I. INTRODUCTION

10.1 In the previous two chapters we made a number of recommendations relating to the general nature of two forms of independent scrutiny, namely Law Society inspections and accountants examinations. In this chapter we look at a number of other issues relating to independent scrutiny We do so under the following headings

• specific aspects of examinations and inspections;
• appointment, qualifications and other issues relating to accountants conducting examinations; and
• duties of solicitors, bankers and accountants to report reasonable suspicions.

II. SPECIFIC ASPECTS OF EXAMINATIONS AND INSPECTIONS

A. Introduction

10.2 In this section we look first at the use of client verification as a means of checking solicitors trust account records, and then at certain other types of specific checks which could be made compulsory or at least be strongly recommended.

B. Client Verification

The Present Position

10.3 Client verification in the course of independent scrutiny involves checking with solicitors’ clients whether or not the trust account records relating to their affairs disclose any inaccuracies or irregularities. It may be confined to verification of the current balance in their trust ledger account, or include verification of each transaction shown therein Under present law, Inspectors can seek client verification in the course of their inspections, and accountants can do so in the course of their examinations. The current practice is described in the following paragraphs.

10.4 Inspectors: Until very recently, Inspectors did not utilise the technique of client verification at least in routine inspections. Since 1983, however, experiments with client verification have been conducted by Inspectors in two areas of New South Wales, with the co-operation of the relevant regional law society.¹ The experiments were to confined to transactions in excess of $10,000 which the solicitorinvolvedhad failed to explainto the satisfactionof an Inspector conducting a routine inspection. If the Inspector considered that verification by a particular client should be sought, he or she could report accordingly to the Chief Executive Officer of the Law Society. If the Chief Executive Officer agreed that client verification should be sought, he would arrange for an appropriate letter to be sent to the client In one area, it was agreed that the letter would be sent by the Society’s own accountants, and in the other area it would be sent by the accountants responsible for examining the trust account in question.

10.5 We understand that thus far verification has been sought in only three instances. The clients involved have been sent a letter² explaining that a “routine inspection” of their solicitors accounts has been carried out and giving details of a transaction recorded in those accounts in which the client was involved. The client is asked to indicate by ticking the appropriate box in the letter, whether or not “the transaction as described above correctly records what you intended to happen to your monies”. The letter concludes: “You may also wish to write on the back of the letter your explanation of what you believe is correct”. In each instance the client responded that the record was correct We have been advised by the Law Society that client verification by Inspectors may be introduced in one or two other areas, by agreement with the regional law societies in question in the reasonably near future.

10.6 Accountants: We have referred earlier to the Accounting Research Centre’s survey of chartered accountants in New South Wales in 1979. Some 11 per cent of respondents to the to the survey that said when examining solicitors trust accounts they “frequently” or “occasionally” obtained client verification of trust account balances.³

Discussion

10.7 We have pointed out that client verification procedures already occur to some extent. The question arises whether they should be made compulsory, or at least be used more extensively.

10.8 It is widely accepted that the mere perusal of trust account and other records provided by a solicitor may fail to detect deliberate or negligent this handling of trust moneys, especially if the solicitor in question has sought to conceal it.⁴ The likelihood of detection may increase substantially, however, if the records are checked with the clients involved in order to ascertain whether the nature and amount of the various transactions shown in the records are accurate and in accordance with instructions. Moreover, the knowledge that such verification may be sought, even of a random sample of clients, can be expected to have a significant deterrent effect on potentially aberrant solicitors. In some circumstances it may be relatively easy to prepare records (such as forged instructions) which, while effective to deceive an Inspector or accountant, are patently false to the client The importance which accountants place on client verification as a technique may be seen from the fact that, when asked by the Accounting Research Centre what checks they would make if required to conduct an audit-like examination some 74 per cent said that they would “frequently” or “occasionally” seek client verification.⁵

10.9 One of our consultants, Coopers and Lybrand, made the following comments to us about client verification.

“In audits of commercial enterprises it is standard practice for the auditor to communicate direct with debtors to obtain confirmation of amounts owing. In common with most modern audit practices, the check is conducted on a sample basis. Usually, the requests for confirmation accompany monthly statements despatched by the client to the debtor, and the debtor is asked to reply direct to the auditor. Any discrepancies reported by debtors are expected to be thoroughly investigated by the auditor.

