Coming to Terms (and into Compliance) with the Trust Accounting Rule Amendments

Author’s Note: The Supreme Court approved the amendments to the trust accounting rules on June 9, 2016. As discussed in this article, newly adopted Rule 1.15-2(s)(1) requires checks drawn on a trust account to be signed by a lawyer or by an employee who is not responsible for performing monthly or quarterly reconciliations. Any lawyer or supervised employee with check signing authority must take a one-hour trust account management CLE course approved by the State Bar for this purpose. To allow CLE providers time to develop and obtain approval for appropriate courses and to allow a reasonable time for all law firms to come into compliance, the CLE requirement may be satisfied in 2017; however, compliance with the other signature requirements for trust account checks should be prompt. Completion of a one-hour trust accounting CLE course taught by the State Bar’s Trust Account Compliance Counsel after January 1, 2015, satisfies the requirement. Additional courses that satisfy the CLE requirement will be identified on the CLE website in August, 2016.

This past October, the State Bar Council adopted the amendments on pages 14 to 17 to Rule 1.15 of the Rules of Professional Conduct. These amendments are now pending before the North Carolina Supreme Court. If and when the amendments are approved, lawyers must act to ensure their compliance with new requirements. To that end, notice of any action taken by the Court will be emailed to the membership and posted immediately on the State Bar’s website.

After a brief background of the procedural history of the amendment process, this article will explain each rule change, give guidance on how to come into compliance with the new rules, and provide links to sample forms and examples to help lawyers and firms comply with the new rules. Although the rules would became effective immediately upon the Supreme Court’s approval, the State Bar understands that becoming 100% compliant with the new rules may take some time.

Background

On October 23, 2015, the council adopted the proposed amendments to Rule 1.15 of the Rules of Professional Conduct of the North Carolina State Bar. The amendments were the result of a rules review process that began in April 2014 at the behest of then State Bar Vice-President Margaret Hunt. Hunt, as chair of The North Carolina State Bar’s Issues Committee, formed a subcommittee in early 2014 to study Rule 1.15 of the Rules of Professional Conduct and determine if any changes should be made to facilitate prevention and early detection of internal theft, and to add clarity to the existing requirements.

In addition to examining the existing rules, the Subcommittee on Trust Account Management was also tasked with developing a procedure whereby a firm with two or more lawyers might designate a firm partner to oversee the firm’s general trust accounts. The subcommittee drafted the proposed amendments, the Issues and Executive Committees approved the amendments, and the full council approved the amendments for publication in the Journal.

The first set of proposed rule amendments was published in the Spring 2015 edition of the State Bar Journal. In response to comments received after publication, the council published additional changes in the Summer 2015 Journal. Based on comments received after the second publication, additional changes were approved and the rules were published a third and final time in the Fall 2015 Journal. No adverse comment was received after that publication and the amendments were adopted by the council.

Explanation of Amendments to Rule 1.15

(Items in bold marked with *** would require action in order to remain compliant)

Rule 1.15-1 Definitions

Rule 1.15-1(a): Adds credit unions to the definition of “bank.” This change allows lawyers and law firms to maintain trust accounts at credit unions. Credit unions were removed from the definition in 2008 due to concerns about whether deposit insurance applied to individual clients in a trust account maintained at a credit union in the same way FDIC insurance applied to trust accounts maintained at banks. The deposit insurance concern was addressed, and credit unions are now eligible to offer IOLTA accounts to North Carolina lawyers.

Rule 1.15-1(k): Adds language excluding “professional fiduciary services” from the definition of “legal services.” The converse of this exclusion already exists in Rule 1.15-1(l). Lawyers who provide “legal services” have different requirements than lawyers who only provide “professional fiduciary services,” so a clear distinction is important.

Rule 1.15-2 General Rules

Rule 1.15-2(f): This rule change clarifies that lawyers may not hold funds for third parties in the trust account unless they were received in connection with legal services or professional fiduciary services.

Rule 1.15-2(g): This one-word change of “may” to “shall” clarifies that a lawyer must promptly remove funds to which the lawyer is or becomes entitled.

