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 lawyers 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management of the funds because funds can be withdrawn by means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 Bars
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 lawyers
questions. He has waited long enough.
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 lawyers 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
lawyers 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.)
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?
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 lawyers 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 DHCs 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.
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 courts reliance on the client-lawyer relationship
as the line of demarcation for subjecting a lawyers 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 lawyers legal practice or a client-lawyer relationship
from funds held in conjunction with the lawyers practice or
a client-lawyer relationship.
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.
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.
a lawyers 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.
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 principals funds or property separate from the
fiduciarys 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 lawyers 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.
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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