A similar practice is used in obtaining confirmation of bank balances and loan creditors. Confirmation of creditors’ balances by direct communication is not customary where creditors’ statements are received by the client. Where statements are not received, however, auditors sometimes communicate direct with creditors to confirm large amounts owing.

Confirmations of account balances by direct communication in controlled conditions are generally regarded as audit evidence of a high order. In some situations, no alternative audit evidence may be available.

An obstacle to the adoption of direct communication checks in audits of solicitors trust accounts is that solicitors do not generally render monthly statements to clients. Frequently, statements are sent only on completion of the matter, e.g., a conveyance of property. Monthly statement despatches are not, however, a pre-requisite to direct communication checks. To overcome the difficulty, the auditor could check and mail statements specially prepared to clients selected by him for the purpose of the test. Generally, a photocopy of the ledger account avoids the necessity of producing a separate statement.

It is recognised that clients are not always able to confirm whether or not the statements of accounts are correct. Nevertheless, the advantages of direct confirmation from clients are significant and it is recommended that such tests, on a sample basis, be standard practice in audits of solicitors trust accounts.”⁶

10.10 Some solicitors have expressed considerable concern about client verification.⁷ The most common concern is that clients who are approached for verification may believe that something must be amiss in their solicitor s practice, even though their own matters are being conducted satisfactorily. Accordingly, it is said, the solicitors reputation and practice may suffer, especially if those clients express their suspicions to other people and rumours begin to develop. Other concerns include the costs involved in an extensive verification procedure, and the danger that the procedure may be ineffective if, for example, the clients indicate satisfaction without really understanding the records sent to them. Moreover, it is said, if solicitors wished to frustrate the verification procedure they could record false addresses for the clients in question intercept the requests for verification, and then provide responses purporting to be from the client.

10.11 In Tasmania there is a specific statutory procedure for client verification in the course of accountants examinations.⁸ Accountants can require solicitors to give them letters in a -bed form written on the solicitors’ letterhead, seeking verification from particular clients. The number of letters required, however, must not exceed 10 per cent of the number of clients of the solicitor in question “who are involved in monies for investment or securities.”⁹ We understand that many accountants make use of this procedure, although they are not required to do so.

10.12 Strong support for client verification has been expressed in other jurisdictions. For example, the Dawson Committee established by the Victorian Government pointed out in 1977 that accountants auditing solicitors’ trust accounts in that State have the power to seek such verification and “it is vital to the effectiveness of an audit that the power should be exercised”.¹⁰ The Committee pointed out that in the area of company audits it is common for auditors to seek verification from persons having dealings with the company.¹¹ We understand that client verification of solicitors’ trust accounts remains uncommon in Victoria, but that some accountants seek verification on occasion and there have been some specific instances in which the Law Institute has authorised one of its Inspectors to seek verification. In New Zealand, a leading firm of accountants was asked in 1977 to report to the Law Society on matters relating to solicitors’ trust accounts.¹² They described as their” single most important recommendation” the introduction of client verification on a sampling basis as part of every accountants examination.¹³ They said that “ the deterrent effect of this [system] should be very great”.¹⁴ They envisaged that verification would be sought by a letter in prescribed form sent by either the solicitor or the accountant, with the client being asked to respond to the accountant. We understand that accountants’ examinations in New Zealand often include client verification at the initiative of the accountants in question but there is no requirement for them to do so.¹⁵

10.13 In our Discussion Paper we suggested that accountants should be able to seek client verification and should be required to indicate in their report whether they have done so.¹⁶ Both the Law Society¹⁷ and the Joint Committee of accountants¹⁸ agreed with this view. As described earlier,¹⁹ the Society has undertaken some experiments with client verification but these have involved specific transactions identified by their Inspectors as needing further investigation, rather than being carried out on a sampling basis as part of accountants examinations. Moreover, the Society has been unwilling to introduce client verification save where the regional law society agrees to it. To date, only two of the regional societies have so agreed.

