Ethics Opinion Articles - NC State Bar Journal

Be Careful What You Ask the Ethics Committee...or, Everything You Must Know About the Revisions to the Trust Accounting Rules

By Alice Neece Moseley

This is the introduction to a series of articles explaining the revisions to the trust accounting rules in the Revised Rules of Professional Conduct. The revisions were approved by the State Bar Council at its quarterly meeting in January 2000. They are now before the North Carolina Supreme Court for approval.

Over a year ago, a member of the State Bar sent the Ethics Committee what I am sure he considered to be a simple inquiry: do the trust accounting rules (Rules 1.15-1 and 1.15-2 of the Revised Rules of Professional Conduct) apply to the account that he manages as the trustee of a revocable living trust set up by a family member for certain other members of the lawyer’s family? Our innocent, inquiring lawyer is in-house counsel at a bank, does not have a client trust account, and does not receive compensation for serving as trustee. The account for the family trust is not maintained in a North Carolina bank, as required by Rule 1.15-1(c),1 but in a Schwab One Account. By placing the family trust funds in this account, however, the lawyer fulfilled his fiduciary duty to maximize the return on the funds through a secure investment vehicle. The account earns a higher rate of return than would be earned by an ordinary bank account because the funds in the account are invested in securities. The investment account provides flexibility in the management of the funds because funds can be withdrawn by means of a checking account that is “embedded” in the investment account. Unfortunately, each check is technically written against a zero balance: until the check is presented, no funds are transferred from the securities to the embedded checking account. Check writing against insufficient trust funds, as every good lawyer knows, is contrary to the most basic requirements of Rule 1.15-1. You tell me: is the lawyer violating the Revised Rules of Professional Conduct?

You may be happy to learn that the Ethics Committee was stumped, too. Our innocent, inquiring lawyer initiated a year of study of the trust accounting rules. A subcommittee of the Ethics Committee was sent back to the drawing board at least twice before the full committee agreed to publish for comment substantial proposed revisions to the rules. The proposed Revised Rules appeared in their entirety in the last edition of the Journal. (You can find them on the State Bar’s website at www.ncbar.com.) At the meeting of the State Bar Council in January, the Revised Rules were adopted and they are on their way to the North Carolina Supreme Court for final approval. It is hoped that the Revised Rules answer our good, patient lawyer’s questions. He has waited long enough.

Professional Fiduciary Services vs. Volunteer Fiduciary Services

The first question the Ethics Committee had to answer was whether funds handled by a lawyer serving in a traditional fiduciary role, such as a trustee, personal representative of an estate, guardian, attorney-in-fact, or escrow agent, should be subject to the regulation of the State Bar. The answer to this question seems clear when the fiduciary service arises out of a traditional client-lawyer relationship. If the lawyer receives compensation, and provides the service as a part of his or her professional services, the lawyer’s conduct is clearly subject to the Revised Rules of Professional Conduct. Therefore, the duties set forth in the trust accounting rules apply to any funds managed by a lawyer acting in one of these traditional fiduciary roles in the context of a client-lawyer relationship. (These duties include the following: avoiding commingling of the lawyer’s funds with clients’ funds by depositing the clients’ funds in a separate trust account with a North Carolina bank; properly labeling the clients’ funds; maintaining minimum records of the funds on deposit in a client trust account; making annual accountings to clients for the funds on deposit in a trust account; reconciling of trust account balances of client funds on a quarterly basis; and properly disbursing client funds.)

Unfortunately, there remain many unanswered questions. What if the lawyer declines compensation? What if the lawyer is not in private practice and is serving in the role as an accommodation to his or her employer or as a part of a business transaction? What if the lawyer is serving in the role because of a familial or personal relationship, like our inquirer, precisely because the family member or friend wants a lawyer to serve? What if the lawyer is compensated for the services even though she is managing an estate or a trust for a family member? Should the trust accounting rules apply to funds that a lawyer handles in a non-traditional fiduciary role, such as cookie chairman for the Girl Scouts or treasurer of a church?

