Ethics Opinion Articles - NC State Bar Journal

The Financial Accounting Responsibilities of Lawyers Who Serve as Fiduciaries

By Alice Neece Moseley

This is the second installment in a series of articles that explain the revisions to the trust accounting rules in the Revised Rules of Professional Conduct. The State Bar Council adopted the revised trust accounting rules at its January quarterly meeting. The revised rules are now before the North Carolina Supreme Court for approval. The revised rules appeared in their entirety in the Journal, Vol. 4, No. 4 (Winter 1999). They can currently be viewed at the State Bar’s website: www.ncbar.com.

In the first article in this series, I explained the reasons for revising the trust accounting rules (Rule 1.15 et seq.) in the Revised Rules of Professional Conduct. Specifically, the article explored the Ethics Committee’s decision to distinguish between a lawyer’s professional responsibilities under the Revised Rules when handling entrusted funds pursuant to service as a compensated fiduciary and the lawyer’s responsibilities when handling funds as an uncompensated fiduciary. A lawyer is always acting as a fiduciary when holding client funds such as an advance fee payment or the settlement check for a personal injury claim. However, fiduciary roles addressed by the revisions to the trust accounting rules do not constitute the practice of law per se, but nonetheless, frequently arise out of a client-lawyer relationship, for example: personal representative of an estate, guardian, trustee of a trust, attorney-in-fact, and escrow agent. A lawyer serving in one of these customary fiduciary roles is subject to the requirements of the revised trust accounting rules if the lawyer is providing the service as a part of his or her professional legal services, regardless of compensation, or if the lawyer is compensated for the service as a fiduciary even though the service is provided outside of a law practice. Funds received by a lawyer while serving as an uncompensated “volunteer” fiduciary, such as the trustee of trust for the lawyer’s family, do not have to be managed in accordance with the record-keeping and accounting requirements of the Revised Rules of Professional Conduct. This article explains a lawyer’s professional responsibilities when holding funds pursuant to professional service and/or as a compensated fiduciary.

Fiduciary Accounts

The revised trust accounting rules include a new definition section found in Rule 1.15-1. To understand the requirements of the rules, a lawyer must be familiar with several of the defined terms in this section. “Entrusted property” is defined in Rule 1.15-1 as “trust funds, fiduciary funds, and other property belonging to someone other than the lawyer which is in the lawyer’s possession or control in connection with the performance of legal services or professional fiduciary services.” “Trust funds” are “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 legal services.” “Fiduciary funds” are “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” refers to “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.” A “fiduciary account” is “an account, designated as such, maintained by a lawyer solely for the deposit of fiduciary funds or other entrusted property of a particular person or entity.” In other words, a fiduciary account is an account in which a lawyer deposits funds that he or she receives in connection with compensated service as a trustee, guardian, personal representative, attorney-in-fact, or escrow agent.

Segregation of Fiduciary Funds

Rule 1.15-2 sets forth the general requirements applicable to entrusted property. All entrusted property must be properly labeled and maintained separately from the property of the lawyer. This duty is better known as the prohibition against commingling of the lawyer’s funds with property that belongs to clients or third parties.

Fiduciary funds must be segregated and promptly deposited in a separate fiduciary account or deposited with client funds or other fiduciary funds in a general trust account of the lawyer. The only funds of the lawyer that may be deposited in a fiduciary account are funds sufficient to open and maintain the account, such as the funds necessary to pay bank service charges, and funds belonging in part to the client or a third party and in part to the lawyer, such as a disputed legal fee. Determining whether to deposit the funds in a general trust account or in a separate fiduciary account depends upon how long the funds are to be held and the nature of the funds. If the fiduciary obligation to manage the funds wisely necessitates prudent investment of the funds, depositing the funds into a separate fiduciary account is probably imperative.

