Virginia Lawyers Weekly

Did you see any law firm managing partners among the nervous depositors in line at IndyMac bank on July 11? After U.S. Senator Charles Schumer publicly mused about what would happen if IndyMac depositors suddenly pulled their deposits, spooked customers did just that, forcing a government seizure. Depositors – individuals, businesses and law firms – were insured only up to $100,000. Here is the lesson for Virginia lawyers: Understand some basic banking rules or be prepared to serve as an insurer to your clients who will look to you if your bank fails.

Virginia lawyers are not immune to the consequences when a financial institution collapses. Not long ago, American National Lawyers Insurance Reciprocal, the malpractice insurance company once endorsed by the Virginia State Bar, failed because its reinsurer failed. Law firms that had just paid a huge premium learned that they had neither coverage nor good prospects for a refund. IndyMac is one of the largest bank failures in recent times, but bank failures occur regularly. Is your law firm’s money in the bank safe?

It is well known that the Federal Deposit Insurance Corporation (FDIC) provides insurance to bank depositors. The basic rule is that a depositor is covered up to $100,000. What does this rule mean for the law firm that has more than this sum in an operating account? What does it mean for the money in law firm trust accounts? What does this mean for bar association foundation funds?

For operating accounts and bar association accounts, the answer is simple. Don’t keep more than $100,000 in a bank account at any one bank. An easy alternative is a side brokerage account. This is perhaps counterintuitive since such accounts do not carry any FDIC insurance at all. However, a law firm could choose to invest in a money market mutual fund that invests only in U.S. Treasuries to provide as much safety as FDIC insurance. Or a law firm can open bank accounts at different banks. Deposits at each separate bank each enjoy $100,000 of coverage. For the case of bar foundation assets, if Certificates of Deposit (CDs) are desired, the Certificate of Deposit Account Registry Service (CDARS) is an option. In a CDARS, a depositor uses one bank which actually invests the money in CDs at other banks to take advantage of the FDIC insurance up to $50 million.

For lawyer trust accounts the answer is more complex. Rule 1.15 (c) (4) of the Rules of Professional Conduct requires prompt payment to a client of trust account funds. This precludes the use of CDARS. Rule 1.15 (f) (vi) defines “financial institutions” in a way that would seem to exclude brokerage accounts – even safe ones that invest only in U.S. Treasury funds.

Fortunately, for lawyer trust accounts, the FDIC will provide insurance for each client with money in the firm’s lawyer trust account up to $100,000 – if the law firm meets two conditions. First, the account must be titled as a fiduciary account. Second, the identities and interests of the firm’s clients must be ascertainable by the bank records or “records maintained in good faith and in the regular course of business by the depositor.” 12 CFR § 330.5 (b) (a summary version of this rule is posted at www.fdic.gov/deposit/deposits/financial/fiduciary.html which, unlike the Rule, specifically mentions Interest on Lawyer Trust Accounts (IOLTA)).

The second prong of this rule should be very easy for Virginia lawyers to follow. Rule 1.15 (a), (c), and (e) already require recordkeeping sufficient to identify the assets of each client in the law firm’s client trust account. But, because the law firm is relying upon its own records, computerized records should be printed regularly. Rule 1.15 (e) (2) (i) requires an annual summary, but a monthly printout would be better recordkeeping.

It is the first prong of the rule that is more likely to cause problems. All Virginia lawyers must check with their banks to make certain the accounts are titled clearly. A title reading, “Washington, Jefferson & Henry, LLP, Client Fiduciary/ Trust IOLTA Account” should be more than sufficient. But not all banks automatically employ language that identifies the account as a fiduciary or IOLTA account. Some don’t title the account any differently than any other checking account, and the only differentiation from the firm’s operating account is a separate account number and different colored checks. A law firm with that set-up is underinsured if their operating and trust accounts combined exceed $100,000.

If your account is titled properly and you follow Rule 1.15, have you earned the right to laugh in the face of potential bank failures? No.

The fiduciary exception to the FDIC’s $100,000 insurance limit creates an unintended trap. While that money is not counted as the law firm’s money for the purpose of FDIC insurance, it is counted as the client’s money and will be aggregated with any other money the particular client has at the same bank – even if the law firm didn’t know that other client money was there. Upon a bank failure, the client will probably ask the law firm “why did you put my money in the bank where I already had $100,000?” Good question.

To avoid this problem, Virginia law firms should consider amending their standard engagement agreements. The amendment should let the client know which bank the law firm uses, alert the client to the FDIC insurance rules, and require the client to alert the firm if he has other funds at that bank.

A sample provision to the engagement agreement could read, “The Client understands and accepts that the Firm uses Freedom Bank of Virginia for its Client Fiduciary/Trust IOLTA Account deposits. While this bank is insured by the FDIC, the insurance is limited. You agree to inform the firm if you have or obtain other funds on deposit at this bank so that moneys could be deposited in a different bank in order for you to be fully insured. Unless you tell us to the contrary, the Firm will assume that you have no money on deposit at Freedom Bank of Virginia.”

Another pitfall occurs where the law firm obtains funds on behalf of any one client for more than $100,000 – such as a settlement. If this is deposited into the lawyer trust account, any excess over $100,000 is unprotected. Don’t be lulled into false security thinking that the money will only be in the account for a day or so before being distributed. If the money were deposited in IndyMac bank for one day only on July 10, the money was not protected. One possible solution is to request the funds in two or more separate payments to be deposited into two or more different banks.

Another option is to open a Repurchase Account through your bank. Colloquially known as a “repo” account, this is a bank account where deposits are “swept” each evening to a brokerage institution in exchange for collateral, such as U.S. Treasuries. From the depositor’s point of view, the account works exactly the same as any checking account but, if invested in Treasuries, the deposits are safe.

So were there lawyers in line at IndyMac? Unfortunately, there probably were. But, with some relatively easy steps, Virginia lawyers can avoid the lines – and the financial loss and stress – if their bank fails.

David A. Oblon is managing partner of Albo & Oblon, L.L.P., which has offices in Arlington, Fairfax, Norfolk and Roanoke/Salem. The firm practices employment law, government contracts, business litigation and criminal defense. Oblon can be reached at dao@albo-obon.com.

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