The decision of the Court of Appeals in The North Carolina State Bar v. Barrett, 132 N.C. App.110, 511 S.E.2d 15 (1999) attempted to resolve these issues by strict construction of the trust accounting rules then in effect and a narrow definition for the client-lawyer relationship. In Barrett, the Court of Appeals upheld a decision of the Disciplinary Hearing Commission (DHC) finding that the defendant violated the Rules of Professional Conduct when she commingled personal funds with rental payments she collected as an agent for a landlord with whom she had no client-lawyer relationship. Specifically, the court found that Rule 10.1(a) (now superceded by Rule 1.15-1 et seq. of the Revised Rules), which required a lawyer to keep “any property received by the lawyer in a fiduciary capacity” separate from the lawyer’s personal funds, applied “not only to a client-lawyer relationship, but also to other business relationships the lawyer may engage in.” Id. at 114, 511 S.E.2d at ___. However, the court reversed the DHC’s finding that the defendant violated Rule 10.2 (now superceded) requiring the maintenance of adequate records of “all funds…or other property of a client,” the quarterly reconciliation of the trust account balances of “funds belonging to all clients,” and the prompt payment of “client” funds. The court held that Rule 10.2 related “solely to lawyer-client relationships” and it could, therefore, be interpreted independently of Rule 10.1. The Court of Appeals held that the defendant violated the commingling requirements of the rules because those requirements applied to all fiduciary property she received, but found that she did not violate the rules with regard to record keeping, reconciliation, and prompt disbursement because there was no client-lawyer relationship with the owner of the property.

The decision in the Barrett case has the unfortunate effect of holding lawyers acting outside the scope of a client-lawyer relationship to the prohibition on commingling but not to the other obligations under the trust accounting rules. Nevertheless, the Ethics Committee found merit in the court’s reliance on the client-lawyer relationship as the line of demarcation for subjecting a lawyer’s conduct while handling fiduciary funds to scrutiny under the Revised Rules of Professional Conduct. The problem for the Ethics Committee was how to create a bright line between fiduciary funds held outside of the lawyer’s legal practice or a client-lawyer relationship from funds held in conjunction with the lawyer’s practice or a client-lawyer relationship.

The committee decided that an appropriate and justifiable distinction could be made between compensated service as a fiduciary and uncompensated service. The committee reasoned that, in most situations, a lawyer will decline compensation or none will be provided when the lawyer is volunteering her services as a fiduciary for the benefit of family, friends, or charity. For this reason, (proposed) Revised Rule 1.15-1 defines “fiduciary funds” that are subject to the requirements of the rules as “funds belonging to someone other than the lawyer that are received by or placed under the control of the lawyer in connection with the performance of professional fiduciary services.” “Professional fiduciary services” are subsequently defined as “compensated services (other than legal services) rendered by a lawyer as a trustee, guardian, personal representative of an estate, attorney-in-fact, or escrow agent, or in any other fiduciary role customary to the practice of law” [emphasis added]. Funds received by a lawyer while serving as an uncompensated “volunteer” fiduciary, whether as a personal representative of an estate or cookie chairman, do not have to be managed in accordance with the revised trust accounting rules.

Words to the Wise

There are three important caveats to keep in mind. First, if you are acting as a fiduciary within the context of the client-lawyer relationship, your conduct will be subject to the trust accounting rules even though you are not compensated for your services. It is possible that whether a fiduciary role arises out of a client-lawyer relationship may now become a contested issue in a disciplinary case. The prudent lawyer will, however, avoid the issue altogether by erring on the side of complying with the rules in most, if not all, situations in which the lawyer is serving as a fiduciary.

Second, although a lawyer’s handling of fiduciary funds may, in some limited instances, be exempt from the money-management requirements of the trust accounting rules (record keeping, annual accountings, quarterly reconciliations, etc.), it is not exempt from the prohibitions on illegal conduct, dishonesty, fraud, and deceit in the misconduct rule, Rule 8.4. In other words, a lawyer who steals fiduciary funds, regardless of the source of the funds, will be subject to prosecution under the Revised Rules of Professional Conduct.

Third, there are a number of obligations created by the law applicable to fiduciaries in general that are remarkably similar to the obligations imposed by the trust accounting rules. By law, a fiduciary may be required to keep the principal’s funds or property separate from the fiduciary’s personal funds or property, to avoid self-dealing, and to account for the funds accurately and promptly. Although there may be no professional discipline for mismanaging a fiduciary account,2 there may be civil consequences.

Having answered the good lawyer’s crucial underlying question as to when he must comply with the trust accounting rules, the Ethics Committee still had to decide whether all of the requirements applicable to client trust accounts should apply to an account managed solely for the benefit of an estate, a trust, a guardianship, etc. Of particular concern to the committee was the possibility that the requirements infringe upon the fiduciary duty of prudent investment. But that discussion is for the next article in this series which will focus on the specific requirements of the revised trust accounting rules.

Alice Neece Moseley is the assistant executive director of the State Bar, counsel to the Ethics Committee, and director of Specialization.

Endnotes:
1. Funds may be maintained at a bank outside North Carolina with the consent of the client. However, this presents the problem of determining who is the client when a lawyer is acting as a fiduciary such as a trustee or personal representative.

2. There may be professional discipline if a lawyer violates a law regarding fiduciary funds and the conduct involves dishonesty or fraud. See Rule 8.4 (c).

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