Location of Fiduciary Account

The depository requirements for a standard lawyer’s trust account (designated a “general trust account” in Rule 1.15-1) differ from those for a fiduciary account. All trust accounts must be maintained in a bank in North Carolina except a trust account dedicated to the funds of one client (designated a “dedicated trust account” in Rule 1.15-1). A dedicated trust account may be maintained in a bank or other financial institution in or outside of North Carolina but only with the written consent of the client. By contrast, a lawyer in the exercise of his or her fiduciary responsibilities may select a bank or other financial institution in or outside of North Carolina in which to deposit fiduciary funds. Consent of the beneficiaries or the client is not required. Unlike a general trust account that may only earn interest if it is an IOLTA account, a fiduciary account can and should earn interest for its beneficiaries.

The authority to deposit fiduciary funds in a financial institution other than a bank is important. A fiduciary has the legal obligation to invest entrusted funds prudently. Under the “old” trust accounting rules, before revision, the choices for sound investment of fiduciary funds were limited because the rules at least appeared to require that all funds entrusted to the lawyer had to be deposited in a North Carolina bank. For example, a lawyer acting as a trustee of a testamentary trust presumably could not deposit the trust funds in an investment account with a New York investment firm. Such a requirement circumscribed the service that a lawyer provided when serving in the fiduciary roles customary to the practice of law.

There are disadvantages to permitting a lawyer to deposit fiduciary funds in the out-of-state bank or financial institution of his or her choice: it makes it more difficult for the State Bar to investigate and audit an account. There is also the possibility that Federal Deposit Insurance will not cover losses from an investment account. Nevertheless, the benefits of enhanced investment opportunities outweigh the costs of allowing a lawyer-fiduciary to chose the appropriate depository for trust funds.

Record-Keeping

Accounts Maintained at a Bank
Under Rule 1.15-3, as revised, the kinds of written records that a lawyer must maintain for fiduciary funds depend upon where the funds are deposited. If the funds are deposited into a general trust account or a fiduciary account at a bank, the lawyer must maintain all bank receipts and deposit slips listing the source of the funds, the date of receipt, and, in the case of a general trust account, the name of the client or other person to whom the funds belong. The lawyer must also maintain all canceled instruments drawn on the account or printed digital images of the canceled instruments. Instructions authorizing the transfer or disbursement of funds from the account must be retained, as must all bank statements. In the case of a general trust account, the lawyer must keep a ledger that contains a record of receipts and disbursements for any person or entity with funds on deposit in the account. Finally, any records required as a matter of law must be retained.

In addition to these record-keeping requirements, a lawyer-fiduciary must file a written directive with the bank requiring the bank to report dishonor of instruments presented against a general trust account or fiduciary account maintained at the bank.

Accounts Maintained at Other Financial Institutions
If a fiduciary account is maintained, by choice of the lawyer-fiduciary, at an institution other than a bank, Rule 1.15-3 requires the lawyer to retain all receipts and deposit slips from the account on which must be listed the source of the funds and the date of receipt. A copy of all checks or other instruments drawn on the account, or printed digital images thereof, showing the amount, date, and recipient of the disbursement must also be kept. Instructions authorizing transfers and disbursements must be maintained together with all statements from the depository institution, including notices of dishonor. Finally, the lawyer must retain any other record required by law for fiduciary funds.

Accountings for Fiduciary Property
Whenever a fiduciary, such as personal representative or a trustee, is required by law to make an annual or more frequent accounting to judicial officials, the revised trust accounting rules do not require separate written accountings to the beneficiaries of fiduciary funds. However, if the law does not require an accounting, a lawyer-fiduciary must provide a written accounting of all transactions concerning fiduciary funds to the beneficial owners at least annually and also upon termination of the lawyer’s professional fiduciary services.

Minimum Record-Keeping Period and Audit by the State Bar
All of the written records required in Rule 1.15-3, whether the records are for entrusted property deposited in a bank or in a financial institution, must be maintained for at least six years. This time period did not change when the rules were revised. Similarly, the authority of the State Bar to audit the required written records randomly or for cause has not changed.

Accuracy and Honesty
The record-keeping and accounting requirements for fiduciary funds in the revised trust accounting rules are not burdensome. Frequently, the requirements of the trust accounting rules are less than the accountings required of fiduciaries by law. Most of the records required by the rules should be maintained by a fiduciary as a matter of prudence and duty, regardless of the requirements of the Revised Rules of Professional Conduct. And remember, accuracy and honesty in record keeping every day keeps Bruno away.

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