Safekeeping Property: Avoiding Ethical Pitfalls with Client Funds

Confidentiality, Ethics, Firm Management, Legal Malpractice

A surprising number of disciplinary actions stem from the mismanagement of client’s funds or property. In fact, according to the State Bar of Texas Commission for Lawyer Discipline’s 2020-2021 annual report, failing to properly safeguard client property as required under Texas Ethics Rule 1.14 (Safekeeping Rule), rounded out the top 5 areas of attorney misconduct for which sanctions were imposed–with 11% of total sanctions.

It’s not uncommon for attorneys to delegate some of the obligations under the Safekeeping Rule to their staff only to find themselves in violation of their ethical obligations. In this Article, we provide a brief summary of the Safekeeping Rule, discuss common ways attorneys find themselves in violation of this Rule due to the conduct of their employees, and offer some risk management strategies.

THE SAFEKEEPING RULE

In a nutshell, Texas Ethics Rule 1.14 is comprised of the following obligations:

Keep property belonging to clients and third persons separate and not commingle. In other words, all such property should be kept separate from the lawyer’s business and personal property. When the property is money, it should be kept in a trust or escrow account. Significantly, an attorney can be found to have commingled in violation of the Safekeeping Rule even if no funds were misused or the attorney had no knowledge of the commingling.

Maintain complete records of property for five years after termination of the representation.

Provide notice after receipt of property belonging to a client or third party.

Promptly provide an accurate accounting of property of clients and third parties. Attorneys frequently find themselves in violation of this rule due to poorly maintained records. There’s no bright line rule on the timeframe in which an accounting needs to be provided, but a Texas Court has found that failure to provide such an accounting for more than 2 years is sufficient evidence that the requirement was violated.

Properly safeguard the property–funds in trust shall be disbursed only to those persons entitled to receive them. Additionally, if a dispute arises, the portion in dispute shall be kept separate by the lawyer until the dispute is resolved, and the undisputed portion shall be distributed appropriately.

COMMON VIOLATIONS OF THE SAFEKEEPING RULE

Between handling substantive client matters and growing their practice, attorneys often find themselves hard pressed to attend to their obligations under the Safekeeping Rule. While bookkeeping tasks can be delegated, it’s important to keep in mind that attorneys are ultimately responsible for the conduct of their staff under Texas Disciplinary Rules 5.01 and 5.03. Accordingly, adequate training and supervision is required.

The following real-life examples illustrate the consequences of inadequate training and/or supervision, as well as negligent hiring.

Lawyer received a public reprimand when client funds were deposited in attorney’s general account by attorney’s employees, attorney was not personally aware of the commingling, no client was harmed and there was no intent to enrich himself. In re: Complaint as to the Conduct of Richard S. Mannis, 295 Or. 594, 668 P.2d 1224 (Or. 1983)

Commingling violation found and lawyer suspended where secretary arranged for loan proceeds to be deposited first into the lawyer’s personal account and from there transferred to the escrow account in order to expedite availability of funds at real estate closing. Attorney Grievance Comm’n v. Dacy, 542 A.2d 841 (Md. 1988).

Attorney disciplined when his secretary failed to properly maintain books, resulting in an overdraft of the trust account. Attorney was suspended for permitting trust account shortages, use of trust funds for personal purposes, commingling and falsely certifying that trust accounts were properly maintained even though he did not have actual knowledge that the books were not properly maintained, the conduct was negligent, not intentional, and no client ever complained or was hurt. In re Montpetit, 528 NW2d 243 (Minn., 1995).

Attorney suspended for failing to adequately supervise his employee, who embezzled money from the trust account to make restitution for funds stolen from the attorney’s general account. If the attorney had checked her references upon hiring, he would have learned she was under indictment for embezzlement. Additionally, he did not review his records or put any safeguards in place after learning of the initial fraud. Matter of Scanlan, 697 P.2d 1084 (Ariz. 1985).

Attorney was suspended for three years after the bookkeeper embezzled over $150,000 from the firm’s trust account. Had the attorney conducted a background check, she would have learned that the bookkeeper had previously been convicted of theft. Moreover, the attorney never looked at her bank statements or performed any reconciliations of the trust account. The Florida Supreme Court ruled that the attorney was negligent in hiring the bookkeeper and not properly supervising her trust account. The Florida Bar v. Blanca Perper Greenstein, No. SC19-919 (Fl. Sup. Ct.)

SAFEKEEPING RISK MANAGEMENT STRATEGIES

Here are a few best practices for safeguarding client funds to consider implementing in your practice:

Adequately screen employees. Prospective employees should be required to complete an application with a written authorization permitting verification of the information provided. Check references and conduct background checks.

Share the responsibilities. One employee should not be responsible for opening mail, making deposits, and reconciling monthly statements as this is a surefire way for fraud or mismanagement to go undetected.

Prepare a written trust fund policy and have it reviewed by your CPA. Additionally, notify employees of the trust fund policy and train staff on red flags to look for.

Consider providing monthly written invoices to the client summarizing the client’s trust account activity (likely not necessary for inactive clients). You may want to include a statement that the client has a set time frame in which to dispute the bill.

Restrict the number of authorized signers. Consider requiring that any disbursement can only be made with two signatures. Note that lawyer signatures are preferred when it comes to disbursement from trust accounts.

Restrict online banking privileges and use difficult to guess passwords.

Reconcile and review client trust funds monthly and promptly investigate any issues.

Have bank statements delivered unopened to the reviewing attorney. Consider having your CPA review the financial statements.

CONCLUSION

Given that suspensions and disbarment are not uncommon when it comes to violations of the Safekeeping Rule, lawyers should exercise a high degree of care in handling the property of clients and third parties. Taking the time to implement proper risk management processes can help to avoid ethical problems.

By Lauren Bianchini