Bruno’s Top Tips for Tip Top Trust Accounting
By Bruno DeMolli
Note: The ABA distributed a press release in late November that supersedes some of the material in the article. Please also review the ABA's release for the latest information.
FDIC Insurance and Your Trust Account
On July 11, 2008, federal regulators took control of IndyMac Bank Corp., a Pasadena, California, bank that collapsed as a result of the subprime mortgage debacle. Since that date, lawyers have been calling—my office, the State Bar ethics and IOLTA offices, their depository banks, the NC Bankers Association—looking for advice about their trust accounting responsibilities in shaky financial times. To reduce the calls and provide guidance and reassurance to the members of the bar at large, the most common questions of callers are answered below. Alice Mine, counsel to the Ethics Committee, provided input on the legal and ethical issues addressed in this article. One cautionary note: this article explains a lawyer's professional responsibilities; it does NOT address issues of legal liability to clients or third parties who have funds deposited in a lawyer's trust account. If you comply with the advice in this article, you will be in compliance with the Rules of Professional Conduct and you should not be subject to professional discipline. You may want to direct questions about professional liability to your malpractice carrier.
Q. What is a lawyer's professional responsibility when choosing the depository bank for a trust account?
A lawyer is acting as a fiduciary when holding client funds in his or her trust account. This means that the lawyer must be prudent when making financial decisions relative to those funds1 including the decision as to the depository bank for the lawyer's trust account. However, in the absence of information tending to suggest the imminent failure of a bank, a lawyer is presumed to be acting ethically if the lawyer establishes his or her trust account at a financial institution insured by the Federal Deposit Insurance Corporation (FDIC). In other words, if the government has made the determination that the institution is insurable, the lawyer may rely upon the government's assessment.2
Q. Does FDIC insurance protect my trust account and, if so, to what extent?
A lawyer's general trust account (sometimes referred to as an "IOLTA account"3) is a fiduciary account4 and, as such, each client's funds deposited therein will be insured by the FDIC (up to the insurance limit) provided the account satisfies the FDIC disclosure requirements. There are two disclosure requirements for fiduciary accounts: (1) the fiduciary nature of the account must be disclosed in the bank's records, and (2) the name and ownership interest of each owner must be ascertainable from the deposit account records of the insured bank or from records maintained by the fiduciary. It is incumbent on the lawyer to make sure his or her bank knows that an account is a fiduciary account so that the bank can title the account as such in its records. Banks typically do not maintain records of the ownership interest of each client whose funds are held in a trust account. Therefore, it is the lawyer's responsibility to maintain these records. If you are complying with the trust accounting and record keeping requirements in Rule 1.15 of the Rules of Professional Conduct, you have already satisfied both of the FDIC "disclosure" requirements.
The general rule5 for the amount of FDIC coverage available to a single depositor in an FDIC insured bank or savings association is that if a depositor's accounts at the institution total $100,000 or less, the deposits are fully insured.6 For a fiduciary account in which the funds of multiple owners are commingled, each owner's interest in the account is insured if the fiduciary satisfies the disclosure requirements described above. This means that, unless a client has more than $100,000 deposited in your trust account, the client's funds are probably fully insured. There is one caveat: if the client has other deposits at the same institution, those deposits may be aggregated with the client's trust account funds for the purposes of determining insurance coverage. The total would be subject to the insurance limit of $100,000.
Here is an example of how this works:
You hold funds of multiple clients in your trust account at XYZ Bank. Client A's interest in the trust account is $50,000. Client A also has an XYZ Bank checking account holding $10,000 and an XYZ Bank savings account holding $45,000. Both accounts are in Client A's sole name. Under FDIC's rules, the funds in Client A's two sole ownership accounts would be aggregated with Client A's interest in the trust account funds for purposes of determining insurance coverage. The total would be insured up to the $100,000 limit, leaving $5,000 uninsured.
Q. Is a lawyer required to explain FDIC insurance to clients who have funds deposited in the lawyer's trust account?
Rule 1.4(b) requires a lawyer to explain a matter to the extent reasonably necessary to permit the client to make informed decisions regarding the representation. Most client deposits in a trust account are substantially less than $100,000 and, when there is little or no risk to a client's funds, there is no need to explain FDIC insurance. Apart from real estate and business transactions, which are discussed below, if a client's funds in a trust account exceed $100,000,7 or the lawyer has reason to believe that the client may have other accounts at the same bank such that the client's aggregate deposits at the bank exceed the insurance limit, the lawyer should advise the client accordingly. This advice might include a recommendation that some portion of the funds be deposited in an account at another institution. If a client has questions about FDIC insurance, the lawyer should refer the client to the FDIC website. See fn. 4.
