Worried about an OCDC audit?

Kelly Dillon is a certified fraud examiner and an investigative examiner for the Missouri Office of Chief Disciplinary Counsel. In her 23 years with OCDC, Kelly has conducted thousands of audits, testified as an expert witness in disciplinary cases involving safekeeping property violations, and provided instruction to lawyers on trust accounting.

As an investigator with the Office of Chief Disciplinary Counsel, I’ve been asked to share some of my more interesting cases and impart a few words of wisdom on the topic of lawyer trust accounting. The information here is all based on actual cases, running the gamut from minor accounting mistakes to outright criminal activity. 

When and why does the OCDC conduct audits?

When OCDC receives an insufficient funds notification from the bank

There are many reasons the OCDC might decide to audit a lawyer’s accounts. Most obvious is, of course, an insufficient funds notice on a client trust account. An overdraft is usually due to an accounting error. And while an accounting error on its own may be best remedied through additional education and support to the lawyer, sometimes a quick review reveals bigger problems.

That was the case with JM. JM’s overdraft was simply the product of a premature disbursement to a favored client. Rules require a lawyer wait a reasonable period of time after depositing client funds prior to disbursing against them. JM disbursed against uncollected funds; by failing to wait, he used other clients’ money. 

However, my review of JM’s client trust account revealed a bigger issue. We noticed that JM had been writing checks to his bank with a note in the memo line with the client’s name and/or their medical provider in an exact amount due to the provider. That practice suggested the checks were being converted to cashier’s checks to pay third-party providers. However, when copies of the cashier’s checks were obtained from the bank, they revealed the checks were payable to JM’s creditors instead of the third-party providers. 

When OCDC gets a client complaint 

The OCDC may also audit if it receives a complaint or report alleging the lawyer failed to return unearned fees or failed to disburse client or third-party funds. In these instances, the OCDC must determine whether the client funds remained in the client trust account as required by the rule. The OCDC investigators — and lawyers holding client funds — must take into consideration that the client trust account is a pooled account. It contains not only the funds of the client in question, but in most cases, it also contains other clients’ funds. It is the OCDC’s duty to conduct an audit that considers all those clients and to learn whether the balance was sufficient for each client whose funds were to be held in trust. 

In the case with LH, we found that the lawyer maintained funds in trust for more than one client, but when we looked at all of the clients whose funds should have been held in trust, the account fell short. 

When statements submitted to the OCDC don’t reconcile with bank records 

When the OCDC audits lawyer accounts, the lawyer is asked to produce copies of monthly bank statements, cancelled checks, and deposit slips with the items deposited. Those are among the records that Rule 4-1.15 requires lawyers to keep as a routine. 

When we asked SW for his records, we entered them into a spreadsheet for reconciliation. The statements SW sent did not reconcile. A visit to SW’s office revealed the statements he submitted to OCDC were altered. His altered bank statements excluded payments he was making to himself. SW’s altered statements constituted additional serious violations. 

Two sets of books? 

Once the bank records are received, OCDC may request additional required client records such as settlement statements, fee agreements, and others to support deposits and disbursements. We then use those records to reconcile the individual client account ledgers within the pool of trust account funds. 

In JA’s case, during that reconciliation process, we found that he was not making complete disbursements of client settlement funds and he produced copies of settlement statements. He claimed the undisbursed funds were fees for representing the same clients in additional legal matters, but he had no supporting documentation. 

Further investigation revealed that JA created two settlement statements for many of his clients. One statement reflected a lesser gross settlement amount than JA actually received on behalf of the client, thus resulting in a lesser amount due to the client. That first statement contained the actual signature of the client. The second statement contained the actual gross settlement amount (which the client was unaware of) and a client signature forged by JA.

What’s wrong with mixing personal or operating funds in trust accounts? 

Client funds must be held separately from lawyers’ business and personal funds. That means that business funds, such as earned fees, must be removed from trust accounts, and client funds should never be in an operating account. Commingling in either account violates Rule 4-1.15(a). It creates a significant risk to client funds because lawyers’ creditors (such as the IRS) can and will collect from any account holding any personal funds. 

When lawyers don’t separate operating funds from personal accounts, problems and embarrassments can result. If during an audit it is discovered that funds required to be held in trust are being transferred to or directly deposited into another account, the OCDC must also audit the receiving account. 

Are “non-refundable fees” enforceable? 

A few lawyers are still depositing flat fees of more than $2,000 to their operating accounts. Even though Missouri Supreme Court Advisory Committee Formal Opinion 128 dates back to 2010,¹ we still frequently see lawyers treating larger flat fees as “earned upon receipt.” A few lawyers wrongly believe they may lawfully deposit them to their operating account by describing them as “nonrefundable” in their contracts. Depositing these funds to an operating account or spending them before they are earned can lead to charges of misappropriation. 

In the case of RJ, the lawyer had a large-volume criminal practice. The lawyer deposited all flat fees, even advanced flat fees, into the operating account. Because RJ considered these advanced fees “earned upon receipt,” he kept no record of when or how the fees were earned. When audited, it was determined that in many cases, RJ had spent the advanced fees prior to earning them, misappropriating client funds. 

Removing earned fees from the client trust account is an important part of the process. Not only does it keep the lights on and provide a paycheck, but it prevents the lawyer from commingling in the client trust account. A common and very serious mistake we see when a lawyer withdraws earned fees from the client trust account is the removal of fees with no basis in an actual accounting. 

Like others, RJ routinely transferred funds to himself when he needed the income. Too often, lawyers base the withdrawals on an “estimation” of fees earned, believing they are taking less than what was earned. In reality, they often take more, resulting in the misappropriation of client funds. 

Fees might be earned on an hourly basis or by benchmark of the case, but no matter the method or agreement with the client, each withdrawal from the client trust account must come with a ledger accounting showing the withdrawal, the associated client, and purpose. A general journal of transactions and ledgers for each client are requirements of the rule. They are also essential to an effective reconciliation process.

What do I do if I’m audited? 

Respond promptly and honestly. 

I’ve seen many lawyers incur additional rule violations for failing to cooperate with an audit. Ignoring a request for records will not make it go away; it will simply lead to issuance of investigative subpoenas to the bank and/or the lawyer to complete the audit. The OCDC will follow up when lawyers ignore requests for records. 

Honesty is the best policy during an audit. If records are requested that the lawyer is not maintaining, it’s best to advise the auditor. With that information, we can work together to gather what is necessary to reconcile the account. In my experience, lawyers who try to create documents after the fact almost never reconcile to the bank account records. 

Also, bank records leave an absolute trail of where the money went. Lawyers who try to rewrite history eventually face the consequences when records reveal the truth.

In closing 

While I could go on and on with cautionary tales of trust accounting breakdowns, I’m told that too long of an article may cause drowsiness, fatigue, and, in rare cases, anxiety. For more detailed information, I encourage every lawyer to visit the OCDC and Missouri Legal Ethics Counsel websites and study Missouri Supreme Court Rule 4-1.15. Also, consider reaching out for an in-person CLE for your group or organization.

Endnotes 

1 Missouri Supreme Court Advisory Committee Formal Opinion 128 was amended in 2018 to allow advance fees under $2,000 that are not payments towards a larger flat fee into an operating account.