April 13, 2022

The plight of law firms

There has been an increasing prevalence of misappropriation of trust funds from attorneys’ trust accounts (Shackleton Risk ‘The Importance of misappropriation of Trust Fund and Professional Indemnity Insurance for attorneys in South Africa’ (www.shackletonrisk.co.za, accessed 10-03-2022)). One of the competing obligations of the Legal Practitioners Fidelity Fund (Fund) is the settlement of misappropriation claims which the Fund ought to properly manage to be sustainable in the long-term (Legal Practitioners Fidelity Fund: Integrated Annual Report 2020 (http://www.fidfund.co.za, accessed 08-04-2022)).

‘Breaches of professional duties in handling clients’ funds lead to disciplinary sanctions imposed on attorneys’ (Gregory Dunbar Soule ‘Attorney Misappropriation of Clients’ Funds: A Study in Professional Responsibility ’, 10 U. Mich. J L. Reform 415, (1977) (https://core.ac.uk, accessed 08-04-2022)). Recent statistics released by the Legal Practice Council (LPC) showed that a significant number of attorneys from across the country have been suspended and struck from the roll of attorneys for various acts of misconduct which included the misappropriation of funds (Pretoria News, SA  Dec 15, 2020 (www.pressreader.com, accessed 28-04-2022)). The Law Society of South Africa and the LPC confirmed that the reason for the removal of the attorneys from the roll was mainly over misconduct that included misappropriation of funds and the defrauding of clients.

‘The legal profession’s response to the problem of attorney misappropriations traditionally has been limited to establishing and enforcing standards for admission to and expulsion from the bar’ (Gregory Dunbar Soule). In addition to reacting to cases of attorney misappropriation through disciplinary sanctions and the fidelity cover, the profession has a further obligation to the public and to its members to prevent such misconduct.

Ss 86 and 87(1) of the Legal Practice Act (LPA) require legal practitioners to maintain a trust bank account and to deposit therein money held by their  practices on behalf of any person(s), and complete accounting records of:

  • all money received and paid on the practice’s own account;
  • any money received, held or paid on account of any person;
  • money invested in a trust account or other interest-bearing account.

Three basic records are required; namely:

  • a cash receipts journal listing the source of each receipt and the date of the receipt;
  • a disbursements journal listing the date of each disbursement and the payee; and
  • a subsidiary ledger that contains a separate page for each client for whom monies have been received in trust, showing the dates and amounts of each receipt and disbursement and any unexpended balance.

Using these records, bank statements, cancelled cheques, and duplicate deposit slips, practitioners are required to perform two accounting procedures on a monthly basis and to retain a copy of their computations. In terms of Rule 54.10, a practice shall update and balance its accounting records monthly. First, a trial balance of the subsidiary ledger which shows the name of the client and the balance of the client’s account as at the end of the month should be calculated. Without such a monthly balance it would be difficult to review the accounts in the event of an audit. Secondly, the practitioner should reconcile the cash balances indicated by the receipts and disbursements journal totals, the bank statement balance, and the subsidiary ledger balance.

‘The legal practitioner remains responsible for the accounting records of the practice and must ensure that the accounting records correctly and accurately reflect the activities of the firm, both from a business and trust perspective’ (Simthandile Kholelwa Myemane ‘Who is responsible for accounting records’ 2018 (June) DR 11 (www.derebus.org.za, accessed 08-04-22)). This, therefore calls on the legal practitioners to review the records as they are ultimately responsible for these records, though not physically prepared by them. Practitioners are duty-bound to produce and make available the required accounting records to appointed auditors or inspectors for purposes of fulfilling their appointment without any restrictions (Rule of Rules made under s 95(2), 95(3) and 109(2) of the LPA). Recordkeeping requirements indicate that the attorney must retain the records for a specified length of time (Rule 54.9.1).

‘Commingling of a practitioner’s funds with those of his/her client is frequently combined with inadequate bookkeeping, which precludes the attorney from determining whether he is spending his own money or that of his clients’ (Gregory Dunbar Soule (op cit). The consequence is often embezzlement, which began as careless and unintentional misappropriation but evolved into embezzlement as the “borrowing” continued and increased in amount. Practitioners occasionally “borrow” from clients’ funds to cover their own expenses and such illegal borrowing frequently involves the attorney in a “web of financial difficulties” that may culminate in substantial embezzlement involving the funds of many clients. Unfortunately, other cases of misappropriation involve practitioners who have deliberately stolen from their clients.

