Ethics Opinion Articles - NC State Bar Journal

A Refresher Course on Maintaining a Trust Account
(or how to make Bruno change his tune)

By Alice Neece Mine

This is the final article in a series of three articles explaining the revisions to the trust accounting rules of the Revised Rules of Professional Conduct. The revisions went into effect when approved by the North Carolina Supreme Court on May 4, 2000. The revised rules can be found in the complete Revised Rules of Professional Conduct on the State Bar’s website, www.ncbar.com, and in the 2001 Lawyer’s Handbook which will be distributed this spring to all active members of the Bar. The first article in the series appeared in the Spring 2000 edition of the Journal. It explained the distinction in the rules between the handling of funds as a professional fiduciary and as a volunteer fiduciary. The second article appeared in the Summer 2000 edition of the Journal. It focused on the financial accounting responsibilities of a lawyer serving as a professional fiduciary. This article returns to basics: the responsibilities of a lawyer holding client funds in a lawyer’s trust account.

The report of the ubiquitous Bruno DeMolli, staff auditor and investigator for the State Bar, is the first item on the agenda of every quarterly meeting of the Ethics Committee of the State Bar. After three months of auditing the trust accounts of lawyers across the state for compliance with the procedural requirements for trust accounts, Bruno returns to the capital city to tell the committee what he is finding out in the field. Unfortunately, Bruno’s presentations are more than a little repetitious: every quarter he reports that more than 50% of the trust accounts he audits are not in compliance with two key requirements of Rule 1.15 of the Revised Rules of Professional Conduct. Specifically, lawyers are not reconciling their trust accounts every quarter and they are not sending each client a written accounting of funds in the trust account annually or upon final disbursement.

This article is a part of a series of articles on the revisions to the trust accounting rules of the Revised Rules of Professional Conduct which went into effect last May. Those revisions were undertaken primarily for the purpose of clarifying the record keeping and money management responsibilities of a lawyer serving in a professional fiduciary role such as personal representative of an estate, guardian, trustee of a trust, attorney in fact, or escrow agent. These roles do not constitute the practice of law per se but are frequently performed as a part of a lawyer’s legal practice. The revisions are designed to protect the funds entrusted to the lawyer acting as a professional fiduciary while simultaneously giving the lawyer discretion to invest the funds prudently. For example, the trust accounting rules were revised to clarify that a lawyer is allowed to deposit funds held as a “professional fiduciary” in an institution other than a North Carolina bank. This clarification permits the investment of fiduciary funds in financial institutions offering higher rates of return.

Although the revisions to the trust accounting rules approved last spring were substantial, for the most part the record keeping and accounting requirements for a standard lawyer’s trust account were left intact. In an effort to change Bruno’s tune at the next quarterly meeting (lovely baritone notwithstanding), this article revisits the primary requirements for the maintenance of a trust account.

Segregation of Entrusted Property

Rule 1.15-2 establishes the general rules for the safe keeping of client funds. Foremost is the requirement that property of a client (or a third party) shall be identified and maintained separately from the property of the lawyer. Rule 1.15-2(a). All trust funds, defined in Rule 1.15-1 as “funds belonging to someone other than the lawyer that are received by or placed under the control of the lawyer in connection with the performance of legal services,” must be deposited in either a general trust account or a dedicated trust account of the lawyer.

General vs. Dedicated Trust Account
A “general trust account” is the defined term for the type of lawyer’s trust account that is familiar to all private practitioners. The funds of many clients, including advance fee payments from clients, are deposited into a general trust account for short periods of time. General trust accounts typically do not earn interest, except as permitted by Rule 1.15-4 for the benefit of the IOLTA program, because of the difficulty of allocating the interest among the funds of various clients. Because funds are held for relatively short periods of time in a general trust account, the absence of interest-earning capacity is a minimal inconvenience to the client.

The “dedicated trust account” is a new name for what is always the preferred way to hold a client’s funds for any substantial period of time. This type of account was allowed under the rules before revision, although unknown to some lawyers. Defined in Rule 1.15-1 as “a trust account that is maintained for the sole benefit of a single client or with respect to a single transaction or series of integrated transactions,” a dedicated trust account allows a lawyer to further segregate funds of an individual client or for a specific transaction in order that earned interest can be readily allocated to a client or interested parties as appropriate. Whether to set up a separate dedicated trust account depends upon two factors: the amount of the funds and the length of time the funds will be on deposit. If either factor is significant, a prudent lawyer will establish a dedicated trust account.

