Other People's Money

Two checks that came back

In May 2010, two settlement checks that a Florida lawyer named Clint Johnson had written to his personal injury clients came back unpaid. Both were drawn on his firm’s trust account. The clients were paid the next day, when the checks were presented again. But the bank had already sent The Florida Bar an overdraft report, and the Bar’s auditor found shortages, negative balances, and improper transfers in and out of the account. Johnson learned of the report in July, two months later, from his longtime bookkeeper. According to the Supreme Court of Florida (opens in a new tab), she had been stealing from his operating account and shuffling money through the trust account to hide it, while he let her run the accounts with little supervision.

The bank noticed before the lawyer did. It could, because Florida requires every lawyer to authorize the bank to report an overdrawn trust account to the Bar. The firm’s own records should have told Johnson first, and they could not, because nobody was reading them against each other. So what does a firm have to keep, and what does it have to check each month, to be the first to know? This reading takes apart the trust account and its records one element at a time. Then it shows how the monthly reconciliation joins them. In the activity, you run one month of Temko Eden’s trust account through the same steps.

Whose money is in the account

A trust account exists to answer one question: whose money is this? Everything in it belongs to someone other than the firm, a client or a third person, until the firm earns it or pays it out. That is why the rule forbids commingling. When firm money and client money sit together with no line between them, no one can say whose dollar paid for what.

The rule’s two exceptions are narrow on purpose. A firm may keep enough of its own money in the account to pay the account’s bank charges, so that a monthly fee never comes out of a client’s balance. And a lawyer may deposit the lawyer’s own money to cover a shortage, a story the last part of this reading tells.

Fees are where the line blurs, so the rules draw it twice. An advance fee, money a client pays against work not yet done, belongs to the client until the firm earns it, so it goes in trust. The firm bills against it each month and moves the earned part out. Once a fee is earned and due, Rule 5-1.1(f) requires the firm to withdraw it within a reasonable time. Leaving it there puts the firm’s money in with the clients’. The comment to Rule 5-1.1 treats a true retainer differently: money paid only to secure the lawyer’s availability is earned when it is paid, so it never goes in trust. If anyone disputes the firm’s right to a fee, the disputed part stays in trust until the dispute ends. Those are the rules of earned fees and disputed funds.

Most client money in a small firm is small or brief: a filing fee advance, a settlement that leaves within the week. That money goes in an IOTA account, one pooled account whose interest the bank sends to the foundation that funds legal aid. The lawyer decides, in good faith, whether a client’s money could earn more interest than it costs to earn. If it could, it goes in a separate account that earns interest for that client. Either way, the firm never keeps the interest.

What the records have to show

Florida does not leave the records to taste. Rule 5-1.2(b) sets out the trust accounting records every firm must keep, and each one answers a different question.

The source documents prove what happened. A deposit slip shows the date, the source of the money, and the client it was for. A trust check carries a number in sequence and the client’s name in the memo line, and the canceled check shows who endorsed it. An electronic transfer needs a record of who authorized it, who received it, and when it went. A wire needs both banks’ routing numbers and the reason for the wire. The bank statement shows what the bank actually holds.

Two books turn those documents into a picture. The receipts and disbursements journal is the account’s diary: every deposit and every payment, in date order, with the client, the check number, the reason, and a running balance. The client ledgers split that diary by client, one page for each client or matter. Each ledger answers the question the whole system exists for: how much of the money in this account belongs to this person?

A ledger has one iron limit. It can reach zero, but it cannot go below zero. A negative balance means the firm paid out more for a client than it ever held for her. In a pooled account, that difference came from someone else’s money.

The firm keeps these records for six years after each representation ends. It may keep them on paper or in digital form, as long as the copies carry everything the originals did.

Three balances that must agree

The records only protect anyone if someone reads them against each other. Rule 5-1.2(d)(1) requires that reading every month, in what practitioners call a three-way reconciliation. The three are the bank’s balance, the journal’s balance, and the total of the client ledgers.

