The Risk Manager, Fall 2014
Nationwide Lawyers Continue to Lose Substantial Sums of Money to Dishonest Staff by Failing to Reconcile Client Trust Accounts
It astonishes how often the press reports a lawyer or law firm suffering huge losses in client trust accounts resulting from a dishonest employee’s embezzlement. In Kentucky a solo practitioner lost over $800,000 this way. Investigation of embezzlement cases often shows that accounts were seldom reconciled and account management entrusted to a single employee with check writing authority.
An auditor in North Carolina who performs random audits of client trust accounts reports that of the 60 law firms he audited in one quarter 60% were not in compliance with account reconciliation requirements. His answer for why so many lawyers fail to reconcile trust accounts is that they simply do not know how. They rely too heavily on trust accounting software that produces pretty reports that are good examples of garbage in – garbage out.
In light of this continuing problem what follows is a brief refresher on internal controls and reconciliation procedures that law firms should employ in managing client trust accounts.
Internal Controls: These are risk management procedures established to assure accurate and reliable control of the integrity of a firm’s accounting and cash management. These procedures include:
- Retention of documents to support account transactions.
- A chart of accounts to record transactions.
- Preparation of reports and records for account reconciliation, client information and notification, audits, and response to KBA inquiries.
- A filing system that assures that required documentation is retained for at least five years after the end of the representation and all funds disbursed.
Reconciliation: All client trust account checkbook registers, dedicated client trust account ledgers, pooled client trust account journals, and subsidiary client ledgers should be reconciled monthly when bank statements are received and never less frequently than quarterly. This involves a three-part review procedure:
- Reconcile the balance in the trust bank with the firm’s client trust account check register just as you would do with a personal account.
- Compare the reconciled balance in the trust bank to the firm’s client trust account check register balance. These two balances should agree.
- Compare the total of ending account balances in subsidiary client ledgers to the firm’s client trust account balance.
At the completion of this process the reconciled trust bank balance, the firm’s client trust account check register balance, and the total of the subsidiary client ledgers should be identical.
For a good quick review of this balancing procedure Google “Two Minute Tips: How to Reconcile Your Trust Account ...” (last viewed on 8/19/14). For a detailed explanation of this procedure go to the Client Trust Account Recordkeeping section of “Client Trust Account; Principles & Management for Kentucky Lawyers 2nd Edition, pages 22-28, available on Lawyers Mutual’s Website at lmick.com/resources, click on the pamphlet (third bullet under the reference information bottom of the page).
Risk Managing the Process
Check Signature Authority: The recommended practice is for a lawyer, usually the managing partner or lawyer who individually or together with other lawyers possesses comparable managerial authority in a firm, to sign all checks. Do not use signature stamps or computer-generated signatures. Do not use ATMs to withdraw or deposit client funds because unauthorized persons may gain access to the card and ATM receipts do not generate an adequate paper record. There is no implied authority for a lawyer to sign a client’s signature on a check. Doing so without authority is conversion of client funds.
- No one person should be able to initiate, record, authorize and reconcile a transaction. Divide bookkeeping responsibilities. The person paying the bills should not be the person who reconciles the account.
- Separate mail opening from the writing of deposit slips, and banking from bank statement reconciliation.
- Have bank statements delivered to you unopened.
- Examine all cancelled checks or their equivalent (e.g., substitute checks) as soon as the statement arrives. Watch for authorized signatures, endorsements, and payees.
- Require two signatures on large checks.
- Do not allow checks payable to “cash.”
- Require supporting documentation for all checks.
- Approve all client billings and reconcile receipts.
- Control access to checkbooks.
- Give receipts when accepting cash and keep duplicates. If possible, have cash payments witnessed.