Location of General and Dedicated Trust Accounts
The depository requirements for a general or dedicated trust account differ. All general trust accounts must be maintained in a bank in North Carolina. Rule 1.15-2(e). However, with written consent of the client, a dedicated trust account may be maintained in a bank outside of North Carolina or a financial institution other than a bank in or outside of North Carolina. Id. The latter alternative is, of course, designed to enhance the lawyer’s options for maximizing the client’s return.

Bruno’s Pet Peeves: Quarterly Reconciliations and Annual Accountings

Rule 1.15-3 (c) requires quarterly reconciliations of the funds on deposit in a general trust account. This requirement has been around since the adoption of the original Rules of Professional Conduct in 1985. Nevertheless, as noted by Bruno every quarter, lawyers routinely fail to comply. Once a quarter, the individual balances for every client, as shown on the ledger of the general trust account, must be totaled and this total reconciled with the current bank balance of the trust account as a whole. Comment [14] for the rule explains: “[t]he current bank balance is the balance obtained when subtracting outstanding checks and other withdrawals from the bank statement balance and adding outstanding deposits to the bank statement balance.” Quarterly reconciliations promote accurate accounting for client funds by insuring that the running balances for each client when totaled equal the total funds on deposit in the general trust account. (Note that quarterly reconciliations are not required for dedicated trust accounts simply because the balance in a dedicated trust account, which contains the funds of one client or for one transaction, should readily reconcile with the current bank balance for the account.)

In addition to quarterly reconciliations, Bruno’s other pet peeve is annual accounting. Pursuant to Rule 1.15-3(d), a lawyer must give a client a written accounting of the receipts and disbursements of all funds held in trust on the following occasions: (1) upon the complete disbursement of the trust funds, (2) at such other times as may be reasonably requested by the client, and (3) at least annually if the funds are retained for a period of more than one year. Lawyers are pretty good about giving a written accounting at the conclusion of a transaction but, when a client’s funds are held for longer than a year, the duty to account annually is regularly overlooked. As noted in the comment to the rule, annual accountings are a necessary part of the duty to keep a client advised of the status of entrusted property held by the lawyer. Rule 1.15, Cmt. [14].

Record Keeping

Under Rule 1.15-3, as revised, the written records that a lawyer must maintain for entrusted funds are determined by where the funds are deposited. If the funds are deposited in a bank rather than an investment institution, the record keeping requirements are slightly more extensive. The required records for a general trust account, which must be maintained at a bank, include all of the following: bank receipts and deposit slips listing the source of funds, the date of receipt, and the name of the client or other person to whom the funds belong; all canceled instruments drawn on the account or printed digital images (front and back) of the canceled instruments; instructions authorizing the transfer or disbursement of funds from the account; all bank statements and documents from the bank including notices of return or dishonor of any instrument drawn on the account against insufficient funds; and a ledger that contains a record of receipts and disbursements for any person or entity with funds on deposit in the account. The records that must be maintained for a dedicated trust account at a financial institution other than a bank are essentially the same except no client ledger is required for obvious reasons. Of course, all records required as a matter of law must be retained for either type of trust account.

Minimum Record Keeping Period
A lawyer must retain all of the written records required by Rule 1.15-3 for at least six years. This requirement has not been changed since 1985, nor has the State Bar’s authority to audit the required records in random audits (Bruno’s specialty) or for cause.

Bank Directive
Bruno’s report to the Ethics Committee frequently mentions that a significant number of the lawyers he audits do not have on file a copy of the bank directive required by Rule 1.15-2(k). This written directive instructs the depository bank for a lawyer’s trust account (general,dedicated, or fiduciary) to report to the State Bar when an instrument drawn on the account is presented for payment against insufficient funds. The purpose of the directive is to prevent defalcations by giving the Bar notice that a trust account may be overdrawn. The bank directive form can be found in the “Forms” section of the State Bar Handbook on CD-ROM and on the website (www.ncbar.com). (Bruno notes that lawyers with signatory authority on fiduciary accounts, such as estate accounts, often fail to comply with this requirement.)

The management and record keeping requirements of the Revised Rules of Professional Conduct are not extensive or burdensome. They are simply common-sense regulations that protect the funds entrusted to a lawyer by clients. So, make Bruno’s report shorter at the next meeting of the Ethics Committee by performing quarterly reconciliations, sending out annual accountings to clients, and filing the bank directive with your depository bank. The Ethics Committee will thank you, and so will your clients.

Alice Neece Mine is the assistant director of the North Carolina State Bar. In that capacity, she serves as counsel to the ethics and administrative committees, and is director of the CLE and specialization programs.