12. Internal control issues for Trust Account Supervisors
Trust Account Guidelines contents
12.1 There are particular issues relating to internal controls that Trust Account Supervisors should be aware of. The issues identified in this chapter of the guidelines are not intended to be comprehensive but list well-known areas of risk that all trust account supervisors should be alert to.
Lending operations
12.2 Issues may arise in respect of lawyers’ nominee company lending, contributory mortgages and single lender mortgages, particularly in cases where borrower and lender have been introduced by your practice.
12.3 You should ensure that the authorities you obtain from lenders and the information you provide to them comply with the LNCR and other relevant requirements. These formalities must be completed before the date of the advance. If appropriate, you should train a staff member to administer the lending operation and monitor that staff member's performance.
12.4 If there are significant volumes of lending, you should operate a proper loan approval system. The loan approval system may be in the form of a practice lending committee, or you may arrange to have a second partner or director review each loan before approval. That committee or reviewing partner or director should be aware that judgement might be influenced by the opportunity of earning significant fees. A record of all the decisions of this committee (or reviewing partner/director) should be circulated to all partners/directors.
12.5 The lending committee should be aware of borrowers or situations that pose a higher than usual risk to the lender, bearing in mind that a practice may often be the lender of last resort. You should ensure the lending committee members know when and how to say "no" to a proposal and that they remain firm in the face of pressure. For example, the lending committee might consider declining proposals:
- where the value of the security and/or the borrower ability to service the debt is dependent on the success of the borrower business.
- where the borrower is already heavily committed.
- where the maintainable income of the borrower is insufficient or marginal in relation to the debt servicing commitment.
- where the borrower is a new client whose past record is unknown.
- where the structure of the borrowing entity is unusual or the form of ownership is complex.
12.6 You should develop lending policies to cover the following:
Lending criteria. For example:
- Will you lend on residential property only or on commercial property as well? Note that lending on undeveloped land generally carries a higher risk.
- If you do lend on commercial property, will there be any reduced lending limits or premium interest rates?
- Will you accept second mortgages? If so, what limitations will be imposed?
- Collateral security requirements.
- The form of valuation required, eg, a registered valuer's report or rateable value (formerly Government Valuation).
- Borrowing maximum as a percentage of property value.
Types of borrower. For example:
- Will you lend to companies or trusts?
- If you do lend to companies, will you require shareholder guarantees?
- Will you require credit checks on borrowers?
- Will you lend to property developers?
- Consider mortgage debt servicing ability.
12.7 You should have a spread of borrowers. It is prudent to set limits on the proportion of total investor funds that may be advanced to any one borrower or related group of borrowers (say 10%), and on the proportion of any investor's funds that may be so advanced (say 20%).
12.8 You should monitor the status of borrowers, including defaults (even if only a few days) and any known changes in their circumstances. It is important to pursue arrears vigorously. You must report to investors under Rule 13 of the LNCR, where appropriate, and keep a file recording all decisions made and action taken on arrears.
12.9 Prior to making a lending decision, certain information needs to be obtained from the borrower. To ensure the information you require is obtained, it may be appropriate to use a loan application form. The information required needs to be determined by each practice and will also be governed, in part, by that practice’s lending criteria.
Borrowers’ information might include:
- a statement of assets and liabilities.
- a statement of present income and expenditure.
- sources of income (eg, employment income might warrant confirmation with the employer), and employment history.
- whether or not the prospective borrower has been denied credit before and the circumstances.
- availability of insurance policies, or any other collateral security.
12.10 Having obtained information from the borrower, it needs to be analysed. In making a lending decision it is important to consider the borrower's ability to service the debt and the financial position of the borrower. In analysing the financial position of the borrower, some points that may be considered are:
- the extent by which income exceeds expenditure.
- the extent by which assets exceed liabilities.
- whether the income is dependent upon the success of the borrower's business.
The key factor to consider when analysing a borrower's debt servicing ability is the ability to make interest and principal repayments pursuant to the lending agreement. This ability is likely to be determined by the borrower's income and expenditure levels.
Daily and monthly routines
12.11 The accounts clerk or computer operator should work to a daily routine of writing up and posting all transactions. It is your responsibility to ensure that this routine is followed and is not prejudiced by pressure of other work. Similarly, the monthly routine of balancing the trust ledger, reconciling the bank account, and scrutinising ledger accounts for discrepancies or unusual features should be carried out promptly by the staff and properly monitored. You should meet with the whole practice regularly to air any concerns over the trust account.
Client queries and complaints
12.12 You should investigate promptly any queries or complaints involving client money, and be alert to any that may indicate a wider problem in the practice. Note that Rule 3.8 of the RCCC requires all law practices to have appropriate procedures for handling client complaints promptly and fairly. Note also the provisions of the RCCC on “Client Service and Competence” (Chapter 3) and “Fees” (Chapter 9).
12.13 You should arrange for mail to be opened and distributed in the presence of a partner, director or senior staff member not directly involved in trust account work. This is your opportunity to detect any client dissatisfaction where it might otherwise have been suppressed. Where possible, rotate this task among the practice’s senior administrators or (if you have a small practice) your partners/directors. Those who supervise the mail opening should be strictly bound to refer any expression of client dissatisfaction to you immediately.
12.14 The principles for monitoring email correspondence are no different from those involved in monitoring “hard copy” correspondence. Accordingly, the person responsible for monitoring emails should either be a partner, director or senior staff member. The monitor should, as a consequence of their appointment, receive the ability to access electronic communications from and to the firm (including to each email address held by the firm and its authors). The monitor should inspect daily each author’s mailbox folders.
12.15 Any delegates of the monitor should be chosen bearing in mind they need the ability to understand both the content and significance of communications they are reviewing. For employment law purposes, it will be highly desirable for each firm’s email policy relating to monitoring to be published to every internal user of emails so they know they are being monitored.
Computer system
12.16 If your trust accounting system is computerised, you should monitor the operation of the system regularly to ensure that all aspects of it are satisfactory. You should ensure that daily balancing and all other routines are up to date. This is crucial where either the system or the operator is relatively new.
12.17 You should ensure that the operator is competent and has been provided with adequate guidance and documentation from the system suppliers. You should also ensure that system suppliers comply with any maintenance contract and that they respond promptly when called upon.
12.18 Where possible, you should ensure that there is a back-up operator who is capable of taking over when the regular operator is sick or on leave.
12.19 You should ensure that there is a properly maintained system for producing and filing away all of the regular reports, particularly those due at day end or month end.
Invoicing
12.20 You should ensure that all authors know and comply with the Regulations and Rules that relate to invoicing or taking legal fees from the trust account (refer guidelines 6.15 to 6.20).
12.21 Where possible, you should ensure that invoices are issued with prior approval from the client for the legal fees involved, or that invoices are adequately presented to the client.
Accounting to clients
12.22 Your practice should have systems for producing statements to clients on completion of transactions or (where appropriate) at least annually (refer guideline 8.1). You should establish and maintain a system for ensuring that all statements have been sent.
High risk clients
12.23 Experience has shown that the following types of clients are especially vulnerable and so conducive to misappropriation or other crises for lawyers, and should be given your particular attention:
- estates or trusts where a partner or director is the sole trustee, or where the trustees do not themselves take an active part in the administration of the estate.
- absentees, where money has been left with one partner or director to invest over a long period.
- elderly people, whose grasp of property or financial matters is slipping and who depend on lawyers to attend to their affairs.
- aggressive property investors who depend on lawyers for loan money. Property investors may put themselves in a situation of imminent financial failure unless more money is made available. This puts considerable pressure on lending practices to lend more, where that course of action may be inadvisable.