Category Archives: Trust Accounts
IOLTA Myths: There’s No Such Thing As “Cleared”
We’ve all been taught that we need to wait until funds “clear” to distribute them. How do I know when “clear”?
As attorneys, we take CLEs from time to time, and some of those have to be about ethics. So, to get our ethics credits, we often look for practical CLEs we can put to good use in the real world, like trust accounting CLEs. Now in those trust accounting CLEs, the presenter always – almost without fail – reminds us that we need to wait for funds to “clear” into our trust accounts before we’re allowed to take those funds back out.
Unfortunately, what most of those CLEs aren’t teaching us is that “cleared” funds are a myth.
What are “cleared” funds?
Understanding what “cleared” funds are – and aren’t – is critical to understanding why most attorneys’ concept of “cleared” funds is a myth. “Cleared” funds are simply money that is in the bank account and available for withdrawal. When funds aren’t available for withdrawal – for example, you just deposited them five minutes ago – they’re pending. Then, once they become available, they’re “cleared”. Most deposits “clear” within one business day.
Unfortunately, “cleared” does not mean that those funds are there to stay. “Cleared” does not mean that funds won’t get unilaterally and unexpectedly yanked back out of your bank account. It does not mean the funds are somehow settled and irrevocable. All it means is that the bank is willing to let you spend that money.
And that’s what makes both the myth and the legend about “cleared” funds: All that we’ve learned about banking and trust accounting implies that “cleared” funds are somehow safe and protected in our account, and they’re there to stay. They’re not.
Some funds really do “clear,” in the permanent sense.
Now that we know what “cleared” really means, let’s take a step back and see what funds, if any, really do “clear” into our accounts permanently. In other words, let’s first look at the kinds of deposits that can’t get yanked back without any warning, consent, or approval. Because luckily, there are a few.
Wire Transfers. Once a wire appears in your account, it’s there to stay. This is one reason savvy attorneys insist on wires for large trust deposits and for deposits of settlement funds. There’s no risk that your depositor will develop buyer’s remorse, yank the funds back out without warning, and leave your trust account with a negative balance while your bank reports you to the state bar.
Cash. Cash is another kind of deposit that is in your bank account to stay – or at least, it won’t be removed from your bank account without your knowledge or approval. Of course, cash deposits are at risk while they’re in transit, so many attorneys tend to stay away from them, despite cash being a great and otherwise secure medium for trust deposits. They’re also inconvenient for many clients.
Cashier’s Check. These are almost as good as cash. I say “almost,” because there is a small chance that a payor can cancel a cashier’s check in transit, before it’s deposited. But, once deposited into your trust account, the funds are safe and secure, and the payor can’t stop payment or cancel the cashier’s check to yank the funds back out.
What deposits are at risk, even after they “clear”?
As mentioned, some deposits are at risk of disappearing from your account without any warning or approval. When this happens, you may find your IOLTA balance negative, and your bank making a mandatory report to the state bar. Unfortunately, these are some of the most common payment methods that attorneys accept into their trust accounts.
Checks. Whether they’re personal checks or business checks, accepting checks as trust deposits does put your firm at some risk. Whether you wait three business days, two weeks, or a month after the check “clears” before distributing those trust funds back out, you can never guarantee the bank won’t yank those funds back out of your account without telling you. This can happen when the check is fraudulent, or simply when the payor gets buyer’s remorse and puts a stop payment on it. So, accepting trust payments via check always comes with some risk.
Credit Cards. You’ve probably disputed charges on your credit card, and you’ve probably gotten your money back pretty much every time. Well, when clients pay you with a credit card, they can dispute the charge, and they usually get their money back, too. And it doesn’t just happen with buyer’s remorse; scammers can use stolen credit cards to steal tens of thousands from your trust account if you’re not careful.
How Can I Keep My IOLTA and Trust Funds Safe?
We’ll be taking a look at this question in our next few posts. So, be sure to check back here (on our blog) regularly, and also be sure to sign up for our newsletter to make sure you don’t miss a post.
IOLTA: Top 5 Attorney Trust Accounting Mistakes (And How To Avoid Them)
Which IOLTA mistakes are you making that could put your law license at risk?
This month on the Skepsis blog, we’re focusing on trust accounting.
Asking an attorney to properly handle and account for IOLTA trust funds is like asking my 10-year-old to drive to the store. Sure, she’s studious, and book smart, and can take and pass a test – but she knows nothing about actually driving. I’m setting her up for failure if I just hand her the keys and tell her to get going.
And yet, that’s exactly what our state bars require us to do each and every day to maintain our privilege to practice law. We had a few classes in law school; we took an ethics portion of the bar exam; and we have the written rules of the road in the RPCs. But how do we actually drive that trust account?
At Skepsis, we’ve seen just about every mistake in the book, and the good news is there are some common themes. Why’s that good news? Because if you understand those common themes, you’ll be well on your way to steering clear of trust accounting trouble.
5. Entering IOLTA transfers as, well…. transfers.
When is a transfer between bank accounts not a transfer? When it’s a transfer into or out of IOLTA, of course. And yet, many attorneys (and frighteningly just as many professional bookkeepers and accountants) happily enter transfers on their books all day every day. A few weeks down the road, your IOLTA accounting is off by a few thousand. Years down the road, it can be off by tens or even hundreds of thousands of dollars.
What these attorneys and accountants don’t understand is that a transfer between IOLTA and operating is not a transfer. It’s two completely separate transactions, and it needs to be entered as such on your books. So, be careful about how you enter transfers between operating and IOLTA in your bookkeeping software, because recording a “transfer” is a classic trap for the unwary.