Recommendations

10.14 In our view, client verification is a very important method of prevention and detection especially in relation to deliberate mishandling of trust money. Indeed, substantially more extensive use of this technique is one of the most sorely needed improvements in the regulation of solicitors’ trust accounts. We have taken note of the degree of concern amongst solicitors that the technique may give rise to unfair suspicions and rumours. We are convinced, however, that this potential problem can be overcome by careful drafting of the prescribed form of communication with clients, extensive publicity to explain the new system and the adoption of client verification in relation to every solicitor. The history of routine inspections by the Law Society’s Inspectors demonstrates how fears of arousing clients’ suspicions can prove to be unjustified if the procedure is applied on a regular basis to all solicitors and thus becomes commonplace and generally accepted. Indeed, if explained appropriately to the public, client verification procedures can improve the general reputation of the profession as being concerned to maintain the highest standards.

10.15 It would not be Justifiable or practicable to require client verification for every transaction shown in a solicitors trust account records, nor to require, for example, that verification must be sought from a prescribed percentage of clients. On the other hand, we believe that some degree of client verification is appropriate for every solicitor holding trust money. The basis for sampling should be left to the discretion of the person responsible for obtaining verification but should be explained in his or her report.

10.16 The question then arises whether verification should be carried out in the course of the Law Society’s routine inspections, or accountants examinations, or both. In our view, both Inspectors and accountants should have the power to seek client verification We have recommended earlier, however, that each practice should be subject each year to both a routine inspection and an accountant s examination. It would not be reasonable to require that both the inspection and the examination must include verification procedures. We favour a requirement that the accountant s examination must include client verification on a sampling basis. Inspectors, on the other hand, would have discretion to undertake their own client verification if they considered it appropriate. It is relevant to note here our earlier recommendation that when inspecting a particular practice, Inspectors should have access to the reports, audit programs and working papers of the accountant responsible for examining the practice.²⁰

10. 17 Accordingly, we recommend that accountants’ examinations should be required to include client verification of a sample of the solicitor’s trust account records. The sampling basis should be determined by the individual accountant and explained in his or her report. If it is considered, contrary to this recommendation that client verification should not be required in every case, we consider nevertheless that accountants should be expressly entitled to seek client verification and should be required to include in their report the nature of any client verification which they have carried out or the reasons why such verification was considered unnecessary.

10. 18 When seeking client verification, accountants should be required to send a letter in prescribed form to the client. The letter should be accompanied by details, in a readily comprehensible form, of the trust account records which it is sought to verify and should ask the client to respond directly to the accountant. The prescribed form of letter should explain that requests for verification are required in relation to every solicitor, that clients to be contacted are chosen on a random basis, and that a request for verification should not be regarded as a ground for suspicion. Clients should be provided with details of all trust account entries relating to them for a recent period, rather than merely the balance currently shown in their accounts.

10.19 In our view, the form of letter currently used by the Law Society is not appropriately drafted to allay alarm or suspicion, and could be expressed in a more readily comprehensible manner. We have no objection to adoption of the Tasmanian procedure by which the letters, although sent by the accountant and to be returned to him or her, are on the solicitors letterhead and are signed by the solicitor.²¹ Where possible, client verification procedures should be coordinated with the sending of statements of account to clients in accordance with recommendations made earlier in this Report.²² Accountants should be entitled to communicate orally with clients if no response is received to the prescribed letter or if the response calls for clarification or investigation.

10.20 In addition, Inspectors should be expressly empowered to seek client verification in the course of routine inspections, if they consider it appropriate to do so, provided that they use a prescribed form of letter similar to that which we have recommended above in relation to accountants.

