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Top 10 Compliance Challenges For Law Firms

While the need for a law firm to remain compliant may sound like a no-brainer, any attorney can tell you that the actual processes and protocols involved are a bit more complicated. And when it comes to Trust Accounting (also known as Escrow Accounting or IOLTA Accounting), individual state requirements and compliance are of the utmost importance. From maintaining meticulous records (both digital and print) to understanding the key differences between earned and unearned income, there are several unique challenges that Trust Accounting presents. Here, we’re uncovering the top 10 trust accounting compliance issues that your firm may face, and we’re explaining how having the right technology in place can help.

Challenge #1: Lack of Trust Specific Knowledges & Rules

Each state has its own compliance guidelines and audit programs that you, as an attorney, are responsible for understanding. Beyond this, it is critical that your firm’s accountant and bookkeeper(s) also understand legal accounting. There are many professional accountants who are unfamiliar with the unique trust accounting challenges and compliance requirements that are present unless they specialize in servicing law firms. Ask your accountant about their experience and expertise with law firms.  

Challenge #2: Limited Resources of Small Law Firms

Here, we’re talking about dedicated resources, training, and IT systems which, for many small firms, are understandably difficult to manage. However, compliance requirements are identical regardless of firm size, and the chance of an audit is the same as your larger counterparts. Make sure that your firm has all of the necessary tools in place to adequately manage your accounts. This doesn’t always mean spending a lot of money — many times implementing even one new tool or dedicating a day to proper training can make all the difference for your law firm.

Challenge #3: Manual Systems

Tracking client funds manually or by using loose spreadsheets is not only slow but is also prone to error. Despite your best efforts, you may waste hours trying to track down a five-cent discrepancy, re-creating records, or writing checks and deposit slips. If your firm uses a general accounting solution, be sure it is setup properly, as such software is not designed for legal practice and requires extra vigilance. Further, don’t wait until an audit to find out if your system is able to produce the required reports.

Challenge  #4: Commingled Trust Funds

There are two main types of commingling:

  1. Losing track of individual client balances in trust accounts (i.e. no separate ledger cards)
  2. Mixing client funds with your own (excluding what is allowed by some states, which also must be tracked separately)

While you can keep different trust funds in one bank account, they must be recorded separately in your books. In some unique situations (for example, large amounts that will remain for a prolonged duration), you may wish to open a separate trust account for your client. Regardless of the system your firm uses, however, funds must be managed by matter; this cannot be an afterthought.

Challenge  #5: Trust Ledger Overdrafts

It is illegal to overdraw trust accounts at the matter level. Even if there are visible funds available in a bank account, the ledger card must have a balance before you draw a check against it. As previously discussed, if funds are commingled, you won’t be able to tell the difference between the two. Unfortunately, there have been many instances of disbarment due to the fact that funds were not cleared from one matter and were disbursed to another account, despite being used for genuine purposes.

Challenge #6: Absence of Safeguards to Prevent Common Trust Mistakes

Common trust mistakes include commingling of funds, overdrafts, duplicate check numbers, lack of identification for each matter, and so on. As a business owner, you can’t take on the role of CPA or bookkeeper, but you still hold the fiduciary responsibility. As a result, you must implement systems and processes that equip your team with the proper tools – why not find a solution that includes such safeguards and forces you to follow certain guidelines?

Challenge  #7: Un-cleared Funds Not Addressed

This has the potential to become a big problem. Most service companies don’t lose sleep when their issued checks are not cleared. However, when it comes to your trust account, you maintain fiduciary responsibility until funds clear. And the longer it goes on, the harder it becomes to “dispose of.” Because of this, it’s important to stay attentive by reconciling monthly and running the necessary related reports.

Challenge #8: Sloppy Bank Reconciliation

Though bank reconciliation is always important, it is especially critical in trust management. And since trust reconciliation is different from operating accounts, you need to perform what is known as “three-way reconciliation” each month. This breaks down your Book Balance, Bank Balance, as well as the Sum of Individual Card Balances (i.e. all accounting for funds in transit). Not only does this help come audit time, but it also allows you to quickly discover any mistakes and address them promptly.

Challenge #9: Separate Billing & Accounting Systems

In most firms, billing, trust, and business accounting exist independently. However, this has the potential to create a lack of communication and result in confusion, especially if/when a situation arises and there’s a person handling billing on one side and another doing the “accounting” on another. Much of the trust fund tracking battle is won when you integrate billing and trust accounting, as there are a few areas in which billing and trust bookkeeping are already intertwined. There are several advantages to integrating the below steps with your billing system, rather than trying to manage each separately:

  • Client trust fund balance must be shown on billing
  • As fees are earned and advance is entered into the trust account, the following needs to occur:
    • Trust money must be moved to business account
    • Trust balance and client ledger need to be updated accordingly
    • Invoice must be marked as paid

Challenge #10: Lack of Controls & Data Protection

Whichever tool you use, it should contain user-level access controls so that you can designate who can do and see what. Additional levels of protection include:

  • An Audit Log which keeps a record of each team member’s activity while using the software
  • Automatic Backups which are a much safer solution than copying from one machine to another or using a zip drive or similar storage device
  • Two-factor Authentication (2FA) which sends a verification code via SMS to your mobile device before you can log in

At the end of the day, issues of compliance are here to stay. Set your firm up for success by taking steps to streamline the process, then get back to what you do best: providing clients with the best legal service out there. For more information on combating these challenges, view our on demand webinar and resource center The Battle For Trust Account Compliance.

 

Rick Kabra

Dr. Rick Kabra is CEO of CosmoLex Cloud, creator of cutting-edge technology solutions to help solo and small law firms law firms. Rick has a Ph.D. in Electrical Engineering from NJIT and has over 10 years of experience in the legal software industry catering to the specialized technology needs of small to mid-sized law firms. Rick has given numerous seminars and published articles on legal technologies such as law practice technology management, cloud computing, and legal billing, business & trust accounting compliance.