4. Sharing your bank login.
It is basic online security: no sharing login information. But all too frequently, attorneys will share their banking information with other attorneys, non-attorney staff, and their bookkeepers. This is a big no-no.
Why’s it so bad to share? First, some would argue that sharing banking login information is a violation of an attorney’s duties of both confidentiality and competency. Because there’s no point in putting a password on an account if the password gets distributed. Second, if your bank account allows transfers or withdrawals from trust, you’re arguably violating the RPCs requiring that only licensed attorneys handle trust funds. Third, from a practical standpoint, you don’t want the FBI to trace that offshore account that was embezzling funds from the firm back to you, just because your login was used to transfer all that money. In other words, the audit trail that individual logins provide is just as important as the security features.
Instead, any staff member that needs access to banking or other financial information must have their own login. Most banks will allow you to add extra logins to your online banking accounts for free. Others will charge a nominal monthly fee if that staff or bookkeeper login requires bill pay or any other access, beyond nust read-only. Individual online banking logins are typically simple and quick to set up, so there’s no excuse for sharing. This is one situation where sharing is NOT caring.
3. Failing to timely return client trust funds at the end of an engagement.
When you run a law firm, completing a project for a client isn’t as easy as a simple goodbye. Instead, as attorneys, we have ethical and insurance obligations we have to fulfill each time we close a matter. And one of the most important of those is returning client trust funds.
Returning client trust funds is so important that a disgruntled client can use failing to timely return funds as a basis for a bar complaint. We know, we’ve seen it happen.
And yet, most attorneys, when we take a peek at their books, have at least a few hundred dollars, if not several thousand, of “stale” trust account money just sitting there in their trust bank account. “Stale” money is any money that should have been returned to the client at least 30 days prior. In most cases, our diagnostics and cleanups find funds that are up to several years old!
One of the best ways to avoid this trust accounting mistake is with a formal matter closing procedure that staff and attorneys follow each and every time a case closes. And of course, that checklist should include a step where any client funds are returned. We’ve put one together and shared it here to help get you started.
Another important step to take is an easy one, and typically takes no more than three minutes each month. That is: When you receive your IOLTA 3-way reports each month, glance through the list of clients with funds in trust. You’ll find that clients with closed matters will catch your eye, and remind you that you’d better get those client funds back asap.
2. Failing to maintain required IOLTA backup documents.
If you haven’t done so recently, we recommend perusing RPC 1.15A and B. (You can find WA 1.15A here, and WA 1.15B here.) As you do, take note of the long list of backup documents we’re required to maintain, most of which is enumerated in 1.15B. Is your law firm keeping all that backup documentation? If they are, and if you were audited by the state bar, or grilled by a client, do you know how to dig it up quickly and easily? Or, would you have to go back to your bank to request some of it, and wait several agonizing weeks for the bank to respond?
Most attorneys don’t maintain the required backup documents. Which is a shame, because most of the electronic accounting software, including Xero and QBO, both allow you to attach backup documents directly to each and every transaction. That way, if a state bar or client were to inquire about that check you wrote out of IOLTA for $1,000, you’d simply pull up the transaction in your bookkeeping software, and BAM! There’s a copy of the check.
With almost infinite data storage at our fingertips, and simple tools to get critical backup documents in an electronic format, there’s no excuse these days for failing to maintain proper backup documentation for your IOLTA transactions. You don’t even have to scan it all in – just snap a quick photo with your phone. There’s even software that will help you snap the image and upload it all at once, saving huge time. However you do it, be sure to get your backup documentation saved in your books.
1. Skipping or short-cutting IOLTA 3-way reconciliations.
One of the first things we do here at Skepsis when considering working with a new client is ask to review their IOLTA 3-ways. More often than not, the response is a blank stare. Some attorneys are confident enough to ask what a 3-way is. It’s an extremely rare occasion when an attorney actually has done an IOLTA 3-way reconciliation.
And yet, this reconciliation is expressly required by the RPCs. See RPC 1.15A(h)(6). What’s more, it’s required “as often as bank statements are generated,” or at least quarterly. Well, most of our bank statements generate monthly, so that means we need to be completing our IOLTA 3-ways monthly, too.
We understand; reconciling can be complicated, especially when you need to go back several years to get caught up. This is one situation where investing in a professional accountant, experienced in trust accounting, can save you big-time in time, money, and headaches. And working with an accountant to get your 3-ways together doesn’t mean you’re stuck with them. Many law firm accountants, including Skepsis, will offer a clean-up to get you all caught up with your 3-ways, setting you up for success to do them yourself moving forward.
Whatever works best for you, we can’t emphasize enough: The number one trust accounting mistake is not doing IOLTA 3-way reconciliations each and every month. Don’t put your law license at risk. Get your 3-ways done every month.
We’re here to help.
Avoiding trust mistakes isn’t always easy. And avoiding that number one mistake can be time consuming. We know, because we do IOLTA 3-ways and fully RPC-compliant trust accounting for dozens of attorneys each and every month, freeing up attorney time to do what those attorneys do best: helping their clients.
Skepsis offers fully RPC-compliant trust accounting for attorneys. I founded Skepsis because, as an attorney myself, I found it extremely difficult to find bookkeepers and accountants who understood and could execute my own trust obligations under the RPCs. I interviewed dozens of professional bookkeepers and accountants for my own law firm, all of whom professed experience and even expertise in law firm trust accounting, only to discover that each and every one of them was making at least one of the top five mistakes above; and most were making all of them.
At Skepsis, our clients sleep better knowing their trust accounts are RPC-compliant. Book your IOLTA evaluation today to find out how your trust accounting measures up, and what you need to do to get your trust accounting fully RPC compliant.