The Law Society has observed a trend of increased employee theft from law firm bank accounts. Employee theft exposes lawyers and law firms to personal financial risk. As described in the July 18 ALIAdvisory:

“The Part B Misappropriation Indemnity (formerly known as Trust Safety coverage) under the Group Policy was designed to protect the public from misappropriation of ‘Money, Securities or Property’ entrusted to a lawyer, either by that lawyer or another lawyer in the same firm.

It is not intended to, nor does it, cover misappropriation by employees of a lawyer or law firm (e.g., a paralegal or an administrative employee). Insurance covering that type of theft can be purchased through an insurance broker and is known as employee theft or dishonesty coverage or fidelity bond coverage.”

Lawyers may also be disciplined by the Law Society for failing to safeguard client funds. Many lawyers rely heavily on their bookkeepers and other staff to handle their firm accounting. Lawyers often feel they lack time to personally handle account reconciliations, and many have no accounting background. Delegating bookkeeping responsibilities to trained staff is ideal but doing so without proper oversight can lead to major problems. Lawyers should educate themselves to protect against fraud and theft.

Case Study

The potential consequences of employee dishonesty are illustrated in a matter that went to a Law Society hearing in 2013.[1]   A trusted employee handled the lawyer’s bookkeeping and acted as paralegal. The Hearing Committee found that the “dual role of paralegal and bookkeeper was a recipe for disaster”.[2]

After working at the firm for a few years, the paralegal became a willing participant in a mortgage fraud scheme. The lawyer was unaware of what was happening and ultimately there was a trust account shortfall of approximately $1.9 million. The paralegal was found guilty of 16 counts of fraud and sentenced to six years imprisonment.[3]

But what about the lawyer? After discovering the fraud, the lawyer immediately took steps to reconstruct lost data and attempted to determine the extent of the paralegal’s misconduct. He promptly reported to the Law Society and cooperated with the police. He, along with other lawyers in the office, promptly replaced the trust shortfall of approximately $1.9 million. The lawyer and firm were themselves victims of the paralegal’s fraud and their response after discovering the fraud was commendable. However, the fraud occurred and went unchecked due to a lack of supervision. At the Law Society hearing, the lawyer was suspended for one month and ordered to pay costs of the proceedings in excess of $10,000.

Common Red Flags

Here are some common red flags the Law Society has observed in cases involving employee theft:

• Theft is often perpetrated by a highly trusted staff member: In fact, thefts are sometimes made possible due to the level of trust in the staff member.
• Lack of oversight by the responsible lawyer: In some cases, a very simple review of bank statements and cancelled cheques by the lawyer would catch the theft. For example, the Law Society has seen instances where trusted employees have forged the lawyer’s signature and written multiple cheques to themselves.
• One employee with too much responsibility: If the same staff member is responsible for handling all aspects of the bookkeeping, it will be very easy to perpetuate and conceal the theft. This is made worse when the firm does not have mandatory vacations, periodic rotations or transfers of tasks between key employees. It is easier to detect theft if multiple employees review accounts and are responsible for different functions.
• Failure to perform monthly bank reconciliations on all accounts (Trust, General, Separate Interest Bearing Accounts, and Credit Cards): This is a clear risk factor observed by the Law Society, and is the number one finding from trust audits.
• A crisis occurs at the office: An unexpected departure of a staff member can result in a single staff member handling the accounting with little oversight.

Tips to Reduce the Risk of Theft

Banking

• The firm’s Responsible Lawyer should review and approve the bank statements and bank reconciliations for all bank accounts (including trust and general accounts) on a monthly basis. As part of this review, they should examine cancelled cheques for potential concerns (e.g. tampered cheques, forged signatures, unusual vendors).
• The Responsible Lawyer should authorize all payments from trust (e.g. cheques, wire, e-transfer, and electronic fund transfers). If staff have access to control incoming e-transfers and deposits, firms should have protocols in place to ensure incoming funds are put into trust and not diverted.
• All withdrawals from trust should require at least two signatures, and lawyers should never pre-sign cheques for use when they are unavailable to sign.

Accounting Records

• The Responsible Lawyer should review and approve all client and trust ledgers on a monthly basis. Discrepancies and unusual transactions should be followed up and resolved in a timely manner.
• Audit trail reports and exception reports should be reviewed on a monthly basis by someone other than the person responsible for day-to-day accounting to identify and follow up on any unusual or adjusting journal entries.
• Mandatory secondary approval by the Responsible Lawyer should be required for any deletions or corrections of client matters.
• The Responsible Lawyer should ensure that backup functions are enabled and cannot be disabled by anyone other than themselves.
• Law firm staff should be restricted from accessing, creating, or working on client matters where a conflict of interest exists (e.g. their own legal matters).
• Law firm staff duties should be segregated, and no financial transaction should be handled by only one person from beginning to end. For withdrawals, this means that different people authorize payments, sign cheques, record payments in the books, and reconcile the bank statements.
• Watch out for returned/non-sufficient funds (NSF) cheques. A law firm should always have sufficient funds to meet all obligations with respect to money held in trust.

What should you do if you discover a theft?

1. Report the matter to police. When reporting to police you must consider your obligations with respect to privilege and confidentiality. If you are unsure of how to navigate this issue, you should contact a Practice Advisor.
2. Report immediately to the Trust Safety department at the Law Society.
3. Stop using the affected account(s). You should not disburse any funds out of the account or deposit any funds into the account.
4. Advise any affected clients. You are obligated to do this under rule 7.7-1 of the Code of Conduct.

Other benefits of reviewing your bank account activity regularly

Not only will regular review of your bank accounts help prevent or identify employee theft, you can also catch other potential frauds or thefts from your accounts.  The Law Society recently received a report of a firm that discovered unauthorized transactions on their trust account. This issue was caught quickly because the firm regularly monitored their trust account. This enabled the firm to freeze their account before any more money could be removed. Your ability to recover stolen funds from your financial institution may be affected by the length of time it takes for you to notice and report the fraudulent withdrawal.

If a trust shortage is identified, the firm is required to replenish the missing funds. Early detection of any form of fraud or theft that affects your account will greatly reduce your exposure.

For more helpful tips on how you can protect yourself, read the Guide for Effectively Managing Trust Safety Risk.

[1] Law Society of Alberta v. Venkatraman, 2013 ABLS 29

[2] Ibid., para 12

[3] R. v. Ellis, 2007 ABQB 722 and R. v. Ellis, 2008 ABQB 40 cited in ibid., at para 33

Written by: Jesse Mackenzie, Practice Advisor