Management Assistance Program
Trust Accounting Basics
By Julie Bays
Safeguarding client funds and property is an important duty. Trust account management is simple and yet honest lawyers sometimes find themselves in disciplinary peril because they did not pay appropriate attention to their trust account.
The Oklahoma Rules of Professional Conduct require a lawyer to hold property of clients or third persons separate from the lawyer’s own property.1 This means retainers and flat fees, filing fees, deposition and expert witness expenses as well as settlement proceeds should go into a trust account until distribution. These funds are required to be deposited in an interest on lawyer trust account (IOLTA).2 The interest earned on IOLTAs are pooled and transferred to the Oklahoma Bar Foundation.
The fiduciary nature of the attorney-client relationship and the need for public confidence in the legal profession require lawyers to maintain trust accounts with the utmost accuracy. Because of this, one of the requirements under Rule 1.15 (l) is that financial institutions must report any overdrafts of IOLTAs to the Oklahoma Bar Association’s Office of General Counsel.
It is very important for lawyers to maintain accurate records and to balance their trust accounts monthly. Frequently, lawyers go into private practice thinking more about their representation of clients rather than the business side of the practice. As a matter of fact, it’s quite common to hear lawyers joke that they went to law school because they couldn’t do math. When it comes to trust accounts, the math is no joking matter. Lawyers failing to properly safeguard the funds entrusted to them by their clients could adversely affect their license to practice law.3
Simple negligence accounts for many trust account violations. Lawyers need to realize they are responsible for their trust accounts. One memorable story is where a California lawyer received notice from the State Bar of California accepting his resignation from the bar. The only problem is that he never resigned. An investigation revealed his trusty and loyal secretary had embezzled $265,000 from his trust account over a five-year period. She was so efficient that she kept him unaware of client complaints and bar disciplinary proceedings by intercepting phone calls, filing responses and requesting delays. Finally, when she was unable to fake his appearance at a deposition, she agreed, on his behalf, to resign and forged his signature on the resignation. The lawyer spent over $250,000 in restitution and legal fees to remedy the situation but was still suspended by the bar. “Simple oversight and minimal diligence would have prevented this lawyer’s problem.”4
More recently, The Florida Bar suspended a lawyer for three years when a bookkeeper she hired embezzled $150,000 out of her trust account from April 2016 through June 2017. The lawyer’s husband referred a new bookkeeper to her and so she trusted his judgment and did not run a background check. If the lawyer would have run a background check, she would have found out her new bookkeeper was a convicted felon for theft. The lawyer also apparently never bothered to check her trust account for over a year. When the smoke cleared, the lawyer divorced her husband, lost her license to practice law and had to pay back the embezzled funds and $8,261 in costs. These types of stories make it clear that a lawyer must be active in reviewing and reconciling their trust accounts. As a matter of fact, a lawyer or small firm should review their online statement each month and, if they still receive their bank statement by paper, they should require it to be delivered to them unopened so the lawyer can review it personally.
RECORD KEEPING AND THREE-WAY RECONCILIATION
Normal two-way reconciliation of the checking account is where one compares the bank statement with the check register. Not everyone today compares their personal check register with their bank statement or even keeps a check register, but this is an important practice for the lawyer’s business accounting records and required practice for trust accounting. It is admittedly rare that a bank will make a mathematical error today but because humans are involved, it is not impossible. It is more important today that the bank statement is carefully reviewed to timely catch any instances of fraud.
Unlike other types of businesses, lawyers need to keep trust ledgers for each client or matter in order to do three-way reconciliations. To perform three-way reconciliations, the lawyer first maintains a “check book register” tracking all deposits, disbursements and service charges. The prior month’s ending balance is the starting point and those times are added or deducted to arrive at the current month’s ending balance. For this to match the bank statement balances, adjustments will generally be made for items such as outstanding checks and deposits that have yet to clear the account. Finally, and most importantly, the lawyer should then total all the individual client ledger balances and compare this to the ledger balance for the trust account. The bank statement, checkbook balance and the total of the clients’ ledgers should all match.