Q. When a transaction such as a real estate closing will result in a single owner having over $100,000 deposited in the lawyer's trust account is a lawyer required to disclose the potential risk or obtain excess insurance coverage?
When the nature of a real estate or business transaction requires the collection of funds from multiple sources for distribution to multiple parties, it is simply impractical to deposit the funds in increments of $100,000 into accounts in multiple institutions in order to guarantee FDIC insurance coverage. It is, therefore, presumed that the parties understand that the financial mechanics necessary to close a real estate or business transaction require the flexibility afforded by a demand account in which funds are readily available, such as a lawyer's trust account, and the lawyer is not ethically required to make any disclosures relative to FDIC coverage or financial risk to the parties depositing the funds for the transaction into the lawyer's trust account.
A lawyer is also not required to obtain excess insurance coverage8 for the funds that are not covered by FDIC insurance although there is a theoretical risk to the closing funds during the usually brief period of time between the deposit of the funds in the trust account and the disbursement of the funds to consummate the transaction. If the FDIC has insured the depository bank, in the absence of actual knowledge that the bank is in imminent danger of failing, it is reasonable for the lawyer to assume, as a matter of professional responsibility, that funds deposited in the trust account are safe.
1. See N.C. Gen. Stat. §32-71(a). The prudent person rule provides that "[i]n acquiring, investing, reinvesting, exchanging, retaining, selling, and managing property for the benefit of another, a fiduciary shall observe the standard of judgment and care under the circumstances then prevailing, which an ordinarily prudent person of discretion and intelligence, who is a fiduciary of the property of others, would observe as such fiduciary; and if the fiduciary has special skills or is named a fiduciary on the basis of representations of special skills or expertise, he is under a duty to use those skills." Id.
2. No ethical standard requires more than confirmation that the depository bank is FDIC insured. However, lawyers are encouraged to use informed judgment when selecting a bank. For example, Veribanc, a bank rating company, is a good resource for determining the safety and soundness of a financial institution. It rates US banks on a quarterly basis and you can order individual bank reports or a summary report for every bank in NC. See www.veribanc.com.
3. Participation in the IOLTA (Interest on Lawyers Trust Accounts) program is now mandatory: all general trust accounts must be established as IOLTA accounts. See my articles in the winter and spring 2008 editions of the Journal for more information.
4. The FDIC specifically recognizes that IOLTA accounts are fiduciary accounts and that the funds in an IOLTA account are insured if the account meets the disclosure requirements. See, "Your Insured Deposits," FDIC Brochure, FDIC - 001-2007. Also visit the FDIC website, which specifically identifies IOLTA accounts for treatment as fiduciary accounts.
5. Depending upon ownership category, a depositor can have more than $100,000 at one insured bank or savings association and still be fully insured provided the accounts meet certain requirements. Those requirements are not discussed in this article. Visit the FDIC website for further information. See footnote 4. Federal law also provides for insurance coverage of up to $250,000 for certain retirement accounts. Id.
7. A dedicated trust account (a non-IOLTA account on which interest for the benefit of the client may be earned) should be established whenever the funds to be held in trust on behalf of one client or one transaction are more than nominal in amount or will be held for a substantial period of time. See Rule 1.15-1(c) and Rule 1.15, cmt. . Note that certificates of deposit are often an appropriate vehicle for a dedicated trust account. At certain participating banks, certificates of deposit are eligible for programs that provide coverage in excess of the FDIC limits. The Certificate of Deposit Account Registry Service (CDARS®) is one such program sanctioned by FDIC. More information may be obtained at www.cdars.com.
8. Some banks obtain depositor bonds (Travelers and Progressive Insurance Companies sell them) to provide high net worth individuals, businesses, and government entities with deposit protection in excess of FDIC insurance coverage. The bank chooses the limits and the specific customers it wants to protect. These excess deposit bonds are not written to cover lawyers' trust accounts because of the difficulty of assessing the risk on an account containing commingled funds of multiple parties. Nevertheless, you may want to ask your depository bank if there is a bond or excess coverage available.
The insured closing letter provided by title insurance companies also does not appear to provide a solution as the protection is limited to the lawyer's fraud or failure to comply with the written closing instructions.
It is also doubtful that malpractice insurance coverage provides any protection. Talk to your carrier about what coverage may be available.
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