What Might Trigger a State Bar Audit in California?

With the implementation of the Client Trust Account Protection Program (CTAPP), the State Bar of California has more data than ever to identify non-compliance.

The best line of defense against an audit is to always have up-to-date and perfectly reconciled accounts. Numbers don’t lie, and any inconsistencies are easily discovered by auditors who are trained to spot them immediately. Leave the headache to us and take one more anxiety off your plate. By delegating this responsibility to a specialist, you ensure your compliance is airtight.

Nonetheless, awareness is crucial to understanding the risks and common pitfalls. The following are some things that could trigger an audit:

1. The NSF Notice (The #1 Easiest Trigger)

IOLTA accounts are specifically identified and registered. By law, banks must report any instrument presented against an IOLTA account with insufficient funds (NSF) to the State Bar.

• Common Misconception: Even if the bank pays the check, they must still report that the balance would have been insufficient.
• Common Cause: Bank service charges hitting an account with no "firm funds" buffer, or depositing a client settlement check and writing distribution checks before the funds have fully cleared.
• Prevention: Maintain a small, permissible amount of firm funds in the IOLTA to cover bank fees, and always wait for confirmation of cleared funds before distributing.

2. Client Complaints

Clients are increasingly savvy. If a settlement check bounces, or if there is an unreasonable delay in distributing funds, clients can (and do) file complaints.

• The Trigger: A client complaint regarding fees or distribution delays could open the door for the State Bar to subpoena all your financial records, not just those related to that specific client.

3. Dangling Client Balances

As a custodian of client accounts, maintaining positive client balances after services have ceased or case files are closed could be deemed wrongful retention of client funds.

• The Risk: A remaining client balance after completion of services or representation; especially with increasing passage of time becomes harder to explain. Such balances could also inadvertently mask other shortages (see below). If a client discovers they are still owed funds, this could lead to a formal complaint.
• Prevention: Implement policies and procedures to monitor aging accounts. Zero out client balances when matters are finalized.
• The Bottom Line: Positive client balances can be just as concerning as negative ones. They can also represent attorney fees that should have been billed, or client refunds that were forgotten.

4. Negative Balances and Ledger Shortages

In a proper Three-Way Reconciliation, your Bank Balance must equal your Book Balance, which must equal the Sum of Individual Client Ledgers.

• The Concern: If you have $100,000 in the bank, but your client ledgers add up to $105,000, you have a shortage. Even if you don't know who is missing money, the fact that money is missing could be a reportable event.
• The Trap: Negative balances or shortages of individual clients can be masked by positive balances of other clients. Your bank total might equal the total of all your client ledgers, but if Client A has a negative balance of -$5,000, you are effectively using Client B's money to cover it.

5. CTAPP Reporting Discrepancies

The new annual CTAPP reporting requirement gives the State Bar much more information and puts your self-assessment on record.

• The Risk: If you certify that you perform monthly reconciliations, but a subsequent investigation reveals you haven't, you could face consequences not just for the accounting error.
• Prevention: Never guess on your CTAPP report. Ensure your certifications are backed by actual, contemporaneous, reconciliation reports.

Disclaimer: The information provided in this article is for general educational purposes only and does not constitute legal, accounting, or tax advice. IOLTA CPA is an accounting service, not a law firm. Please consult with legal counsel regarding legal issues.