‘There is a need for the development of new instrumentalities, including bookkeeping and accounting requirements questionnaires and certificate requirements that provide evidence of practitioner compliance with the Rules, and periodic “compliance checks” that ascertain whether practitioners have complied with the bookkeeping regulations’ (Gregory Dunbar Soule (op cit)). These additional procedures complement but do not supersede, the disciplinary proceedings and the fidelity cover response. In part, the additional safeguards are intended to enhance the deterrent value of existing disciplinary sanctions by increasing the likelihood that misappropriations by practitioners will be discovered. More importantly, however, these new procedures are designed to provide guidance to attorneys regarding the best ways to handle and account for the funds of their clients.

The LPC or the Board is empowered through s 87(2) (a) of the LPA to satisfy itself that the requirement of keeping proper trust accounting records is complied with. The LPC or the Board may achieve this by conducting inspections itself or through its nominee (Rule 50.1.1). The responsibility of regulators does not end with the publication of the rule (Organisation for Economic Co-operation and Development (OECD) ‘Reducing the risk policy failure: Challenges for Regulatory compliance’ (2000) (www.oecd.org, accessed 10-03-2022)). ‘There is a need for heightened regulations accompanied by information campaigns to ensure that they are brought to the notice of and made comprehensible to the target group’. A framework to support initiatives on improving regulatory enforcement through inspections, making them more effective, efficient and less burdensome for those who are inspected and at the same time, less resource-demanding for the LPC or the Board is required.

‘The spot audit programme is designed as a proactive measurement and problem detection tool’ (Law Society of Ontario (LSO) ‘Spot Audit’ (https://lso.ca, accessed 10-03-2022)). Spot audit supports and promotes high-quality law firm record keeping by providing guidance regarding the trust and general record-keeping requirements. Spot audits measure the integrity of law firm financial reporting, assess ongoing compliance with financial record-keeping requirements and identify serious misconduct related to financial matters. A primary goal, which reflects a remedial approach, is to provide on-site guidance aimed at helping your law firm correct minor deficiencies within your record-keeping practices before they lead to serious misconduct issues (LSO (op cit)). In addition to examining the law firm’s financial records, spot audits also provide an in-depth review of problematic client files.

‘There are basically two kinds of inspections’ (Gregory Dunbar Soule (op cit)). The first kind consists of comprehensive audits triggered by a credible client complaint or other circumstances constituting a good cause. A complete audit may be undertaken if the practitioner has failed to file a certificate or if a cheque that he has drawn on his client’s trust account has been returned for insufficient funds. Other circumstances which suggest possible misconduct are also sufficient to trigger an audit, for example, if a practitioner fails to distribute funds for a client, a broader investigation of his records would probably be justified.

The second inspection mechanism is a “compliance check” that involves pre-arranged appointments that are less intrusive than unscheduled visits and provide you with the opportunity to rectify any minor errors in your record-keeping practices prior to the auditor’s visit. Alternatively, you may be required to fax or e-mail a copy of your most recent trust reconciliation, trust bank statement(s), detailed trust reconciliation(s) and client trust listing to the auditor. Failure to do so may result in an immediate unannounced visit or a referral to the LPC.

‘If you aspire to be a practising attorney with your own law firm, you need to understand what records you need to maintain. Understanding the fundamentals and using specialized accounting software can keep your practice secure’ (Glenn Tyndall ‘Maintaining Law Office Financial Records’ (January 19, 2019) (www.thebalancesmb.com, accessed 08-03-2022)). It is in the best interest of the practitioner to appreciate accounting principles, and at least be able to interpret accounting records. The accuracy and reliability of financial reporting information by legal practitioners are of critical importance in ensuring a fair, efficient and transparent practice (2021 (Sept) DR 20). Proper compliance with the obligations imposed on trust account legal practitioners enforces professionalism and ethical conduct and achieves proper management of the risk of misappropriation of trust funds (Rampela Mokoena ‘Handling of trust money – dealing with the obligations of a trust account legal practitioner’ 2019 (May) DR 6 (www.derebus.org.za, accessed 10-03-2022)).

