Law Societies in Canada dictate the rules and regulations that lawyers are governed by. As part of this oversight, lawyers are routinely audited and required to produce reports in order to ensure compliant record keeping. While understanding the requirements and necessary reports can seem like a daunting task, adherence is mandatory for law firms and critical to passing an audit.
The bulk of a Law Society compliance audit focuses on proper recordkeeping and having specific reports prepared and accessible. Lawyers face significant consequences for not passing an audit, so it’s important to have a solid grasp of what is involved. To be properly prepared you should understand the background and purpose of these audits, what reports will be required and how to maintain accurate record keeping.
Regardless of who in the firm is assigned to handle record keeping, lawyers are the ones solely responsible for accurate bookkeeping in the eyes of the Law Society. Become familiar with the relevant rules and bylaws regarding record keeping and compliance for your Law Society. Even if you do not personally handle these matters, it will allow you to check in on key pieces that could signal a problem and result in an issue during an audit.
LAW SOCIETIES & AUDITS
Within Canada there are 14 provincial and territorial Law Societies governed by the Federation of Law Societies of Canada. Lawyers are required to be a member of their respective Law Society, which not only sets the standard for admission to the society but also monitors and audits law firms. These law societies were created to protect the interests of the public, rather than the interests of its members who are instead represented by the Canadian Bar Association.
Because trust accounts are comprised of client funds, Law Societies focus heavily on regulations and proactive audits in order to prevent any inappropriate handling. At the core of these audits are required reports to ensure compliant bookkeeping and adherence to Law Society trust accounting rules. While the purpose is to uncover any misconduct, these audits also aim to provide on-site guidance and an opportunity to correct minor recordkeeping deficiencies.
Without the proper reports and bookkeeping records you may not only fail an audit and face follow-up from the Law Society, but you could also be responsible for the cost. Generally the cost of the audit is the responsibility of the Law Society but in certain situations, such as when a follow-up audit is needed, recovery costs can be pursued. Your firm may also have to pay if it takes too long to produce the required documents, extending the time of the audit and delaying completion.
AUDIT PROCEDURES & FIRM SELECTION
Each Law Society has their own procedures for the audit process, including how individuals are selected and what documents are required to be presented differently. While some Law Societies aim to audit firms every 5-10 years, others base their audits on required submission of annual reports. Having accurate and complete reports not only ensures compliance in the event of an audit, but can also help reduce the chance of being audited to begin with.
The annual submission of reports required by Law Societies varies. An Annual Report is a common requirement, which includes general practice questions as well as detailed financial reporting. These reports can also include a Trust Account Report or an Accountant’s Report, such as this one from the Law Society of Alberta:
Accountant’s Reports are usually required if trust accounting data isn’t uploaded directly to the Law Society. Not submitting these reports by the Law Society’s due date can result in fines and suspension.
These reports can impact a firm’s likelihood of being selected for an audit, so it’s important to have records clear of any inaccuracies or potential red flags. For example, the Law Society of Alberta has a mandatory electronic upload program where lawyers upload their annual submissions. Rather than randomly auditing firms, the Law Society focuses on firms whose submitted information triggers a warning in the system.
The Law Society of Ontario uses the annual reports they receive in a similar way. While a large majority of their audits are completed at random, certain events increase the odds of being audited. Along with new firms and those with previous inadequacies, failure to file an Annual Report or a report which shows issues makes an audit more likely.
Once you receive notice of an audit, also sometimes referred to as a spot audit, you will usually get a list of what documents should be prepared for review when the auditor arrives. Not every Law Society requires the same documents, but the Law Society of Ontario’s pre-audit letter outlines a lengthy list of all required documents including ledgers, journals, reconciliations and supporting documentation. Oftentimes there will be particular documents auditors require photocopies be prepared of in advance.
WHAT AUDITORS LOOK FOR
During audits there are a significant number of reports law firms will be expected to produce. The focus of these items relates mostly to trust accounting, but there are also reports relating to the general account as well. Auditors may also look at client files particularly when the firm has control of a client’s estate or is acting for a private lender.
Verifying compliance with Law Society rules and making sure client funds are handled appropriately is a primary reason for the audit. This means in addition to items requested in the pre-audit notification, auditors can also request at any time the documents and records that must be maintained according to Law Society bylaws and rules. By-Law 9 (Financial Records & Transactions) of the Law Society of Ontario outlines the specific financial recordkeeping requirements for their members.