Rule 1.15-2(h): This amendment clarifies any confusion caused by the old language, but does not change the substance of the rule. Any item drawn on the trust account must identify (by name, file number, or other information) the client from whose balance the item is drawn. The identification must be made on the item itself, not on a stub or other document.

Rule 1.15-2(i): The amendment prohibits cash withdrawals by any means, not just debit cards.

Rule 1.15-2(j): The amendment moves the debit card prohibition from the end of Rule 1.15-2(i) to a standalone paragraph.

(All subsequent paragraphs in Rule 1.15-2 are relettered)

Rule 1.15-2(k): An amendment to the title of the rule clarifies that entrusted funds should not be used or pledged for the personal benefit of the lawyer or a third party.

Rule 1.15-2(p): This is a substantive amendment to the lawyer’s duty to report misappropriation or misapplication of entrusted property. While confirming that intentional theft or fraud must be reported immediately, this amendment removes the reporting requirement for unintentional and inadvertent misapplications of entrusted funds if the misapplication is discovered and rectified on or before the lawyer’s next quarterly reconciliation. The amendment also clarifies that to satisfy the lawyer’s duty to self-report, the lawyer may reveal confidential information otherwise protected by Rule 1.6. Comment [26] further explains the lawyer’s duty to report misappropriation or misapplication of entrusted funds, and a comment to Rule 8.3, Reporting Professional Misconduct, clarifies that a lawyer has a duty to report misappropriation or misapplication of trust funds regardless of whether the lawyer is reporting the lawyer’s own conduct or that of another person.

***Rule 1.15-2(s) – This amendment requires that checks drawn on a trust account must be signed by a lawyer, or by an employee who is not responsible for reconciling the trust account and who is supervised by a lawyer. Further, any lawyer or employee who exercises signature authority must take a one-hour trust account management CLE course before exercising such authority. The rule also prohibits the use of signature stamps, preprinted signature lines, or electronic signatures on trust account checks. As Comment [24] explains, “[d]ividing the check signing and reconciliation responsibilities makes it more difficult for one employee to hide fraudulent transactions. Similarly, signature stamps, preprinted signature lines on checks, and electronic signatures are prohibited to prevent their use for fraudulent purposes.” ***

(Note: To ease the burden of the CLE requirement, the State Bar has partnered with the North Carolina Bar Association to produce an online trust accounting training CLE series that will be available for free to all North Carolina lawyers. More information on the CLE program will be provided as it becomes available.)

(Editor’s Note: Lawyers Mutual’s upcoming Put Into Practice CLE series includes an hour that has been approved to satisfy the new trust accounting CLE requirement.  For more information and to find a location near you, please visit our website.  This CLE is free for Lawyers Mutual’s insured attorneys and staff.)

Rule 1.15-3 Records and Accountings

Rule 1.15-3(b) and (c): Lawyers can now electronically maintain images of cancelled checks and other items instead of hard copies because new Rule 1.15-3(j) allows lawyers to maintain records electronically provided certain requirements are met. Rule 1.15-3(b) also amends language to mirror the clarification in Rule 1.15-2(h).

***Rule 1.15-3(d): Explains how a quarterly reconciliation should be performed and adds the requirement that a lawyer must review, sign, and date a copy of all monthly and quarterly trust account reconciliations. ***

***Rule 1.15-3(i): The new rule requires the lawyer to 1) review bank statements and cancelled checks for each trust account and fiduciary account on a monthly basis, 2) at least quarterly, review a random sample of a minimum of three transactions (statement of costs and receipts, client ledger, and cancelled checks) to ensure that disbursements were properly made, 3) resolve any discrepancies discovered during the reviews within ten days, and 4) sign, date, and retain a copy of a report documenting the monthly and quarterly review process, including a description of the review, the transactions sampled, and any remedial action taken. ***

The monthly review will disclose: a) forged signatures, b) improper payees or checks to cash, and c) unexplained gaps in check numbers indicating checks may have gone missing. The lawyer can verify that checks from the general trust account properly identify on the face of the check the client from whose balance the check is drawn. The lawyer can also examine the back of cleared checks to ensure proper endorsements were made.

Random review of ledgers and settlement statements helps to ensure that the ledgers and statements accurately reflect the transaction. This type of review can uncover improper disbursements, incorrect deposits, and substituted or unissued checks. While the random review requirement may not uncover any improper activity, it will most definitely act as a deterrent to employee malfeasance.