C. Other Specific Checks

The Present Position

10.21 We have mentioned earlier the specific checks that are currently required to be undertaken in the course of an accountant s examination in New South Wales.²³ They relate principally to identification and investigation of debit balances, and to certain arithmetical checks and reconciliations. Many accountants have prepared their own lists (sometimes called Audit Programs or Plans) of specific steps for themselves and/or their staff to take in the course of the examination. No such list, however, has been issued or endorsed by the Law Society or the associations of accountants.

10.22 The Law Society has drawn up a “check-list of steps which it requires its Inspectors to take when conducting a routine inspection. The list is lengthy, and many items involve very simple checks, especially of an arithmetical nature. There are, however, a number which merit special mention here. They are:

• “Are cheques:
  
  (a) “crossed” and marked “not negotiable - a/c payee only”

  (b) “crossed” and marked “not negotiable”

  (c) signed by the principal or partner”?

• “Do cheque signatories satisfy themselves:
  
  (a) that there are sufficient funds in the trust ledger account

  (b) as to the authenticity of all payments”?

• In relation to the Trust Journal:
  
  “Are there any entries towards the end of the month which have been reversed in the next month. If so - check”.

  “Have there been any entries made from accounts in credit to other accounts for the purpose -of eliminating debit balances”?

• In relation to a sample of Trust Ledger entries:
  
  “Check [those] entries [with] documentation authorities on files in regard to:

  (a) costs

  (b) loans

  (c) investments

  (d) payments to other parties

  (e) whether income from investments has been received;

  (f) security or other documentation”.

“List old balances and record reasons for delay in finalisation”.

Discussion

10.23 The items listed in the previous paragraph relate to particular types of transactions, office procedures or entries in accounts which the Law Society’s experience indicates as being causes or symptoms of mishandling. It may be argued that if such checks are regarded as a necessary part of a routine inspection they should be regarded as a necessary part of an accountants examination or at least should be included in advisory guidelines for such examinations. This is particularly so if, as we have recommended, the examinations should become substantially more rigorous, and if the thoroughness with which Inspectors can make these checks continues to be limited by the fact that, on average, they are expected to complete each inspection in one day.

10.24 We have referred earlier to the relative frequency with which problems have arisen in relation to the handling of money in respect of costs and disbursements, and we have made detailed recommendations about the rules which should be applied in this area.²⁴ There would be obvious advantages in requiring, or at least advising, inspectors and accountants to give special attention to the way in which costs and disbursements have been handled and recorded. The same applies to a number of other recommendations which we have made, such as requirements to prepare monthly reconciliation statements, to issue statements of account, and to record certain transactions in a Direct Payments Register.²⁵

10.25 In most, if not all, other jurisdictions there is a statutory list of specific steps which must be taken in the course of an accountants’ examination Such lists exist in jurisdictions (such as Queensland²⁶ and Victoria²⁷) in which the examination is called an audit, and also in jurisdictions (such as Tasmania²⁸ and England²⁹) in which it is called an examination. A number of the items relate to relatively minor arithmetical and book-keeping checks akin to those currently required in the New South Wales accountants’ examination. Other checks required in some jurisdictions, however, relate to transfers from trust accounts to general accounts in respect of costs and disbursements,³⁰ debit balances³¹ dormant balances (for example, those remaining unchanged for more than 12 months)³² and other matters. Generally speaking, when accountants are required to carry out a particular type of check they also are required to state in their report that they have done so.

10.26 In South Australia the Law Society has published a “suggested audit program which is “a general guide and should be amended where required to suit the practice being audited so that sensitive areas can be given priority”.³³ The program contains suggested checks, and summaries of relevant legal principles, in relation to many different aspects of the examination. Areas given special attention in the program include transactions between solicitors and clients, costs and disbursements, administration of estates and dormant balances.³⁴ In New Zealand, an advisory Audit Program has been prepared by the Society of Accountants and circulated by the Law Society. A report commissioned by the New Zealand Law Society recommended in 1978 that Audit Circulars should be prepared and distributed each year to accountants responsible for auditing solicitors’ trust accounts.³⁵ In Victoria, the Dawson Committee recommended in 1977 that the Law Institute, in conjunction with the accountants associations, should distribute material “setting out what is expected of the auditor and suggesting appropriate techniques”.³⁶ It also proposed that they should prepare

