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Changes in Trust Account Laws

As of the beginning of this year, IOLTA accounts no longer have the unlimited Federal Deposit Insurance Corporation (FDIC) coverage that they used to have. In essence, each client’s money in a client trust account is now only insured up to a maximum of $250,000. This poses several problems for lawyers and required immediate attention.

Because of the cutoff for insurance at $250,000, it may be necessary for you to split the money of any one client in multiple banks. In addition, there is a renewed emphasis on accurate bookkeeping, as banks and FDIC insurance must be able to clearly and quickly identify the account as a client trust account in order to provide the proper insurance.

What to Do Now

There are several things that lawyers must now be aware of in order to protect both themselves and their clients’ money.

Firstly, accurate bookkeeping is crucial under these new laws. In order for any client’s money to be insured, everything must be clearly documented in the lawyer’s books, and the account must be clearly identified by the bank. This will require the lawyer to identify each client in the lawyer’s books and how much money that client has in each bank. The account must also be labeled as a fiduciary account. Even having the words “Client Trust Account” in the title should be satisfactory, unless a different name is specifically required.

Secondly, it may now be necessary for you to divide an individual client’s money amongst several banks. The new laws provide insurance for each individual client (not account) per bank. Thus, if you have a client with more than $250,000 in their trust account, you should split that money up among several banks to get maximum coverage.

Simply splitting the money into two separate accounts in the same bank will not guarantee the proper amount of insurance. There is also the possibility that if your client has a personal account in the same bank as the client trust account, and the total money amounts to more than $250,000, then they are not receiving full coverage. In this scenario, the money should again have to be split up among several banks.

Thirdly, you must discuss with your client whether the client has or will have any indebtedness to the bank you use for the client trust account. The client should be advised of the bank’s rights to offset the debt with the client’s money in the trust account.

There are an infinite number of “what if” questions that arise. I strongly suggest you immediately communicate with your bank regarding the policies and rules of that bank, and check if there are any other requirements to keeping your clients’ money safe.

The Background and History

Historically, lawyers kept their clients’ funds in non-interest bearing trust bank accounts called “Demand” accounts. Demand, over simplified, meant that the money was available on 24-hour demand by the lawyer. The bank had to reserve assets to protect “Demand” Accounts. The funds were protected, to a degree against bank failure because to some degree, they were secured.

The alternative to “demand” accounts was savings accounts. Savings accounts bore interest but demand or checking accounts did not.

FDIC insurance functioned like savings accounts. When a bank failed, the FDIC could pay off the claim of a depositor over a period of time. They never did this, but had the right to do so.

California recently recognized that FDIC insurance was no guarantee of immediate payment, and FDIC could limit claims. This may be one of the reasons the California legislature eliminated the requirement of FDIC insurance for trust accounts.

As the financial crisis of the 1980’s recession increased, depositors moved their money away from small banks to major banks that were less likely to fail, resulting in severe problems for the smaller banks which lost deposits to the bigger banks.

To slow or eliminate the shifting of funds, FDIC insurance was extended to all non-interest bearing accounts, including fiduciary accounts. IOLTA depends on the interest income and ABA successfully lobbied to treat IOLTA accounts as non-interest bearing accounts with unlimited FDIC coverage.

This extension of unlimited FDIC insurance for non-interest bearing accounts ended on 12-31-12 as part of the laws to prevent falling off the “fiscal cliff.”

Accordingly, all accounts, regardless of whether they are interest bearing or non-interest bearing, are now treated the same with $250,000 of insurance coverage per person.

The problems of FDIC coverage can become extremely complex when one person or entity has more than $250,000 in a single bank, whether in one account (the trust account) or in multiple accounts (including the trust account). In these scenarios it is highly advisable to split up your client’s money amongst multiple banks in order to be confident that all of the money is covered by FDIC insurance.

More information on these changes are included in my forthcoming book, tentatively titled “What Every Lawyer and CPA Needs to Know About Client Trust Accounts.” Check back for more information.