To the attention of the Managing Partner

Proposal for a new model of Trust Assurance

An information and consultation paper for the profession

June, 2000
Deadline for comments:
September 15, 2000

Introduction

For the past several months, the Law Society has given serious consideration to different trust assurance program models as alternatives to the current Accountant's Report (Form 47): see the January-February, 2000 Benchers' Bulletin for all lawyers .

The Benchers are favourable to exploring in more depth the implementation of a program whereby each law firm would 1) file with the Law Society its own annual report on trust accounting activities without the need to retain a Form 47 accountant, and 2) undergo a Law Society audit at least every four years. The primary advantage of this proposal is that it would appear to be more effective in detecting and deterring trust losses, which should consequently provide better protection for the public and greater stability for the Special Compensation Fund in the long term. Another important advantage is that this proposal would appear to cost the profession less overall than the current Form 47, which means reduced costs for many firms. This paper summarizes the objectives of a system for reviewing law firm trust accounts, compares our current Form 47 to the proposed alternative and compares costs.

Accompanying this paper is Trust Assurance Standards: Forecasting the Self-Reporting & Audit Inspection Model, prepared for the Special Compensation Fund Committee and presented to the Benchers at their June meeting. The Benchers have asked that this material be provided to the profession to provide further background.

A copy of each of these papers is being sent to each law firm (care of the managing partner) in mid-June for discussion and comment. They will also be posted in the Resource Library (Reports) section of the Law Society website at www.lawsociety.bc.ca and referenced in the next Benchers' Bulletin, for the profession as a whole.

If there is interest within the profession, the Law Society would also be pleased to hold information sessions on the proposal early in the Fall, possibly in conjunction with local bar association meetings. The schedule for any information sessions will be posted in the Events Calendar section of the Law Society website.

The Special Compensation Fund is working on the development of these reforms. The Committee, the Benchers and staff welcome questions and comments from law firms, individual lawyers and interested law firm staff by September 15, 2000 by contacting:

Law Society of British Columbia
c/o Jerome Malysh, Senior Auditor
845 Cambie Street
Vancouver, B.C. V6B 4Z9
Fax: (604) 605-5399
Email: TrustReview@lsbc.org

What is the purpose of a trust assurance program?

B.C. lawyers commit to high standards of professionalism and financial responsibility, and clients can justifiably have confidence that their funds in trust with a lawyer are secure.

As the regulatory body for the legal profession, and in fulfilling its statutory responsibility to protect the public interest, the Law Society sets and enforces these standards. The Law Society trust assurance program is a critical part of ensuring the integrity and security of trust funds. An effective trust assurance program has several key components:

  • Compliance: the program encourages and assists all lawyers to comply with trust accounting standards;
  • Deterrence: the program deters the mishandling of trust funds;
  • Detection: the program detects misappropriation or other misuse of trust funds at as early a stage as possible; and
  • Credibility: the program protects the interests of, and has the confidence of, clients, lawyers and the community.

Lawyers who fail to meet professional standards are subject to Law Society discipline and practice standards programs. A Special Compensation Fund — which is funded by all practising lawyers in B.C. — compensates people who suffer loss through theft by a lawyer acting in that capacity. These programs are essential for ensuring public confidence in the profession.

It takes only a few dishonest lawyers to tarnish the reputation of the profession and drive up losses in the Special Compensation Fund.

What is our model for trust assurance and why would we change it?

For more than 20 years, the Law Society of B.C. has required all law firms that maintain one or more trust accounts to file an Accountant's Report (Form 47), which is prepared by an accountant retained by the firm. The accountant is required to conduct tests deemed necessary to confirm compliance with Law Society accounting rules, in particular that:

  • books and records have been properly maintained;
  • monthly reconciliations of bank accounts have been performed; and
  • an adequate system of record keeping has been maintained.

The public accountant does not perform an "audit," but rather conducts a review based on a test sample of accounting transactions. Any exceptions are reported to the Law Society on the Form 47 and, from the random sampling, assumptions are made about the state of the books and records overall.

What are the strengths and weaknesses of the current program?

  • The Form 47 ensures that, at least annually, the books and records of a law firm have been reviewed by a third party and are brought up to date.
  • The Form 47 review is not designed to detect theft or fraud. Occasionally Forms 47 reveal serious accounting rule violations that will lead to an order by the Discipline Committee for an audit investigation, but most audit orders actually arise from complaints.
  • In working to minimize costs, accountants usually work to the minimum standard required by the Form 47. If the accountants also assist the firm in maintaining the accounting records, they may find themselves in an inherent conflict of interest.
  • The Form 47 program is expensive. With each law firm paying outside accountants an average of $1,700 for a Form 47 review, the program costs the profession $5 million a year overall. A 1998 survey of the profession reveals that many lawyers perceive the cost of the Form 47 as in excess of its value.

