Real Claims: Misuse of Trust Funds
While it may seem obvious that misuse of trust funds ought to be avoided and could be easily avoided, claims in this area do occur and can result in high value losses for clients.
Also known as defalcation claims, these claims are the basis of claims CLIA sees under its Compensation Fund coverage afforded to its subscribing law societies. Under the mandatory errors and omissions policy, misappropriation of funds and any form of fraud are excluded by the policy and would not be covered. Misuse of trust funds or trust fund fraud exposes lawyers and law firms to potentially uninsured liability.
Real Claim Examples
A lawyer at a small firm of less than 10 lawyers was creating fake invoices and billing for over 30 clients, paying the falsified invoices through money held in trust. A forensic audit was conducted which revealed the existence and extent of the fake invoices. It was discovered that the lawyer and the firm were experiencing financial difficulties and difficulties managing debt. The firm had 8 trust accounts and all lawyers at the firm had signing authority. However, the lawyer committing the fraud was the managing partner and had little to no oversight from other partners over the trust accounts. The magnitude of the fraud was nearly $2 million.
A lawyer at a midsize firm advised clients to invest money in businesses, when in fact the businesses were a sham or closely related to the lawyer and/or the lawyer’s family (without disclosing the close relationship to clients). Money was taken from clients and put into the trust account and then several cheques were requisitioned to an unfamiliar company. The accounting manager at the firm noticed the unusual pattern with the cheques being issued, which prompted an investigation into the lawyer’s trust accounting. The firm acted quickly once the fraud was discovered, initially supervising all trust transactions, and then eventually freezing the lawyer’s access to firm networks before terminating the lawyer from the firm. The magnitude of the fraud was approximately $3 million.
A trustee was appointed to take over an estate lawyer’s practice after the lawyer passed away. Upon reviewing an estate file, it was discovered that the lawyer overbilled the estate and billed for amounts in excess of what was allowed by estate tariffs. In addition, the lawyer’s file was lacking documentation to back up work that was billed for. The magnitude of the misappropriation was approximately $60,000.00.
Common Themes and Tips to Avoid Misuse of Trust Funds
Here are just some tips resulting from the above examples:
Trust accounts must be used for legitimate legal matters/services and not for personal or other business, investments, etc.
Ensure oversight and internal controls – no one person should have complete control over accounts with minimal to no oversight.
Train staff and management to be alert to unusual trust accounting patterns and red flags.
Avoid conflicts of interest. Clients should not be encouraged to invest in related businesses without full disclosure and independent review. Lawyers should generally avoid loaning money to a client or borrowing money from a client, except under limited circumstances that may be allowed by the Code of Conduct, rules, or regulations in their jurisdiction.
Ethical billing practices must be followed, including diligent time keeping and record creation and keeping. Do not charge clients and use trust funds for work that was not done or was not properly recorded. Ensure you are familiar with any tariffs that apply to your practice area and keep up to date.
Be particularly mindful when/if the firm is experiencing financial difficulties or other extenuating circumstances. Fraud may be more likely under these circumstances.
Respond immediately to warning signs by freezing or supervising trust transactions, reviewing recent files, and involving outside forensic accounting if needed, and report to external agencies, like the law society, where necessary. Quick action can stop losses from growing.
Trust fund accounts are heavily regulated by law societies. Familiarize yourself with rules and regulations in your jurisdiction.
Other Resources Related to Mitigating Trust Fund Fraud Risks:
https://lsnl.ca/lawyers-students/practice-resources/managing-money/