“an audit program [which] should be issued as a guide only. It should be made plain that the work listed is a minimum and that further tests and checks may be necessary in the exercise of the auditor’s discretion.”³⁷

10.27 In our Discussion Paper we suggested that, in addition to the checks currently required, accountants should be required to make, and report that they have made, sample checks of transfers in respect of costs and disbursements, and inquiries about transactions between the solicitor and his or her clients.³⁸ The Law Society responded that it did not oppose these suggestions but “would want to know what additional efficacy would be achieved.”³⁹ We also suggested that the Law Society, in conjunction with the associations of accountants, should “settle an audit program guide and distribute it to both solicitors and accountants”.⁴⁰ Both the Law Society⁴¹ and the Joint Committee⁴² of accountants responded that a uniform program could not be presented because of the variations between solicitors’ practices. It is unclear to what extent they would oppose introduction of a program which is advisory only and includes alternative suggestions to meet different situations. The Joint Committee added that the program for a particular solicitor s practice should not be shown to the solicitor, thus making effective deception by the solicitor more difficult.⁴³ This latter comment may be more relevant to a detailed audit plan prepared by a particular accountant for a particular practice, rather than to an official audit program containing guidelines and suggestions of general application.

Recommendations

10.28 In our view, the current check-list for Law Society Inspectors in New South Wales identifies a number of important problem areas to which any thorough inspection or examination of a solicitors trust accounts should give special attention Another area meriting special attention is the handling of deceased estates, which has caused particular problems both here and in other jurisdictions. In addition we have recommended earlier the introduction of certain requirements relating, for example, to statements of account and Direct Payments Registers, which would be more likely to achieve prompt and widespread observance is at least in the first five years after their introduction they were given particular attention by accountants and Inspectors.

10.29 Accordingly, we recommend that, in addition to certain basic book-keeping and arithmetical checks, accountants’ examinations should be required to include checks of systems, and sample checks, in order to enable the accountant to express an opinion whether

• transactions in respect of
  
  (i) the solicitor’s costs and disbursements;

  (ii) the administration of estates;

• the Direct Payments Register has been maintained correctly;
• the requirements concerning delivery of statements of account have been satisfied;
• reconciliations between the trust ledger and the bank records have been prepared each month;
• conveyancing or borrowing transactions between the solicitor and his or her clients have been made in compliance with the rules and Law Society statements relating to the provision of independent legal advice for clients, and any trust moneys involved have been handled and recorded correctly.

In order to facilitate the last of these checks, solicitors should be required to disclose to their accountant all conveyancing or borrowing transactions between themselves (or an associated party)⁴⁴ and one or more of their clients. Accountants should be required to state in their reports that they have undertaken each of these checks, and to state their opinion on each of the matters listed above. Other matters which, in our view, should have to be stated specifically in the report are discussed elsewhere in this chapter and in other chapters.

10.30 The Law Society, in conjunction with the two principal associations of accountants and the Auditor-General, should prepare an advisory Audit Program (or different Programs for different types of practice) and issue it to all accountants responsible for examining solicitors’ trust accounts. The Program should include, amongst other things, items of the kind that are currently included in the check-list for Inspectors, especially those to which we have referred in paragraph 10.22 above. The Program should be supplemented by regular Audit Circulars. Accountants should be required to state in their reports that they have perused the current Program and Circulars.

10.31 It should be made clear to accountants that the generality of their obligations to conduct an audit and to express opinions of a general nature about compliance with the law are not limited to carrying out such specific checks as are required by statute or mentioned in an Audit Program.

10.32 Consideration should be given to amending the check-fist for Inspectors so as to require Inspectors to conduct some or all of the checks which we have recommended above⁴⁵ should have to be conducted in the course of accountants’ examinations.