What other models have been considered?

To protect both the public and the profession, it is vitally important that the Law Society trust assurance program be as effective as possible in deterring the mishandling of funds and detecting theft at an early stage. In this respect, the Law Society has monitored the experiences of other law societies — both in Canada and in other countries. Within the last three years, three jurisdictions (New Zealand, Scotland and Ontario) have changed their model of trust assurance and have adopted some form of mandatory trust audit. New Zealand did so after suffering large losses to its own fidelity fund.

New Zealand now requires law firms to file their own monthly certificates on client trust funds, take an accounting course and undergo a Law Society audit every three years. In Scotland, law firms self-report by filing an accounts certificate with the Law Society every six months and they undergo a Law Society audit every two years.

The Law Society of Upper Canada was the first to introduce a self-reporting and audit model in Canada, almost two years ago. Ontario law firms file an annual certificate to declare compliance with trust accounting standards and are expected to be audited every four years. Alberta and Manitoba have retained a form of accountant's report (shorter than the Form 47) and law firms are also subject to audits — every eight years in Alberta and every four years in Manitoba. Firms may be selected for audit strictly on a random basis, or priority may be given based on risk.

From the Law Society's review of these other jurisdictions, the Alberta and Manitoba models were considered. Under a similar model in B.C., however, law firms would still have to pay to retain a public accountant to conduct a review every year (although the cost would likely be less than the Form 47), in addition to funding a Law Society audit program. This model would prove fairly expensive, especially if Law Society audits were conducted on a four-year cycle.

The Benchers are now giving serious consideration to adapting the Ontario model for B.C. as an alternative to our current Form 47 program.

A new proposal for B.C.: Annual self-report and audit program

This proposal features several components:

  • Annual self-reports: B.C. law firms would directly report to the Law Society on their compliance with Law Society accounting rules and would no longer need to retain an accountant to complete a Form 47. The form of self-report has yet to be decided, but would likely be based on a form used by the Law Society of Upper Canada.
  • Audits at least every four years: Each law firm, regardless of size, would also undergo an audit inspection by Law Society auditors, on average once every four years. New firms would be inspected within six months of start-up to ensure they have adequate accounting systems and controls.
  • Trust accounting courses: A trust accounting course would be designed for lawyers to reinforce their obligations under the Law Society Rules, and another course would be offered to law firm accounting staff to develop a standard of generally accepted trust accounting practices.

Under the audit program, it is expected that firms with certain risk factors, such as a history of inadequate accounting systems, would be given higher priority for auditing or would be audited more frequently. They also might be required to file biannual, quarterly or monthly certificates to authenticate their accounting compliance. Firms whose lawyers practise in areas that have historically resulted in claims against the Special Compensation Fund would also be audited more frequently.

For the majority of law firms, the Law Society audits would be directed at ensuring compliance with the Law Society Rules, educating lawyers on their responsibility to account to clients and helping firms with the efficiency and effectiveness of their accounting systems and staff.

Considerations

These are some of the relevant considerations in evaluating the self-report / audit program:

  • Law Society audits will focus on problems unique to trust accounting and will ensure a standard of consistency and quality.
  • These audits are likely to provide a better level of detection and deterrence of mishandling of trust funds.
  • Law Society audits and education programs will help lawyers to increase the efficiency and effectiveness of their accounting systems and staff.
  • Law firms will no longer need to retain accountants to conduct a Form 47 Accountant's Report.
  • Some of the money that law firms now pay for their Form 47 will shift to pay for the development of a Law Society audit department through staff or contractors.
  • There may be an increase in discipline, Special Compensation Fund claims and other regulatory matters during the first five years, which would have an impact on fees.

What is the comparative cost of trust assurance models?

In reforming the Law Society trust assurance program, there is an opportunity to make the program, not only more effective, but less costly for many law firms, as they would no longer have to bear the cost of the Form 47 review.

According to a Law Society survey of the profession conducted in 1998, law firms pay on average $1,700 for their Form 47, a total of $5 million overall.

It is important to bear in mind that a more effective audit program may well result in the detection of more losses and consequently may increase claims against the Special Compensation Fund, at least in the early years of the program. This impact has been factored into the comparative costings set out below. At the same time, a proactive audit program is expected to better deter mishandling of funds, which enhances the security of the Fund in the long term and increases lawyer accountability.

 

 

Approximate cost of funding trust assurance program models*

   

# of firms

 

Average cost / firm  

 

Total  

Current program: Cost of Form 47

2,976

$1,700

$5.0 million

Alternative program: Cost of self-report / LS audits

2,976

$672

$2.0 million

*Note: These costs are in addition to current costs of Law Society audits ordered by the Discipline Committee, which remain unchanged.