For the larger firm with many lawyers, a more rigid set of processes may be adopted to make certain that staff properly handles the trust account transactions under the supervision of the lawyers. These steps may include additional record keeping not noted below. For the smaller firm with no staff or the practitioner who chooses not to delegate any trust accounting management to staff, I have outlined a few simple steps below to make certain trust accounting can be done efficiently and without errors.
TRUST ACCOUNTING TOOLS
The OBA Management Assistance Program staff prefers software tools that will expedite the lawyer’s handling of the trust account. Several of these tools have been recognized as OBA member benefits including TrustBooks and several practice management solutions that provide appropriate trust accounting. The OBA member benefits offer a free trial period so lawyers can test out their products. Visit the Practice Management Software Benefits link on MyOKBar for additional information.
Lawyers can also use generic accounting software such as QuickBooks. The challenge is that most generic tools are not designed for the unique requirements of attorney trust accounting and these products may be too complex for those with no experience or training. They may also allow you to “overdraw” the account or a client ledger where software designed for trust accounting software will not. To learn more about setting up a trust account with QuickBooks, attorney Cheryl Clayton’s article in the August 2017 Oklahoma Bar Journal titled “Using QuickBooks for IOLTA Trust Accounting” is a good resource.
Accounting “by hand” using preformatted forms or electronic equivalents is an option that may work for small firms and solo practitioners. Preparing ledgers and reconciliations by hand is time consuming and system safeguards against human error are limited. Regardless, a lawyer must understand how trust accounting practices would be accomplished if done manually.
UNDERSTANDING THREE-WAY RECONCILIATION
The required records to adequately reconcile a trust account are 1) a checkbook register where a lawyer keeps track of all deposits and disbursements along with
a running balance of the total monies in the account, 2) individual ledgers for each client’s deposits, disbursements and running balances, 3) a monthly reconciliation form that the lawyer will complete 12 times per year and 4) a monthly bank statement from the financial institution where the trust account is maintained. Today many bank statements are delivered electronically, but for lawyer’s records, these monthly payments must be retained in the lawyer’s records either saved as a PDF file or printed on paper. The lawyer never wants to be in a position of requiring old bank account records to respond to a grievance and learning that there will be a “research fee” and delay or that the previous bank is now in receivership and there will be problems obtaining these old records.
Many have discussed the need for mindfulness in a lawyer’s daily life and some lawyers practice meditation for self-care. Any time a lawyer is dealing with their trust account, it is suggested that the lawyer first take a deep breath and then proceed slowly and deliberately with the attitude that handling client funds is one of the lawyer’s most sacred and important duties. Do not let the press of other business cause you to rush through trust account transactions.
- When processing a deposit to the trust account, such as a retainer fee, cost deposit or settlement proceeds, first enter the amount and date in the checkbook register and reference either the client name or client name and matter (g., “Retainer from Bob Jones” or “Settlement proceeds in Bob Jones v. Smith”). Then total the new running balance of the trust account. For example, if the lawyer had $17,000 in the trust account and deposited $2,000, the new balance would be $19,000 but these numbers will rarely be round numbers and it is suggested a calculator or software tool be used to minimize math errors. Do this twice because one can make an error entering numbers into a calculator.
- Then immediately go to the client’s ledger sheet, enter the deposit and date and compute the running balance. Again, do it twice. This is simple:
Bob Jones Retainer $5000 Balance $5000
If this is the client’s initial deposit to the trust account, the lawyer will need to create a new ledger sheet for the client identifying the client by name and perhaps referencing the client matter.
Even though it may seem obvious that the first entry on the client’s ledger from the client is a retainer fee, you want to develop the good habit of always identifying the source of and reason behind every deposit. These notes may be useful in jogging the attorney’s memory later and will be invaluable if the lawyer is under some sort of temporary disability and the court has appointed someone to manage the lawyer’s trust account or others in the firm are assisting.
- With checks and other disbursements, the process is similar, but it proceeds in the opposite order. Before writing a check or approving another type of disbursement, the lawyer first consults the client’s ledger to make certain there are sufficient funds on behalf of the client to satisfy the intended payment.
