
• Does the employee come in on Saturdays, Sundays and holidays when not required to do so?
• Does the employee fail to take earned vacations?
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E. Process
It is essential that all law firms develop a sound, routine process for handling checks that any deviations will serve to highlight questionable practices. Key among these
processes are:
Use restrictive endorsements on all checks received, marked “for deposit only”
into a specific account or accounts.
Require two signatures for large checks.
Never use a facsimile signature stamp.
Never write trust account checks to cash.
Never use an ATM card to withdraw trust funds.
F. Billing Clients Regularly
One of the quickest ways to determine whether or not fees paid by clients for legal services (as well as other monies paid to the law firm on the client’s behalf) have been handled improperly, is to bill clients promptly. If money is diverted to other purposes by law firm staff and is not correctly reflected on the bill, the client will be the first to
complain. For this reason, many lawyers also account to clients more frequently than they are otherwise obligated to do.
G. Separate Trust Accounts For Lawyers in Same Firm
There is no limit to the number of client trust accounts that may be maintained by a lawyer or law firm. There is also nothing that prohibits each lawyer in a firm from maintaining trust accounts in the lawyer’s own name separate from the firm. However, for good control, oversight and accountability, firm accounts are preferable to individual accounts. When individual partners or shareholders have separate trust accounts, they unnecessarily expose other principals to liability, usually without the other principals having any ability to exercise oversight or control over the handling of clients’ funds in the separate accounts.
H. Insurance—The Ultimate Control
The ultimate risk control mechanism is insurance. Despite all prudent audit control steps one may take, it is still possible that a theft may occur. If reasonable audit control steps have been followed, however, such a theft will be detected at an early time and, hopefully, while the amount of money taken is small. Nevertheless, in a time where typical mortgage amounts run from $100,000 to $400,000, just one theft can expose the
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Insurance may be the key to avoiding liability for theft by another lawyer or employee in the firm. Malpractice insurance policies usually have a standard exclusion relating to criminal, fraudulent and dishonest conduct of an insured. However, many also contain an “Innocent Insured Exception” to this inclusion. Some companies writing lawyer malpractice policies have a standard provision in its “claims made” policy that, in effect, covers each and every insured who did not personally commit, participate or acquiesce in the criminal, dishonest, fraudulent or malicious act, or remain passive after having personal knowledge of such act.
Under this policy an “innocent” lawyer partner, shareholder or sole practitioner would not be faced with declaring personal bankruptcy if another lawyer in the firm stole $800,000 as the result of a gambling, drug or alcohol problem. Every lawyer should inquire into the feasibility of having the firm’s malpractice policy contain this “innocent” lawyer exception. Lawyers should also inquire about the cost of “Dishonest Employee”
coverage for non-lawyer staff members who handle trust and business funds.
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