III. APPOINTMENT, QUALIFICATIONS AND OTHER ISSUES RELATING TO ACCOUNTANTS

A. Introduction

10.33 In this section we look at a number of issues relating to accountants who are responsible for examining solicitors’ trust accounts. They are:

• appointment and removal;
• qualifications and training;
• carrying out other work for the solicitor;
• delivery of reports.

B. Appointment and Removal

The Present Position

10.34 At present, the accountant by whom a solicitor s trust accounts are to be examined is chosen by the solicitor in question.⁴⁶ There is no requirement that the appointment be made prior to or during the year to which the examination relates, nor that it be notified to the Law Society or anyone else prior to submission of the chosen accountant’s report on his or her examination.

10.35 Solicitors are free to change accountants at will and, indeed, if their chosen accountant gives them an unfavourable report they need not forward it to the Society. Instead, they can seek a more favourable report from another accountant and send it to the Society without making any mention of the previous report The Law Society has no power to reject the solicitors choice of accountant, provided that he or she is a registered public accountant. It may, however, seek a report from a second accountant chosen either by the solicitor or, if it wishes, by the Society.⁴⁷

Discussion

10.36 Independence: It is clearly of fundamental importance that accountants’ examinations should be conducted by an accountant who is independent of the solicitor whose accounts are being examined. An accountant’s independence is seriously compromised if he or she is not only appointed, but can be removed at will, by the solicitor being examined. There is reason to suspect that lack of independence on the part of some accountants has contributed to the failure of accountants examinations to play a significant role in reporting fraud or serious irregularities to the Law Society in New South Wales. Dishonest or incompetent solicitors may have little difficulty in finding an accountant with characteristics similar to their own, and in dispensing with the services of one whose diligence and responsibility threatens exposure.

10.37 These considerations suggest two principal options in relation to appointment and removal. The first is for both appointment and removal to be the responsibility of some authority independent of the solicitor being examined. The second is for the accountant to be appointed by the solicitor but to be appointed permanently and be removable only by, or with the approval of, an independent authority.

10.38 Other Considerations: Certain other considerations suggest that accountants should be appointed permanently, or at least at the beginning of the year to be covered by their examination and report. First, an accountant who has become familiar with a particular practice over a number of years maybe able to conduct examinations more efficiently, identify irregularities more readily, and pursue investigations more thoroughly. On the other hand, of course, familiarity may breed complacency, lack of independence, or a reluctance to expose mistakes which should, perhaps, have been detected earlier.

10.39 A second consideration is that, for reasons explained earlier, we have recommended that examinations should be required to include an unannounced visit during the year, an expression of general opinions about compliance with the relevant law during the year in question and about the adequacy of the solicitor s accounting systems, and specific checks of matters such as the preparation of reconciliation statements each month and the sending of statements of account.⁴⁸ The effectiveness of each of these recommendations depends solely or largely on the accountant being appointed at or before the beginning of the year in question.

10.40 Procedures Elsewhere: In each Australian jurisdiction the accountant is selected by the solicitor being examined, although in some the appointment needs approval by an independent authority (for example, the Law Society in Tasmania⁴⁹ and the Registrar of the Supreme Court in South Australia⁵⁰). In some jurisdictions (including Queensland⁵¹ and South Australia⁵²) the appointment must be made, and notified to a specified authority (for example, the Law Society), within a fixed period after the solicitor enters into practice or begins holding trust moneys, and the appointment remains effective until resignation or removal.