- Then enter this transaction in the client ledger, referencing a check number if there is one and providing the reason for the payment, payee, amount and date (g, 11/11/2019 Tulsa County Court Clerk – Bob Smith Filing Fees – Case number if available and amount). Then compute the client’s new running balance (which must always be a positive number). We still suggest doing the calculation twice or double- checking the math.
- Next, go to the checkbook register and enter all of this information again. Calculate the new balance of total funds on deposit in your trust account, as always, double-checking your math.
The above steps cover each transaction, but there are a few more periodic duties to assure complete compliance with the lawyer’s ethical duties and give the lawyer the ability to “close the books” on the trust account each month.
It is a good idea to review all of your trust account transactions each week just to make sure that everything is in order, but a monthly review is required. The Oklahoma Rules of Professional Conduct do not state that you must balance your trust account each month, but if you do not do this and there is an error that is not caught for several months, it can be problematic to find and fix the error. If there are multiple errors that are not found over months or years, this can create a nightmare scenario perhaps requiring a forensic accounting investigation. In addition, if you find yourself in a situation where there is an ethics investigation and discipline is being considered, there is a huge difference between a situation where an innocent error was found by the lawyer and corrected long ago versus a situation where the trust account is in disarray and many hours of accounting review are now required to determine the exact status.
Once you determine that the bank statement balance, checkbook register balance and the total of the clients’ ledgers all match, you note that in your records and your trust accounting tasks for the month are completed.
It should also be noted that a lawyer co-mingling their personal funds in a trust account is an ethical violation, but Oklahoma Rules of Professional Conduct Section 1.15 (h)(4) allows a lawyer to keep some funds in the trust account to pay bank service charges or credit card processing fees. A ledger should be kept to track that balance just like a client ledger. Many IOLTA-friendly banks will not charge monthly service fees on that account. Credit card fees vary depending on the service. OBA member benefit LawPay can be set up to debit any credit card processing charges from the lawyer’s operating account, simplifying trust accounting.
As noted previously, three-way reconciliation means that on the date each month the lawyer or law firm selects, it is determined that the total of all client balances held in the trust account equals the balance listed on the bank statement (or other online bank records) with adjustments made for items such as outstanding checks and deposits that have yet to clear the account and on the checkbook register. The form below can assist with that task and can be found on the OBA Management Assistance Program’s Opening Your Law Practice resource page at www.okbar.org/oylp.
TRUST ACCOUNT RECONCILIATION
Date of Statement: 12/01/2019
Date Reconciled: 12/02/2019
Before inserting the register balance below, make certain any necessary adjustments to the balance in your transaction register due to service charges and/or other deductions or credits to the account that are identified in the bank statement.
To complete the monthly reconciliation, the following balances must be equal:
The above steps necessary to properly maintain a trust account are detailed and can be time consuming depending on the number of transactions. There are software tools on the market that can make this task easier.
As someone who started her career as a bookkeeper, there is something Zen-like and satisfying when the numbers match in a perfect balance.
ABOUT THE AUTHOR
Julie Bays graduated from the OU College of Law in 1998. She worked in the Oklahoma Attorney General’s Office from 2002-2018 when she started at the OBA as a practice management advisor in the OBA Management Assistance Program, aiding attorneys in using technology and other tools to efficiently manage their offices.
- Oklahoma Rules of Professional Conduct (ORPC) 5 O.S. Ch. 1, app. 3-A, Rule 1.15 (a).
- Oklahoma Rules of Professional Conduct (ORPC) 5 O.S. Ch. 1, app. 3-A, Rule 1.15 (h).
- In State ex rel. Okla. Bar Ass’n v. Perkins, 1988 OK 65, 765 P.2d 825, State ex rel. Okla. Bar Ass’n v. Weigel, 2014 OK 4 (Okla., 2014).
- Melissa DeLacerda and Dan Murdock, “The Trustworthy Trust Account,” 74 OBJ 3393, Dec. 13, 2003.
Originally published in the Oklahoma Bar Journal — December, 2019 — Vol. 90, No. 10