A more detailed costing of the Law Society audit program and other related financial impacts on regulatory programs is set out in Trust Assurance Standards: Forecasting the Self-Reporting & Audit Inspection Model, a paper from the Special Compensation Fund Committee that the Benchers considered in June and wished to send to the profession as background.

How would a self-report / audit program be funded?

The self-report/audit program proposed would be funded through the Special Compensation Fund, as is now the case for the review of Forms 47 and for Law Society investigative audits.

A formula is proposed that ensures that lawyers in private practice, who maintain trust accounts, fund the majority of program costs. A portion of the cost would be shared by all lawyers, however, through a modest increase in the Special Compensation Fund and General Fund fees. Lawyers outside of private practice do not maintain trust accounts and are not subject to trust reviews, but would nevertheless benefit from an improved program. Not only does such a program help limit losses to the Special Compensation Fund and other Law Society regulatory programs, but maintains the integrity of the legal profession as a whole.

Under the proposed funding formula there would be:

  • annual law firm trust account fees, paid by all firms with one or more trust accounts, consisting of :
    • a basic law firm trust account fee; and
    • a fee based on the number of lawyers in the firm;
  • a modest increase to the Special Compensation Fund fee, paid by all lawyers; and
  • a modest increase to the General Fund fee, paid by all lawyers.

Here is a sample breakdown for funding a self-report / Law Society audit program:

 

Proposed funding formula for a self-report / audit program

   

Lawyers/firms  

 

Fee

Total

Trust account fees (new):

     

          a) law firm fee

2,9761

$300

$892,800

          b) per-lawyer fee

6,7502

$75

$506,250

Special Compensation Fund fee (increase)

8,7003

$50

$435,000

General Fund fee (increase)

8,7004

$25

$217,500

Total firm cost

   

$2,051,550

1 Number of law firms; each firm would pay a flat $300 fee if it maintains one or more trust accounts.

2 Number of lawyers in private practice; each firm would pay a $75 per-lawyer fee (based on the number of lawyers in the firm) if the firm maintains one or more trust accounts.

3 Number of practising lawyers, each of whom would pay a $50 increase in the Special Compensation Fund fee.

4 Number of practising lawyers, each of whom would pay a $25 increase in the General Fund fee for this program.

Under this alternative self-report/audit model, law firms would no longer pay an accountant to conduct a Form 47 review. Based on a 1998 Law Society survey, law firms paid an average of $1,700 for their Form 47 review overall, with sole practitioners paying an average of $1,034.

Here are examples of the estimated cost of the proposed self-report / audit program model that might apply to a sole practitioner, a four-lawyer firm, a 10-lawyer firm and a 50-lawyer firm. Please note that neither costs nor funding formula for this model have yet been finalized:

Estimated costs for law firms of a Law Society self-report / audit program

Sole practitioner

 

# of Lawyers

Fee

Total

Trust account fees (new)

     

          a) Law firm fee

1

$300

$300

          b) Per-lawyer fee

1

$75

$75

Special Compensation Fund fee (increase)

1

$50

$50

General Fund fee (increase)

1

$25

$25

Total cost

   

$450

4-lawyer firm

 

# of Lawyers

Fee

Total

Trust account fees (new)

     

a) Law firm fee

1

$300

$300

b) Per-lawyer fee

4

$75

$300

Special Compensation Fund fee (increase)

4

$50

$200

General Fund fee (increase)

4

$25

$100

Total cost

   

$900

10-lawyer firm

 

# of Lawyers

Fee

Total

Trust account fees (new)

     

a) Law firm fee

1

$300

$300

b) Per-lawyer fee

10

$75

$750

Special Compensation Fund fee (increase)

10

$50

$500

General Fund fee (increase)

10

$25

$250

Total cost

   

$1,800

50-lawyer firm

 

# of Lawyers

Fee

Total

Trust account fees (new)

     

a) Law firm fee

1

$300

$300

b) Per-lawyer fee

50

$75

$3,750

Special Compensation Fund fee (increase)

50

$50

$2,500

General Fund fee (increase)

50

$25

$1,250

Total cost

   

$7,800

For many firms, a new trust assurance program would be less expensive than the Form 47 review. While this might not be true for all firms — as some may pay the same or possibly more — the profession overall would appear to benefit significantly from reduced costs and a program that better protects the public and the stability of the Special Compensation Fund.

What are your views?

The Special Compensation Fund, the Benchers and the Law Society staff welcome questions and comments from law firms, individual lawyers and their staff on the proposal for change set out in this paper prior to decisions being made on implementation: please see contact information on page 2. The Law Society would also be pleased to schedule information sessions on this issue in the early Fall at local and county bar association meetings on invitation. Please take the time to contact us.