Trust account risks are a significant risk exposure that should be on top of the agenda of the practitioners (2021 (Sept) DR 20). A related source of risk is that legal practitioners can also be exposed to the risk of management obscuring their mismanagement and/or bad management (Michael Potts (op cit)). Another source of risk is the propensity of good people to accept and/or undertake bad and/or unethical actions. All that is required of a practitioner to stay in compliance with the trust accounting rules is a healthy respect for the rules ( LexisNexis – Law Firm Practice Management ‘A lawyer’s 7-Point Plan for Trust Account Management: How to reduce liability and avoid sanctions with good trust accounting practices’ (www.lexisnexis.com, accessed 10-03-2022)).

Rule of the LPA, requires the legal practitioner to implement and design internal controls to provide reasonable assurance of reliable financial reporting, and to ensure that they operate effectively and are monitored regularly throughout the reporting period. ‘Legal practitioners ‘are required to have a greater claim to business savvy and financial acumen’ (Michael Potts ‘Risk Management, Chaos Theory, and the Corporate Board of Directors1’ (www.academia.edu, accessed 10-03-2022)). They must be sufficiently skilled to understand their firms’ risk management organization and its reports. Practitioners must be sufficiently prepared to understand their firms’ responsibilities that contemporary corporate governance is forcing upon them.

‘Risk management must be developed at law firms compatible with the publicly available governance frameworks, and emphasis to be placed on the development of internal controls to deal with trust accounting issues and monitoring the effectiveness thereof’ (Michael Potts (op cit)). Risk management is an element of governance. ‘The most widely known current approach to wide-ranging risk management is identified by the term enterprise risk management (ERM)’ (Uwuigbe Olobukunala Ranti ‘Corporate Governance and Financial Performance of Banks: A study of listed banks in Nigeria’ (www.academia.edu, accessed 10-03-2022)).

‘Compliance with the regulations is a form of internalized norm enforcement within an organization’ (Pacella, Jennifer M. ‘The regulation of lawyers in Compliance’ (2020) (http://dx.doi.org/10.2139/ssrn.3430093, accessed 10-03-2022)). Monitoring compliance trends should also be a key part of the ex-post evaluation programme for existing regulations. Industries and businesses are becoming increasingly digital and regulators around the world are also experimenting with data-driven tools to apply and enforce rules in a more agile and targeted way (Organisation for Economic Co-operation and Development ‘Regulatory enforcement and inspection’ (www.oecd.org, accessed 10 – 03 – 2022)). The use of Artificial Intelligence (AI) and machine learning tools in regulatory inspections and enforcement, e.g. complaint management software, may be beneficial to regulatory enforcement.

‘Regulatory compliance is a strong driver of risk management purposes’ (Michael Potts (op cit)). Failure to ensure that proper and accurate trust accounting records are maintained leads to qualified audit reports, which in turn may result in denial of a Fidelity Fund Certificate to legal practitioners linked with the trust account practice and may also result in claims for theft or misappropriation of funds. ‘Failure of a trust account practice to receive a clean audit report negatively impacts the profiling of the trust account practice, and may result in the trust account practice being subjected to an inspection as the risk posed to the Fund may be elevated’ (Simthandile Kholelwa Myemane  ‘The increased importance of maintaining proper and accurate trust accounting records’ www.derebus.org.za accessed 08-04-2022)). The challenge for the LPC is to develop and apply enforcement strategies that achieve the best possible outcomes by achieving the highest possible levels of compliance. ‘There is a need for the increased role of risk management, heightened regulations and greater strictures in the legal practitioners’ or law firm activities’ (Michael Potts (op cit)).


Please note that our blog posts are informal commentaries on developments in the law at the time of publication and not legal advice.




About the author 

Sipho Nkosi

Sipho Nkosi is an experienced Legal Professional with a demonstrated history of working in the legal services industry. A strong legal professional with a B Proc degree focused in Law from the University of Natal (Howard College), with a keen interest in corporate governance and a profound insight into Compliance Risk Management. Skilled in litigation and procedural law, and an affiliate member of the Compliance Institute Southern Africa.

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