Trust Accounting for Plaintiffs’ Lawyers, Part 2
This is Part 2 of a two-part series on trust accounting basics for plaintiff’s personal injury firms. Part 1 focused on the common pitfalls of plaintiff’s firm trust accounting and how to avoid them. Part 2 is about the basics of trust accounting, so that you’re armed with the information you need to comply with your duties.
The Trust Accounting Triangle
Trust accounting can really be boiled down to what my friend, Ken Wahlster, CEO of the forensic accounting firm Stak8, calls “the Trust Accounting Triangle.”
Like any triangle, the Trust Accounting Triangle has three sides:
Bank Account Statement Balance (less uncleared items): This is the balance on your monthly bank statement.
Trust Account Register (also called a “General Ledger”) Balance: This is the ledger that shows all transactions in your IOLTA. For the purposes of a reconciliation, you should exclude uncleared items from the calculation of this balance, as those items would not yet be reflected in the balance reflected on your bank statement.
Client Subaccount Ledger Roll-Up Balance: You should be keeping individual ledgers for each client or third person on whose behalf you’re holding money. The roll-up balance is the sum of all of those individual subaccount ledgers.
For a reconciliation to be accurate, all three sides of the Triangle must be equal. So, if your bank statement shows that you had $50,000 in your IOLTA on a certain date, your trust account’s general ledger should also reflect a $50,000 balance on that date, as should the sum of all your client subaccount ledgers. If these balances match, then your accounts reconcile. If the balances don’t match, then your accounts don’t reconcile—and you need to figure out why ASAP.
Compliance Tips for Attorneys
Reconcile Monthly: Stay on top of account balances to detect discrepancies early.
Understand the Fundamentals: Be confident in your ability to explain how every cent in your trust account is allocated.
Always Leave a Trail: Never make an IOLTA check out to cash. In many jurisdictions this is a violation of the rules of professional conduct.
You Are Ultimately Responsible: You don’t have to do the books yourself, but you need to ensure that the books are done correctly.
When Accounts Don’t Reconcile, Consult an Ethics Lawyer Immediately
Often, when accounts don’t reconcile, it’s due to an unintentional clerical error—e.g., you accidentally paid a client $1905.72 instead of $1509.72. However, over time, these errors can add up, especially if you’re in a high-volume practice or one where you’re cutting a high volume of checks. I’ve handled cases where unrealized clerical errors added up to nearly $100,000 in less than 10 years.
In other cases, accounts don’t reconcile because someone—either a partner, bookkeeper, controller, accountant, etc.—is embezzling money.
Whatever the case, if your trust account can’t be reconciled you need to get an ethics lawyer involved right away. This is doubly true if the state bar is already investigating you.
Many lawyers’ first instinct is to hire an accountant rather than an ethics lawyer—but this is often a mistake. While an accountant will generally know more about accounting than an ethics lawyer, an ethics lawyer knows more about the laws that govern your ability to practice than an accountant.
Moreover, most lawyers have zero fluency in the language of accounting. However, a good ethics lawyer will be at least proficient enough to explain to you what’s going on, accounting-wise; and to explain to the accountant what’s going on from a legal/regulatory perspective. The ethics lawyer bridges that knowledge gap and can coordinate the design and implementation of the solution in a way that keeps everyone in the loop.
The High Cost of Non-Compliance: State Bar Investigations and Audits
Many law firms don’t realize their trust accounting practices are insufficient until an IOLTA check bounces. Unfortunately, once that happens, it’s often too late to fix the problem without collateral damage to your firm.
When you bounce an IOLTA check due to insufficient funds (NSF), the bank automatically sends a letter to the State Bar informing them of the NSF. Once the State Bar receives the bank’s letter, they’ll send you a letter informing you that they’re opening an investigation into the matter. The State Bar’s letter will ask for your response to the inquiry and will ask you to produce certain accounting records to substantiate your response. These records normally include your last 6 months of: IOLTA bank statements, reconciliations, trust account general ledger records, and client subaccount ledger records.
Once you receive this letter, you need to hire ethics counsel. This is where a good ethics lawyer can be the difference between a formal prosecution and a non-disciplinary disposition. A good ethics lawyer can look at your books and help you prepare a response that will help allay the Bar’s concerns. They’ll start by reviewing your reconciliations and other trust accounting documents to understand the source of the NSF.
In some cases, where a law firm’s trust accounts have been non-compliant for many months or years it may be necessary to hire an accountant to help perform a forensic reconciliation. In the most extreme cases, it may be necessary to perform a forensic reconstruction of your trust account books. This process is expensive—even a relatively easy forensic reconstruction can cost $20,000—but it’s often your best chance to avoid a full-on cavity search of your practice by the State Bar. The State Bar’s concern is that you might be stealing client funds—as there have been many high-profile examples of lawyers doing just that in the last few years—so, you need to be able to tell them to whom every cent in your IOLTA is owed. If you can do that, you might be able to avoid full-on prosecution.
All that to say, an ounce of prevention is truly worth a pound of cure here. A prosecution for misappropriation can be a death sentence for a plaintiffs’ firm. Your clients hire you because they trust you. That can all be shattered if the bar accuses you of stealing client money.
If you have any doubts as to whether your trust accounts comply with your jurisdiction’s trust accounting rules, contact Little today.
Final Thoughts
Trust accounting is the one area of legal practice where attorneys have complete control over compliance. Proactively addressing potential pitfalls can save immense stress and protect your license. If you're uncertain about your compliance, let us help you with a trust account check-up. In legal ethics as in medicine, early detection is key.
Call Little Today
Don’t wait until it’s too late. At Little, we can design solutions to help you ensure that your trust account is compliant with your jurisdiction’s rules. Reach out today for a comprehensive trust account check-up or compliance monitoring appointment. Protect your practice, reputation, and license.
No client’s too big and no problem’s too small.
