Trust Accounting for Plaintiffs’ Lawyers, Part 1
Without a doubt, trust account mismanagement is the easiest way to lose your law license. This article is Part 1 of a two-part series geared toward trust accounting for plaintiff’s firms. Part 1 discusses trust accounting issues broadly, why Plaintiff’s firms are often over-scrutinized in their client trust accounting, and some common trust accounting pitfalls for plaintiff’s firms. Part 2 discusses the basics of trust accounting and reconciliation.
Types of Trust Accounting Issues
Misappropriation
There are three broad categories of trust account mismanagement: misappropriation, commingling, and improper record keeping. Misappropriation is when a lawyer improperly withdraws IOLTA funds that belong to a client or third party. Misappropriation can be intentional (e.g., embezzlement) or unintentional (e.g., accidentally refunding a client too much money). While the Bar takes all trust accounting issues seriously, in my experience, they prosecute misappropriation most harshly—even unintentional misappropriation can lead to a lengthy suspension or disbarment.
Commingling
Commingling is when a lawyer improperly holds personal funds in their IOLTA. Lawyers are generally allowed to hold a nominal amount of personal funds in their IOLTAs, as those funds will be used to cover bank charges, etc. However, anything more than that could lead to discipline. In my experience, the Bar is generally willing to work with lawyers who unintentionally commingle personal funds in their IOLTA; however, intentional commingling (e.g., for tax evasion or asset shielding) is generally prosecuted quite harshly.
Improper Record Keeping
Lawyers can also be prosecuted for failing to keep proper trust accounting records. In general, lawyers have an ethical duty to keep certain types of accounting records, including reconciliations. Failure to keep those records will not only subject you to disciplinary liability, but it makes it more likely that you accidentally engage in misappropriation or commingling, as you won’t have accurate records of who’s owed what.
Improper record keeping cases are often the most difficult to defend, as the lawyers involved often must hire both ethics counsel and a forensic accountant to reconstruct their books. This is one area where an ounce of prevention is truly worth a pound (or more) of cure.
Why Plaintiff’s Firms Are Targeted
In my experience, plaintiff’s personal injury attorneys are generally the most heavily scrutinized when it comes to trust account management and audits. I believe this is for two reasons. First, PI firms often handle large sums of client money, and regulators naturally want to make sure that these funds are properly handled. Second—and likely the biggest reason—is that state bars across the country have dealt with a string of high-profile cases where PI lawyers embezzled client funds. For example, in California, we had Tom Girardi and Michael Avenatti, who collectively embezzled nearly $30 million from their clients. These cases brought heaps of bad PR for lawyer regulation agencies, many of whom have implemented new measures to monitor lawyers’ trust account management practices. For example, California has implemented the CTAPP program, while Illinois created Illinois Rules of Professional Conduct Rules 1.15A, 1.15B, and 1.15C, which provide for greater monitoring and scrutiny of lawyers trust accounts.
Plaintiff’s Firm Pitfalls in Trust Accounting
In my time as both a bar prosecutor and defense lawyer, I’ve noticed that most plaintiff’s firms’ trust accounting issues can be traced back to one of three things.
Trusting the Wrong Person to Do Your Bookkeeping
By far, the biggest mistake I see PI lawyers make with their trust accounts is trusting the wrong person to do their bookkeeping. This is especially true for PI firms that started out as solo practices and have grown into mid-sized or large firms. Very often, the person who does that firm’s bookkeeping is the same employee who’s done it since the firm’s opening—often several decades ago.
However, the firm’s bookkeeping/trust accounting needs are radically different than they were when the firm was still a solo practice. The firm is handling much more money than it used to, settlements are much more complex than they used to be, and the regulations around the holding and disbursement of funds has changed several times over the years. Additionally, the person doing the bookkeeping may not be tech-savvy, and may have a ‘proprietary’ accounting system that the firm owners don’t understand.
In my professional experience, these are the ingredients for a horror story. The story I’ve seen play out the most is this: the law firm bounces an IOLTA check, which triggers a state bar investigation. The bar asks for the firm’s trust accounting records, at which point the firm hires ethics counsel. Ethics counsel takes one look at the books and realizes they’re a mess. They hire a forensic accountant, who corrects the books, but realizes that the account is short. Very short. Tens of thousands, hundreds of thousands, or even millions short. Everyone asks the logical question: was someone skimming money? The answer is (usually) no, but it soon becomes clear that hundreds or thousands of small errors accumulated over time, and “accounting” never caught them because the person in charge of accounting is the “bookkeeper” who’s been doing the firm’s books since its opening.
The end result in these cases is often hundreds of thousands in legal and accounting fees, as well as hundreds of thousands—if not millions—more in personal/firm funds deposited into the IOLTA to correct the shortages.
Practice Tip: As your firm grows, continually assess whether your internal bookkeeping and accounting systems are still sufficient.
Failing to Keep Accurate Accounting Records
Some lawyers simply don’t keep proper accounting records. On some level, this is understandable—after all, you went to law school to practice law, not be an accountant. Many lawyers find themselves in law school because they hate math. In some cases, lawyers who feel this way often forget to maintain proper records, as they’re busy serving their clients.
In many cases, these lawyers eventually bounce a check from their IOLTA, which triggers an automatic bar investigation. Very often, the Bar’s inquiry letter will request at least 6 months of accounting records, which the lawyer doesn’t have. When this happens, there’s often a mad scramble to forensically assemble the records and respond to the bar. This process is both stressful and expensive—often running into the mid-five-figures for accounting and legal fees.
Practice Tip: If you’re this type of lawyer, you should pay an accounting firm to do your books, and an ethics lawyer to briefly review them to ensure they were done correctly. You may think you don’t have the money, but a few hundred dollars per month can save you $40,000-$50,000 (or more) in legal fees down the road.
Keeping Paper Records
Another mistake I see people make is using paper records. Often, this is because the lawyer is not comfortable with technology or doesn’t know what software to use. However, it’s simply too easy to lose, damage, destroy, or manipulate paper records. If that happens, you wouldn’t be able to respond to a bar complaint or understand the history of your IOLTA.
Practice Tip: If you’re uncomfortable keeping paper records, hire an accounting firm to do your books and an ethics lawyer to make sure they’re done correctly.
Failing to Understand Trust Accounting Generally
Finally, many lawyers simply don’t understand how to do trust accounting. Unfortunately, those lawyers are the most vulnerable to employee embezzlement or unintentional commingling.
The good news is, trust accounting is straightforward enough that anyone can learn the basics. I’ll cover that in Part 2 of this series.
If your firm has trust accounting issues, or if this article resonated with you, contact Little today to see how we can help you design and implement compliant trust accounting practices.
Why Little?
At Little, legal ethics is what we do.
We have extensive experience analyzing and designing law firms’ trust accounts and trust accounting practices. So, we can help you Do the Right Thing when it comes to navigating the trust accounting challenges you’re facing. Contact us today to learn how we can help you protect your license, reputation, and practice.
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