Usually the review covers a reporting period of 12 months. While reviewing the documents from this time frame, auditors check for very specific issues that may require a correction in record keeping procedure or be a signal of a larger problem such as misappropriation of funds. Common issues that arise in improper record keeping include:
Having the right reports maintained on a consistent schedule will not only ensure compliance but will also make the production of audit documents much easier.
REQUIRED REPORTS TO ENSURE GOOD STANDING
To try to correct any deficiencies or produce all necessary documentation once notification of an audit is received will be nearly impossible. To be completely prepared and in compliance you should set up procedures to regularly produce specific reports and reconciliations. Once you know what auditors look for, it becomes easier to determine these reports should consist of.
To make sure you’re in compliance with your Law Society’s requirements, completing the below documents and reports on an ongoing basis will cover any necessary recordkeeping. Be sure any reconciliations are completed for the previous month by the 25th of the current month. For best practices and accurate records, entries should be made at least daily.
All examples below are courtesy of CosmoLex. To download a full set of report examples in PDF format click here: Complete Law Society Report Examples.
Client Trust Listing – Lists the client file, matter owner (responsible lawyer), and the current cleared and uncleared trust ledger balance.
The client trust listing helps point out any existing negative ledger balances and helps the firm stay on top of uncleared funds. A large amount of long-term outstanding funds can be an issue for the firm as they need to be addressed in a timely manner. The date of last activity column in this report can also be helpful in determining inactive matters which require attention.
Trust Journal – Tracks all activity for an individual trust bank account, including date, payee/payor, method, client/matter, memo, amount and the running balance.
The trust journal is helpful to see complete ‘book’ record of trust transaction activity with total deposits and withdrawals. Being able to see the running balance will let you know if there is an account level overdraft at any time, which is a significant compliance issue. Regular reporting will provide an opportunity to identify where the error occurred and to correct it. Each and every listed record must be able to identify its corresponding matter.
Trust Receipts Journal – The ‘deposits half” of the trust journal report.
Trust receipts focus on funds received during a time frame showing who they were received from, by which method, the amount received and what client matter the deposit relates to.
Trust Disbursements Journal – The ‘withdrawal half’ of the trust journal report.
The trust disbursements journal is a record of funds withdrawn during a given time frame, who they were paid to, what method of payment was used, and what client matter it relates to.
Client Trust Ledger – A mini bank statement for each client file.
The client trust ledger shows the opening balance as well as each transaction for a client within a particular bank account during a given time period. This report will point out if a matter level overdraft occurred, when and from which transaction.
Trust Transfer Record – Shows a record of all occurrences where funds were moved from one client file to another within the same bank account.
Bank Reconciliation Report – A comparison of the bank versus book balances.
The bank reconciliation report should be completed monthly after reconciling all of your accounts. This report is especially useful for trust accounts as it will show any discrepancies and uncleared transactions.
Any transactions which remain uncleared for an extended period of time are still the fiduciary responsibility of the firm and need to be addressed within a reasonable amount of time. Generally if a cheque has been outstanding for longer than six months, it should be reversed and the books updated accordingly.
Trust Bank Client Reconciliation – A three-way reconciliation of the balances of the client ledger, bank and book unique to trust accounts.
The trust bank client reconciliation shows the balances of not only the book and bank, but the client ledger as well. When compared, all three final balances should be equal.
These are account specific reports. If you have multiple general accounts these reports need to be generated for each.
General Journal – Shows all activity for an individual general account, including date, payee/payor, method, client or matter, memo, amount and running balance.
The general journal is a helpful way to get a complete book record of bank activity including deposits and withdrawals. By looking at the running balance you’ll also be able to see if there was an account level overdraft at any time.
Receipts Journal – The ‘deposits half” of the the general journal report.
The receipts journal focuses on funds received during a time frame showing who they were received from, by which method and the amount received.
Disbursements Journal – The ‘withdrawal half’ of the general journal report.
The disbursements journal shows funds withdrawn during a time frame, who they were paid to, by which method (i.e. cash, credit), the amount and the tax breakdown.
Client’s General Journal – Shows specific client activity within the general account, such as invoice payments.
The client’s general journal is broken down by client file so you can see each general transaction. Some of the transactions shown may be paid by the firm on behalf of the client while others may be ‘payments on account’, which are invoice payments.
Each transaction is broken down by date and memo as well as the breakdown between disbursements, fees and taxes. The final balance column takes the fees and expenses billed to the client minus the payment on account.
