Every law firm, regardless of size, will find themselves managing client funds at some point, whether it’s for advance payments, settlement checks or other expenses. Managing such funds is a critical piece of practice management, and improper management or use of client funds is a top reason why lawyers get disbarred.
Client fund administration requirements may sound simple, but for a busy firm or complex cases, it’s anything but. Compliant administration requires good organization, discipline and experience.
Here are some basics to consider:
Simply put, when holding client money in a trust, a lawyer takes on personal fiduciary responsibility. This responsibility cannot be delegated to a third party like an accounting firm, bank or software vendor. Two significant fiduciary considerations for lawyers to pay particular attention to are accounting responsibility and selecting the bank itself.
From an accounting side, the complexity arises when there is more than one client in a client trust account, which is almost always the case, seeing as most lawyers work with several clients at the same time. Even though the money is all in one account, each client’s funds must remain separate from one another.
To accomplish this, it’s critical that the attorney do proper “subaccounting.” Essentially, this amounts to a ledger system whereby each individual client’s funds are tracked separately. When done properly, the sum of each individual client ledger will equal the total amount of funds in the account. Every ledger must properly log all transactions, such as credits, debits, interest earnings and bank fees — and must be supported by a clearly documented audit trail.
“Simply put, when holding client money in a trust, a lawyer takes on personal fiduciary responsibility. This responsibility cannot be delegated to a third party like an accounting firm, bank or software vendor.”
Transaction times and processes are also a consideration in accounting for these funds. For example, in a settlement case, incoming monies for a client can take up to several weeks to clear at the bank before they become “available.” If a lawyer were to make a settlement payment before the funds were “available,” they would in effect be using a different client’s funds — thereby engaging in improper use of funds.
In addition to accounting concerns, a newer administrative challenge has emerged for lawyers. In the wake of recent bank failures, lawyers should be particularly careful when selecting the financial institutions they use to hold client trust accounts. A typical lawyer or firm is not going to have the expertise, nor the time, to properly evaluate a bank’s safety and soundness. Yet as fiduciaries for their clients’ funds, they may be liable should the bank they’ve chosen fail.
To prevent this, lawyers should only consider Federal Deposit Insurance Corporation (FDIC) insured banks and be very careful about the account titling and subaccounting record keeping. Through what is known as FDIC pass-through coverage, when you are managing funds for the benefit of your clients and your accounts are titled correctly, deposit insurance worth $250,000 will extend to the client. However, the coverage for any individual client, at any individual bank, is limited to $250,000; if an individual client’s balances exceed that amount, the lawyer should consider opening accounts at multiple banks to ensure that all their client funds are protected.
Managing this takes ledger complexity to a new level. Fortunately, there are service providers that offer solutions specifically designed for law firms, including those that automate the management of a network of banks to optimize deposit allocations and provide full FDIC insurance. Additionally, this process maximizes any interest for the client. As a result, these types of solutions are gaining popularity among law firms looking to de-risk the administration of client deposits.
