A new era of trust accounting

In a recent conversation somebody offered me the following generalization: “Lawyers usually don’t make very good business people.” We all know that stereotypes are often unfair. And I have certainly seen lawyers who understand the business extraordinarily well. But that was also far from the first time that somebody had shared that view with me.

Perhaps that belief, coupled with recent reports and editorials about disciplinary complaints involving California lawyers, led to the Client Trust Account Protection Program (CTAPP) that the State Bar implemented at the end of 2022. As the State Bar has indicated, the program is designed to do two things: (1) protect the public by ensuring proper accounting and safeguards for client funds entrusted to attorneys; and (2) educate, support, and assist attorneys in complying with the ethical and accounting requirements of managing client trust accounts. And though we are now past the reporting period for 2022 – the usual Feb. 1 deadline had been extended through April 3 – there are still plenty of things for lawyers to consider, perhaps to make next year’s reporting process go smoother.

For many lawyers, the reporting requirement has been an eye opener in reminding them of the obligations that lawyers have, including making sure that the State Bar is notified of any changes to the client trust account and that lawyers need to maintain multiple records associated with the accounts – including client ledgers, account journals, bank statements and canceled checks. In that respect, the program has succeeded in addressing its goals.

Although the State Bar has provided a Client Trust Accounting handbook for many years, it may be that some lawyers who were in charge of their own accounts did not consult with it. As such, they needed to work to recreate the finances for the year. For those who found themselves in that position, there may be a few things to keep in mind.

First, your bank statements are not your account journal. Yes, the numbers should line up, but your journal should be separately kept and used later to confirm that the bank statements are accurate. Keep your account journals the same way that you keep your client ledgers, contemporaneous with each transaction.

Be sure to know when your bank provides statements so that you can compare, keeping in mind that the timing of when deposits are cleared and checks paid may impact the balance. Not only may this help you to fulfill your trust accounting obligations, it can help you in preventing theft from within the firm. Indeed, for that very reason, it makes sense for lawyers to apply this same practice that they are required to take regarding their trust account to their operating account.

Lawyers may have also realized that the monthly reconciliations that they make – and, pursuant to Rule 1.15(d)(3) and (e), are obligated to maintain records of – are more than just comparing discrete data across two documents. It is a process to make sure that there are no errors and no missing funds along the way.

It seems increasingly common to overhear conversations from lawyers about what to do when they cannot determine which funds belong to who. If the trust accounting is done correctly, that should never happen. And, escheatment of funds could signal to regulators that lawyers are either not maintaining records the way they should, or are potentially failing on other fronts – including failing to update client contact information or making timely distributions. Likewise, if money is left sitting in a client trust account after a lawyer has earned it, that would risk discipline for commingling.

In addition to being required, monthly reconciliations are a great way to avoid these circumstances. Importantly, what is expected for client trust accounting is a multi-step process. First, the account journal needs to be reconciled with the client ledgers to make sure they agree with one another. In many ways, this should be the easiest step. The totals from all of the client ledgers should match the balance of the account journal.

Then, the person conducting the reconciliation enters bank charges and interest shown on the bank statement into the account journal and appropriate client ledgers – either for a specific client or the bank ledger – as appropriate. Because lawyers won’t know what these charges or credits are until the bank statements come in, they need to consider them before comparing the ledgers and journal to the statements.

After that, the account journal and client ledgers are reconciled with the bank statement to make sure that the lawyer’s or law firm’s records agree with the bank’s. And then, finally, the corrected month ending balances and corrected current running balances are entered into the account journal and client ledgers.

If the numbers do not match on the first pass, it’s not necessarily a reason to panic. The point of the process is to identify errors so they may be timely addressed.

Though related regulatory changes have brought about less fanfare than CTAPP reporting requirements, they likewise should be addressed through any process changes that firms may be considering. Perhaps the most significant of these involves the new definition of what is timely notice and a timely distribution of funds received. Though lawyers have always had an obligation to “promptly” perform each task, they now have fixed deadlines to do so. Specifically, they must notify anybody within 14 days of receipt of funds or property that the lawyer knows or reasonably should know they have an interest in. And lawyers must make distributions within 45 days of when the interest in funds or property becomes undisputed.

As a practical matter, waiting for monthly reconciliations will not enable lawyers to be able to meet the first standard. Statistically, half of the time the notice will be too late. Accordingly, lawyers may consider adopting a process whereby every time a positive entry is made in the journal and the ledgers, a communication goes out to the interested persons. At the same time, if distributions are not immediately being made, it may make sense to add a calendar entry 30 days out to revisit what distributions can be made.

Finally, all lawyers must keep their eye out for phase two of CTAPP by the State Bar. It will include compliance reviews of selected lawyers by a certified public accountant to ensure adherence to client trust account management requirements. So, yes, your trust account may be audited for compliance. This is, in itself, a strong motivator for ensuring your trust account is in tip top shape.

I recall sitting in depositions, committee and board meetings, and other legal community gatherings where lawyers commented that they came to our profession because they were not good at math. Regardless of whether that was said in jest, this aspect is a necessary part of our work. And it has the incidental benefit of helping us to be better business people.