While some law societies don’t require this report, it’s good business practice to do so in order to keep track of all the expenses, payments and invoices for each client in one convenient record.
Fees Book – Shows a breakdown of each invoice with fees, disbursements, taxes and write-offs.
The fees book centers around each invoice. The fee book should include fees charged to the client, the date, the client being billed and any other billing charges.
PRODUCING FINANCIAL REPORTS
Once you know which records you’re responsible for maintaining, the next piece is determining how your firm will be producing them. While manual production of the required financial reports is possible, this method is prone to errors, including general arithmetic mistakes and failure to post to sub-ledgers such as individual client ledgers. The time and cost associated with manual accounting combined with the increased likelihood of errors makes it more efficient to utilize software
Most firms rely on software developed specifically for the legal industry to stay compliant with the extensive number of law firm specific accounting requirements. These programs provide mechanisms to create the needed reports along with safeguards to prevent errors such as overdrafts of trust accounts. As firms add additional partners, office locations and practice areas these legal specific programs also offer a way to scale easily with the firm’s growth.
Within Canada there are several legal specific programs available that make it easy to produce the reports and records necessary to stay compliant. Popular options include PCLaw and ESILaw, which provide installed desktop solutions, and CosmoLex, a web-based solution. For firms looking to minimize errors, ensure automatic calculations and posting to subledgers, these programs offer accurate and detailed reporting.
BEST PRACTICES FOR MAINTAINING FINANCIAL REPORTS
After deciding on a process to create the required reports and records, the next step is figuring out how long these documents need to be kept and how to store them. The range for how long to keep financial records varies by Law Society. For example, Sections 23(1) and 23(2) of By-Law 9 of the Law Society of Ontario require certain financial documents to be kept for six years while others need to be kept for ten.
Documents required to be kept for six years:
Documents required to be kept for ten years:
The Law Society of Alberta rules requires law firms to handle financial record keeping differently according to Rule 119.37. Law firms must keep particular financial records for at least ten years from the time the records came into existence while trust ledger accounts need to be kept for ten years after the trust ledger was closed. All documents are required to be kept at the office location for at least two years.
With varying times mandated, you should research the bylaws and rules of your specific Law Society to make sure you’re keeping the documents for as long as necessary. To be on the safe side, store all financial records for at least ten years plus the current fiscal year.
For most Law Societies, these documents can be stored electronically. Other supporting financial records can also be kept digitally including cheques, deposit slips and receipts. Many financial institutions provide electronic images of cashed cheques. Keeping legible copies of these with images of the front and back of the cheque will satisfy Law Society requirements.
In the event of an audit you should be able to produce paper copies of these records. All documents should be accessible within a 30-day time frame. Printing records and journals monthly can help avoid problems that could arise with data corruption and computer crashes.
When choosing how to store records, digital storage is considerably cheaper in the long run so many law firms lean toward this format. If considering electronic copies of records remember lawyers have a fundamental obligation to make sure financial data, especially that which pertains to trust accounts and clients, is securely stored and confidential. Selecting a service provider requires adequate due diligence to make sure they’re adequately equipped to securely store law firm data.
When choosing a storage provider be aware of their service agreement, security and backup, especially for cloud-based programs. Look for a provider which encrypts data at rest, has redundant backups of their data and has proven they will have longevity or make full data downloads readily available. Should a provider discontinue their services, you want to make sure you’ll be able to retrieve your records and information.
The Law Society of British Columbia has published a very useful Cloud Computer Checklist that discusses lawyer’s responsibilities when dealing with technology and file storage, and what questions to ask a potential provider. If choosing to store documents electronically, be sure to implement a paperless procedure to your office. All staff should be aware of how to scan in documents and how to store them according to a specific system so they’re easily located.
BE PREPARED & IN COMPLIANCE
Keeping the records and bookkeeping reports required by Law Societies isn’t an option for firms. In order to pass an audit and maintain compliance, firms need to know what the Law Society expects. Once the specific requirements have been determined, firms should then set up a plan to ensure ongoing financial record keeping and reporting is taking place.
Consistent reporting will ensure compliance, help you avoid any complications or sanctions and provide a clear financial standing of the firm. These records need to be stored in a format selected through appropriate levels of due diligence for the amount of time mandated by your Law Society. Completing all of these steps means you’ll be fully prepared when you receive an audit notification.