By Sandy Abalos and Karen Clark
Arizona soon will become one of the few states in the country that subjects lawyers to random audits of their client trust accounts.
Many lawyers need help understanding the newest Arizona Supreme Court rules about trust accounting: the new random audits, acceptance of payments by credit card, and the new rebuttable presumption when adequate records are not kept. This article briefly covers the current rules that govern how lawyers handle their clients’ money.
Lawyers need to know that there are specific requirements for trust accounting recordkeeping, including risk management and internal control procedures.
What rules have changed?
There have been two sets of changes. The rule allowing for Small Business Administration (SBA) audits took effect January 1, 2009. The rule regarding credit cards took temporary effect January 1, 2009, and was made permanent in September 2009. Rule 44 Ariz.R.Sup.Ct. is gone and has been merged into Rule 43 Ariz.R.Sup.Ct.. The new provisions involve:
- Credit card transactions ER 1.15, Rule 43 Ariz.R.Sup.Ct.
- State Bar random trust audits Rule 43(d)(1) Ariz.R.Sup.Ct.
- Rebuttable presumption Rule 43(d)(1) Ariz.R.Sup.Ct.
What rules have stayed the same?
The rules about how a lawyer should treat clients’ money have not changed. The type of money dictates where it goes. In general, client money goes into a trust account, and firm money goes into an operating account. The following must go into a trust account:
- Money that belongs entirely to the client
- Money that belongs in part to the client and in part to the lawyer (now or in the future)
- Money that belongs to a third party in connection with a representation
- Funds to cover bank charges
Under the Bar’s 10-Day Rule for clearing deposits, lawyers must wait 10 business days as a rule of thumb prior to disbursing against a deposit to ensure it has cleared their Interest on Lawyers Trust Accounts (IOLTA). Limited-risk uncollected deposits may be disbursed against immediately only for checks involving (1) a certified or cashier’s check; (2) a financial institution; (3) a government entity; (4) or checks and drafts from insurance and title companies. The lawyer must replace any disbursement against uncollected trust funds (with the lawyer’s own funds) within three business days.
Lawyers cannot make a mistake when it comes to depositing client money in the right account. It is the nature of the funds themselves that dictate in which account they belong. Four types of advance fees are described in Comment to ER 1.5:
- Retainer – As an advance fee paid to ensure the lawyer is available to the client, a retainer is earned upon receipt. Time cannot be billed against a retainer – the money goes in the operating account.
- Advance fee deposit – This is a security deposit to ensure the payment of fees when they are subsequently earned, either on a flat fee or hourly fee basis. Time is billed against an advance fee, and the money goes in the trust account.
- Flat fee – These are set amounts for a specific task. The lawyer must explain to the client in writing whether the fee is earned upon receipt and non-refundable, or whether the work must be performed before it is earned. Time cannot be billed against a flat fee. The money goes where the designation demands.
- Non-refundable/Earned upon receipt – It is ethically permissible to charge a non-refundable/earned upon receipt fee, but only if the client is told (in writing) that it may have to be refunded (ER 1.5(d)(3)).The lawyer must take a “backward look” to make sure the fee is reasonable (In re Hirschfeld, 192 Ariz 40). An earned upon receipt fee cannot go into trust and may still be refundable. These fees go into an operating account.
The lawyer must keep client money separate and save the records for five years after termination of the representation. Due professional care and adequate internal controls are required. The sophistication of the trust accounting system will be directly related to the complexity and transaction volume of the trust account. Some useful tips we give to lawyers for trust accounts include the following:
- Different color check stock from operating account to insure correct account is used
- Different deposit slip stock
- Partner(s) as signers – recommended
- Cut bank statement off at Month End to facilitate the bank reconciliation function
- Indicate as Client Trust Account – FDIC
Required trust accounting records include proof that the lawyer has performed the required monthly three-way reconciliation which insures the trust accounting is accurate. The three-way reconciliation matches the check register checking account balance to the bank reconciliation book balance to the individual client ledger summary.
The question often asked is: “What if it doesn’t balance?” In that event, the first step is to identify the period of time the accounts are not in reconciliation. The second step is to identify which part of the three-way reconciliation is out of balance. If the error is with the check register, one would double-check that all entries were recorded in the check register and addition/subtraction is correctly computed. If the error is with the bank reconciliation, one would double check that all deposits in transit and outstanding checks are correctly listed and calculated. If the error is with the individual client ledger summary, one would insure that all transactions entered into the check register were correctly posted to and added or subtracted from the individual client ledgers.
A computerized double entry software program, such as QuickBooks, can be easily formatted to maintain most of the required accounting records and minimize the potential for math and posting errors.
Tools to help lawyers stay one step ahead of a random audit
We have joined together to help attorneys stay one step ahead of a random audit, including ways to keep the right records, keep them organized, and ensure a high level of accuracy. Our service is a comprehensive, independent, and confidential assessment of an attorney’s trust account bringing them into compliance in advance of any Bar audit.
The service brings together the expertise of attorneys and certified public accountants – licensed professionals who will help ensure that trust accounting systems comply with the legal and accounting requirements of ER 1.5, 1.15 and Rule 43, Rules of the Supreme Court. This includes a customized firm trust accounting records binder in which to hold work papers and document quality control to make a law firm audit-record-ready.
Rules – What’s new regarding credit cards?
In September 2008, an ethics opinion stated that “Credit-card payments are impermissible for receipt of advance payment for fees and costs.” Effective September 2009, the rule changed. Lawyers may now accept credit card payment of advance fee deposits, but only if the stringent requirements of the new rules are met.
Using a credit card doesn’t alter the nature of funds! If it is earned, it goes in the operating account; if it is unearned it goes in the trust account. If a lawyer uses a credit card service that allows the lawyer to identify which account the funds are deposited into, and the lawyer receives funds that belong partially in trust and partially not, then the lawyer cannot deposit earned fees into trust.
Lawyers must know whether their client’s credit card company allows the client to use the card to pay for future services. If the lawyer takes credit cards, he or she must keep sufficient funds in trust to pay all fees, including bank and credit card fees. This money must be deposited into the account prior to the charge. If not, this will be considered misappropriationof client funds. The lawyer may only deposit firm money in trust in an amount reasonably necessary to cover bank fees related to the trust account, or fees or charges related to credit card transactions or debits for credit card charge backs.
“Lawyers who maintain an unreasonable amount of their own funds in their trust accounts (for credit card fees) will be subject to a finding of misconduct.” (Rule 43 Ariz.R.Sup.Ct., comment 6)
Audits and rebuttable presumption
There is a new rebuttable presumption that if a lawyer fails to maintain trust account records required by the rules or fails to provide them to the Bar, they have failed to properly safeguard client funds as required by Rule 43 Ariz.R.Sup.Ct. and ER 1.15. When the Bar starts auditing lawyer’s accounts, it is likely that if they find a violation, any violation, the lawyer will be responsible for paying the costs and expenses of the audit, in addition to any sanction they receive for mismanaging their trust account.
The above information is specific for Arizona trust accounts and is not universal to all attorney IOLTA trust accounts.
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