Rule 4 Trust Account Regulations and Minimum Trust Accounting Records

COMMENT:

[1]Rule 4 of these Rules enumerates the basic financial records that a lawyer must maintain with regard to the business and trust accounts of a law firm. These include the standard books of account and the supporting records that are necessary to safeguard and account for the receipt and disbursement of client funds as required by these Rules. These records shall be maintained by the lawyer for a period of 6 years after termination of each particular legal engagement or representation, or the last transaction on the account, whichever occurs later.

[2]Rule 4(b) enumerates minimal accounting controls for client trust accounts. It also enunciates the requirement that only a lawyer admitted to the practice of law in the jurisdiction shall be the authorized signatory or authorize electronic transfers from a client trust account. The lawyer has a non-delegable duty to protect and preserve the funds in a client trust account and can be disciplined for failure to supervise subordinates who misappropriate client funds. See Rules 5.1 and 5.3 of the Hawai‘i Rules of Professional Conduct.

[3]Authorized electronic transfers shall be limited to (1) money required for payment to a client or third person on behalf of a client, (2) expenses properly incurred on behalf of a client, such as filing fees or payment to third persons for services rendered in connection with the representation, (3) money transferred to the lawyer for fees that are earned in connection with the representation and are not in dispute; or (4) money transferred from one client trust account to another client trust account.

The requirement in paragraph (a) that receipts shall be deposited intact mean that a lawyer cannot deposit one check or negotiable instrument into two or more accounts at the same time, a practice commonly known as a split deposit.

[4]Rule 4(c)(7) of these Rules requires that the physical or electronic equivalents of all checkbook registers, bank statements, records of deposit, pre-numbered canceled checks or check stubs, and substitute checks be maintained for a period of 6 years after termination of each legal engagement or representation, or the last transaction on the account, whichever occurs later. The “Check Clearing for the 21st Century Act” or “Check 21 Act,” codified at 12 U.S.C.§5001 et. seq., recognizes “substitute checks” as the legal equivalent of an original check. A “substitute check” is defined at 12 U.S.C. §5002(16) as a “paper reproduction of the original check that contains an image of the front and back of the original check; bears a magnetic ink character recognition (MICR) line containing all the information appearing on the MICR line of the original check; conforms with generally applicable industry standards for substitute checks; and is suitable for automated processing in the same manner as the original check.” Banks, as defined in 12 U.S.C. §5002(2), are not required to return to customers the original canceled checks. Most banks now provide electronic images of checks to customers who have access to their accounts on internet-based websites. It is the lawyer’s responsibility to download electronic images. Electronic images shall be maintained for the requisite number of years and shall be readily available for printing upon request or shall be printed and maintained for the requisite number of years.

[5]The ACH (Automated Clearing House) Network is an electronic funds transfer or payment system that primarily provides for the inter-bank clearing of electronic payments between originating and receiving participating financial institutions. ACH transactions are payment instructions to either debit or credit a deposit account. ACH payments are used in a variety of payment environments including bill payments, business-to-business payments, and government payments (e.g. tax refunds.) In addition to the primary use of ACH transactions, retailers and third parties use the ACH system for other types of transactions, including electronic check conversion (ECC). ECC is the process of transmitting encoded information from the bottom of a check and converting check payments to ACH transactions, depending upon the authorization given by the account holder at the point-of-purchase. In this type of transaction, the lawyer should be careful to comply with the requirements of Rule 4(c)(9) of these Rules.

[6]There are 5 types of check conversions where a lawyer should be careful to comply with the requirements of Rule 4(c)(9) of these Rules . First, in a “point-of-purchase conversion,” a paper check is converted into a debit at the point of purchase and the paper check is returned to the issuer. Second, in a “back-office conversion,” a paper check is presented at the point of purchase and is later converted into a debit and the paper check is destroyed. Third, in an “account-receivable conversion,” a paper check is converted into a debit and the paper check is destroyed. Fourth, in a “telephone-initiated debit” or “check-by-phone” conversion, bank account information is provided via the telephone and the information is converted to a debit. Fifth, in a “web-initiated debit,” an electronic payment is initiated through a secure web environment. Rule 4(c)(9) of these Rules applies to each of the type of electronic funds transfers described. All electronic fund transfers shall be recorded and a lawyer should not re-use a check number which has been previously used in an electronic transfer transaction.

[7]The potential of these records to serve as safeguards is realized only if the procedures set forth in Rule 4(c)(8) of these Rules are regularly performed. The trial balance is the sum of balances of each client's ledger card (or the computerized equivalent). Its value lies in comparing it on a monthly basis to a control balance. The control balance starts with the previous month's balance, then adds receipts from the Trust Receipts Journal and subtracts disbursements from the Trust Disbursements Journal. Once the total matches the trial balance, the reconciliation readily follows by adding amounts of any outstanding checks and subtracting any deposits not credited by the bank at month's end. This balance should agree with the bank statement. Quarterly reconciliation is recommended only as a minimum requirement; monthly reconciliation is the preferred practice given the difficulty of identifying an error (whether by the lawyer or the bank) among three months' transactions.

[8] In some situations, documentation in addition to that listed in paragraphs (c)(1) through (c)(9) of Rule 4 is necessary for a complete understanding of a trust account transaction. The type of document that a lawyer must retain under paragraph Rule 4(c)(10) because it is “reasonably related” to a client trust transaction will vary depending on the nature of the transaction and the significance of the document in shedding light on the transaction. Examples of documents that typically must be retained under this paragraph include correspondence between the client and lawyer relating to a disagreement over fees or costs or the distribution of proceeds, settlement agreements contemplating payment of funds, settlement statements issued to the client, documentation relating to sharing litigation costs and attorney fees for subrogated claims, agreements for division of fees between lawyers, guarantees of payment to third parties out of proceeds recovered on behalf of a client, and copies of bills, receipts or correspondence related to any payments to third parties on behalf of a client (whether made from the client’s funds or from the lawyer’s funds advanced for the benefit of the client).

[9]Rule 4(d) allows the use of alternative media for the maintenance of client trust account records if printed or electronically transmittable copies of necessary reports can be produced. If trust records are computerized, a system of regular and frequent (preferably daily) back-up procedures is essential. If a lawyer uses third-party electronic or internet-based file storage, the lawyer must make reasonable efforts to ensure that the company has in place, or will establish, reasonable procedures to protect the confidentiality of client information. See ABA Formal Ethics Opinion 398 (1995). Records required by Rule 4 of these Rules shall be readily accessible and shall be readily available to be produced upon request by the client or third person who has an interest as provided in Rule 1.15 of the Hawai‘i Rules of Professional Conduct, or by the official request of the Office of Disciplinary Counsel, including but not limited to, a subpoena duces tecum. Personally identifying information in records produced upon request of the client or third person or by the Office of Disciplinary Counsel shall remain confidential and shall be disclosed only in a manner to ensure client confidentiality as otherwise required by law or court rule.

[10]Rule 4(e) provides for the preservation of a lawyer’s client trust account records in the event of dissolution or sale of a law practice. Regardless of the arrangements the partners or shareholders make among themselves for maintenance of the client trust records, each partner may be held responsible for ensuring the availability of these records. For the purpose of these Rules, the terms “law firm,” “partner,” and “reasonable” are defined in accordance with Rules 1.0 (d), (g), and (i) of the Hawai‘i Rules of Professional Conduct.