Legal accounting can be a complex and challenging area, particularly when it comes to managing Lawyer Trust Accounts (IOLTA). With strict ethical guidelines and legal limitations governing these accounts, mismanagement can have severe consequences, ranging from a reprimand to disbarment. However, by understanding the regulations that define and govern IOLTA accounting, you can minimize the risk of compliance issues and avoid common pitfalls.
What is an IOLTA Account?
An IOLTA (Interest on Lawyer Trust Account) is a special account set up by lawyers or law firms to hold client funds until they can be properly distributed. While the attorney of the firm has custody of these funds, they are not funds of the firm. Rather, they belong to the client until an accurate determination and disbursement can be made. Improper handling of IOLTA funds can lead to ethical violations at both the American Bar Association (ABA) and the state level.
IOLTA Account Rules and Compliance
The ABA Model Rules of Professional Conduct, specifically Rule 1.15, titled Safeguarding Property, outlines the responsibilities that attorneys have concerning client funds. Attorneys must segregate client funds from their own by placing them into designated trust accounts. Any legal fees and expenses paid in advance should be deposited into the client’s trust account and only withdrawn as fees are earned and expenses are incurred. Many state bars have implemented measures surrounding the operation of a trust account to ensure compliance. Ethical or fraudulent issues surrounding IOLTA occur most often in the following areas:
Commingling of Funds
Commingling of funds occurs when you mix client funds with personal or firm assets, which is prohibited. Lawyers are expected to keep client funds fully segregated from their own, ensuring that client money is never used for personal or firm operational expenses.
Misappropriation of Client Funds
Like commingling funds, misappropriating client funds can be met with disciplinary actions. Client funds are not the firm’s or the attorney’s. These funds must be handled with care and must not be used for anything other than their intended purpose.
Inadequate Record Keeping
Failure to maintain accurate and detailed records can lead to mismanagement of IOLTA funds. You not only have to keep the money in the trust account but also keep a ledger of what makes up these balances. This ledger should be reconciled with both the bank statement and back to the ledger, which should be the source of truth for the funds. This is called a three-way reconciliation.
Unmanageable Number of Accounts
Holding multiple small client accounts or having multiple offices can lead to confusion, especially if the client file naming conventions are unclear. For example, if you label accounts with the last name plus the first initial, you open the possibility of mislabeled accounts: John Jones and Jim Jones could easily get mistaken. Mistakes like these could lead to funds being misallocated, which can result in violations of ABA and state bar rules. To avoid such errors, ensure that account identifiers are clear and unique.
Lacking Segregations of Duty
Segregation of duties is essential to reduce the risk of errors or fraud. That starts by separating critical functions in the accounting area. While attorneys may not be directly responsible for performing reconciliations or disbursements, they are responsible for overseeing these processes. Staff should be properly trained to comply with ethical guidelines, and if possible, an external party or vendor should be involved in performing reconciliations to ensure full compliance.
IOLTA Account Best Practices
Running afoul of the rules surrounding IOLTA accounts gives the state bar authority to discipline you. Consequences could include the loss of your license or disbarment, which equals the loss of your livelihood. To mitigate the risk of violations or fraudulent activities, consider implementing the following best practices:
- Perform reconciliations regularly: Conduct IOLTA reconciliations or have them performed on at least a monthly basis.
- Adopt three-way reconciliations: Put three-way reconciliations into practice to ensure you are keeping detailed records on both a global trust account balance level and on the sub accounts that make up that trust account.
- Ensure accurate sub accounts: The sub account should be a source of truth tying back to the trust account balance and the reconciled balance.
- Train and supervise staff: Ensure that all staff involved in managing IOLTA accounts understand and adhere to state and ABA regulations regarding trust accounts.
Three-Way Reconciliations
Three-way reconciliations are crucial for IOLTA trust account management. This process ensures that client funds remain segregated from business or personal accounts and helps detect discrepancies caused by fraud or errors. Here is how to perform a three-way reconciliation:
- Gather your bank statements
- Review your general ledger for the trust account as well as the subledger for all the accounts that make up that balance
- Reconcile your bank statement back to the check register to match deposits, ticking off checks that cleared and subtracting the outstanding checks and deposits in transit from your bank statement
- Compare the result of the above with your general ledger trust account balance
- Verify individual client ledger balances to ensure they add up to the same total as the general ledger and the reconciled bank balance
Three-way reconciliations ensure that bank statements are balanced so once the bank reconciliation is done, it ties back to the register or the overall account balance on the books of the firm, which also ties back to the individual client ledger balances. So, if your trust account has $19,500 in it, that is also reflected in your general ledger and your bank reconciliation. The third leg of the stool, so to speak, is to add up all the sub accounts that make up that trust account, which should once again tie back to that $19,500 figure.
Maintaining IOLTA accounts in compliance with ABA and state bar codes of conduct is possible. A regular cadence of three-way reconciliations can help attorneys protect client funds while maintaining ethical compliance and avoiding disciplinary actions. A third-party vendor can help smaller firms with separation of duties, a fundamental tenet of the accounting profession.
Effectively managed IOLTA accounts play a pivotal role in maintaining the ethical and legal standards essential to the integrity of the legal profession. Reviewing your IOLTA practices can prevent trouble with your state’s bar associations and keep your trust ledger in good standing.
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