The bank and the journal rarely match on the last day of the month, and the reasons are usually innocent. Suppose the statement shows $20,000. A $1,500 deposit made on the thirtieth reached the bank’s books on the first of the next month, so it is a deposit in transit. Check 1107, for $600 to a court reporter, has not been cashed yet, so it is outstanding. The adjusted bank balance is $20,000 plus $1,500 minus $600, or $20,900. If the journal also shows $20,900, the first two agree. Then the ledgers must add up to $20,900 too. If they do not, the rule wants a specific description of every difference and the reason for it. A reconciliation is not finished when it balances. It is finished when every difference has a cause.

Some differences are not timing. The bank can do things the journal does not know about: charge a fee, or take back a deposit that failed to clear. That is why Rule 5-1.1(j) lets a lawyer pay out a client’s money only against collected funds, money the bank has finally settled and credited. The rule lists six low-risk exceptions, such as a cashier’s check, a government check, or an insurance company’s draft the lawyer reasonably believes will clear. A payment made against any other deposit before it clears is at the lawyer’s risk. In Johnson, the Bar’s evidence showed fees and payments to clients made before the settlement check for that client had even been deposited.

What does a missed reconciliation cost? In The Florida Bar v. Rousso (opens in a new tab), a firm’s bookkeeper embezzled about $4.38 million from its trust account and then, the referee noted, allegedly fled to Argentina. The firm kept no separate ledger for each client and made no monthly reconciliations. The referee found that if the lawyers had followed the minimum rules, the theft could have been exposed “before damage extended beyond the second month.” The court disbarred both lawyers. It approved the referee’s finding that a lawyer’s responsibility for trust money cannot be delegated to a nonlawyer employee. In other words, the bookkeeper may keep the books, but a lawyer must read them.

When the balances do not agree

A reconciliation that ends in a shortfall has found a trust account shortage: the account holds less than the firm owes the people whose money is in it. The first job is to find the cause and the client. The second is to make the account whole, and the rules say how.

Rousso shows the history. When the lawyers learned of the theft, they poured their own money and borrowed money into the trust account to cover the loss. The referee called it a matter of personal honor. The Supreme Court of Florida called it commingling and found them guilty of it. Two years later, the court amended the rule in In re Amendments to the Rules Regulating The Florida Bar (Biennial Petition), 167 So. 3d 412 (Fla. 2015) (opens in a new tab). A lawyer may now deposit the lawyer’s own money to replenish a shortage, but no more than the shortage. The lawyer must also notify the Bar’s lawyer regulation department immediately of the shortage, its cause, and the amount deposited. The court said it wanted lawyers to fix shortages without fear of a commingling charge, and it wanted the Bar told, so the Bar could decide whether anyone had broken a rule.

A failed deposit has a rule of its own. When a check deposited for one client bounces after the firm has already paid out against it, other clients’ money covered the payment. Rule 5-1.1(j) requires the lawyer to act immediately to protect them. The rule also says a lawyer who accepted the dishonored check is not guilty of misconduct if the lawyer personally pays the failed amount. Arranging payment from a source other than other clients’ trust money works too.

Rousso teaches one more thing about shortages: they are not hidden. The lawyers covered the loss quietly, kept taking new client money into an account they knew was short, and told most clients nothing. The court found that conduct dishonest.

The written trust plan is how a firm decides these questions before it faces them. Rule 5-1.2(c)(1) requires one of every firm with more than one lawyer. It must name each person who signs trust checks, the lawyer responsible for the monthly and annual reconciliations, and the lawyer who answers questions about the account. The sample plans the Bar’s practice resource center publishes (opens in a new tab) show the usual division of labor: staff prepare the checks, the deposit slips, and the reconciliations, and named partners sign, review, and approve them. Under Rule 5-1.2(c)(2), every lawyer answers for the lawyer’s own handling of trust money. A lawyer who knows the firm is out of compliance may report it to the managing partner, and if it is not corrected in a reasonable time, may have to report it to the Bar.

Back to April

Temko Eden’s April is waiting in the Other People’s Money activity. Dana Whitfield wants the reconciliation by Friday, prepared by you and ready for her signature. Start with the workbook’s Accounts sheet, so you know what each client’s money is for. Then read the bank statement, the journal, and the ledgers against each other, the way no one read Clint Johnson’s records. If an item on one record has no partner on another, it has a reason, and your job is to name it. When you find what went wrong, the memo tells Dana what the rules require next. The plan decides who will catch it next time.