Rule 1.15-3(j): The new rule provides for the retention of records in electronic format provided 1) records otherwise comply with Rule 1.15-3, including any signature requirements, 2) records can be printed on-demand, and 3) records are regularly backed up by an appropriate storage device.

Rule 1.15-4 Alternative Trust Account Management Procedure for Multi-Member Firm

This new rule permits, but does not require, a law firm to designate a trust account oversight officer (TAOO) to oversee the administration of the firm’s general trust accounts. This is an optional rule; firms are not required to designate a TAOO. However, if the firm would like to designate a TAOO, it must follow the following guidelines.

Rule 1.15-4(a): permits a firm to designate a partner as the firm’s TAOO. A partner is defined as a member of a partnership, a shareholder in a law firm organized as a professional corporation, or a member of an association authorized to practice law. The designation must be in writing, and signed by the TAOO and the managing lawyers of the firm. A law firm may designate more than one partner as a TAOO. Comment [27] explains the supervisory requirements for delegation under Rule 5.1, and states that “delegation consistent with the requirements of Rule 1.15-4 is evidence of a lawyer’s good faith effort to comply with Rule 5.1.”

Rule 1.15-4(b): Lawyers remain individually responsible for the oversight of any dedicated trust account and fiduciary account associated with a legal matter for which the lawyer is primary legal counsel, and must continue to review disbursements, ledgers, and balances for any such account. Comments [28] and [29] further explain the limitations on delegation.

Rule 1.15-4(c): Explains the initial and annual training requirements of a TAOO. Comment [29] further explains this requirement.

Rule 1.15-4(d): Sets forth what must be included in the written agreement designating a lawyer as a TAOO.

Rule 1.15-4(e): Requires any firm that designates a TAOO to have a written policy detailing the firm’s trust account management procedures.

Coming into Compliance

While most of the proposed amendments are stylistic and nonsubstantive, lawyers will need to become compliant with the procedural changes and additional review requirements. The following checklist and sample forms, which can be found online at ncbar.gov/for-lawyers/forms, should ensure compliance with the new requirements if they are approved by the Supreme Court.

Compliance Checklist

___ 1.   All trust account checks are signed by a lawyer, or by an employee who is not responsible for reconciling the trust account and who is supervised by a lawyer.

___ 2.   Any person with signatory authority on the trust account has taken a one-hour trust account management CLE (within the last three years).

NOTE: Proof of completion of the CLE requirement will not need to be sent to the State Bar, but should be retained and will be checked during a random audit.

___ 3.   No trust account checks are signed using signature stamps, pre-printed signature lines, or electronic signatures.

___ 4.   All reconciliations are reviewed, signed, and dated by a lawyer.

___ 5.   A lawyer reviews the bank statements and cancelled checks for all trust and fiduciary accounts on a monthly basis and a report is created documenting the review.

___ 6.   At least quarterly, a lawyer reviews a random sample of at least three transactions (selected by the lawyer) to ensure that disbursements were properly made by reviewing the statement of costs and receipts, client ledgers, and cancelled checks for each transaction. Transactions should include multiple disbursements where available. A report is created documenting the lawyer’s review.

___ 7.   All reports are signed and dated by a lawyer.

___ 8.   Any discrepancy discovered during reconciliations or reviews is investigated and resolved within 10 days.

The State Bar has created forms for lawyers and law firms to conduct the required monthly and quarterly trust account reviews and reconciliations. Although recommended, lawyers will not be required to use the State Bar forms if they have an alternate method of ensuring compliance. Proper completion of the State Bar’s forms should ensure a lawyer’s compliance with all of the monthly and quarterly reconciliation and review requirements.

Conclusion

The proposed amendments to the trust account rules are the product of a two-year effort that involved public comment and multiple revisions. While the proposed review requirements may seem onerous, the minimal extra work involved should help deter and prevent costly mistakes and thefts that could jeopardize a lawyer’s practice and pocketbook. For questions about the proposed amendments or any other trust account questions, please contact Peter Bolac at PBolac@ncbar.gov or (919) 828-4620.