10.41 In a number of jurisdictions, a solicitor cannot terminate an accountants appointment without approval by a specified independent authority, such as the Law Society.⁵³ In some jurisdictions, such as South Australia,⁵⁴ approval is even necessary before resignations can take effect. The grounds on which approval may be withheld are usually rather vague. For example, in South Australia the approval of the Registrar of the Supreme Court must be obtained, and the Registrar “shall not withhold his approval if it is reasonable in the circumstances.⁵⁵ In Victoria, the law Institutes approval is required, and it must be granted if the solicitor satisfies the Institute “that it is reasonable in the circumstances to do so”.⁵⁶ Some law societies have power to order the removal of a particular accountant, or to refuse to approve his or her appointment. The permissible grounds for such action may be “If the [Law Institute] is of the opinion that the auditor for any reason may not properly perform his duties” (as in Victoria),⁵⁷ or negligence or proved professional misconduct (as in England),⁵⁸ or include any “sufficient reason” (as in South Australia).⁵⁹

10.42 Our Discussion Paper: In our Discussion Paper we suggested that the appointment of an accountant should have to be made and notified within a prescribed time after the solicitor in question first receives trust money.⁶⁰ We also suggested that if the solicitor intends to terminate the appointment he or she should have to provide the Law Society with reasons therefor, and that if the accountant wishes to resign he or she should have to do the same.⁶¹ The Law Society has made no comment on these suggestions, but the joint Committee has expressed broad agreement with them, at least in relation to appointment and removal.⁶²

Recommendations

10.43 In our view, the lack of procedures designed to enhance accountants’ independence is a major weakness of the present system of accountants examinations in New South Wales. Moreover, in order to provide continuing, well-informed scrutiny, accountants should be appointed permanently rather than at the beginning or end of the year under examination.

10.44 Accordingly, we recommend that

• appointment of the accountant by whom a solicitor’s trust accounts are to be examined should be made by the solicitor, and notified to the Law Society, within one month of the solicitor first holding any trust money;
• appointments should be subject to the Law Society’s approval, and the Law Society should be entitled to withhold or withdraw approval if it believes on reasonable grounds that the accountant in question may not properly perform his or her duties or has not properly performed them in the past;
• the Law Society should not withhold or withdraw approval without giving the accountant and the solicitor an opportunity to show cause why approval should be granted, and there should be a right of appeal to the Supreme Court against a withholding or withdrawal;
• solicitors should not be permitted to terminate an accountant’s appointment without the approval of the Law Society, which approval should not be unreasonably withheld,
• accountants should not be permitted to resign an appointment without the approval of the Law Society, which approval should not be unreasonably withheld;
• persons seeking approval for termination or resignation should be required to provide reasons therefor to the Law Society.

C. Qualifications and Training

The Present Position

10.45 At present, the required examinations of solicitors’ trust accounts must be conducted by accountants who are registered as public accountants under the Public Accountants Registration Act, 1945.⁶³ In order to become so registered, an accountant must have specified professional qualifications and auditing experience (not necessarily, of course, in relation to solicitors’ trust accounts).⁶⁴ There are approximately 6,500 registered public accountants in New South Wales. The principal associations of accountants have organised occasional seminars on examination of solicitors’ trust accounts, but the seminars are not conducted on a regular basis nor are they compulsory for accountants who are responsible for examining such accounts.

Discussion

10.46 It is sometimes suggested that registration as a public accountant should not be sufficient.⁶⁵ For example, accountants could be required to undergo special training in examination of solicitors’ trust accounts before becoming qualified to conduct such examinations, and/or to attend special lectures or courses on an ongoing basis if they have been appointed to examine any solicitor s accounts.

10.47 The principal argument in favour of requiring some form of special training is that while most accountants are familiar with the task of auditing ordinary commercial accounts, relatively few have substantial experience of examining solicitors’ trust accounts.⁶⁶ An accountant who is not broadly familiar with the types of transactions with which solicitors are commonly involved, and with some of the basic terminology and conventions of the legal profession, may have considerable difficulty in planning and conducting an effective examination It is less likely that common problem areas, and entries in the accounts which merit special investigation, will be, identified. There is also less likelihood that false or misleading explanations by solicitors will be recognised as such.

10.48 On the other hand, the examination of solicitors trust accounts is not a particularly large or lucrative field of work for the accounting profession. Most registered public accountants might be unwilling to undergo onerous additional training in order to become qualified to undertake this type of work. Moreover, the combination of special training requirements and a reduction in the number of accountants working in the field might cause a substantial increase in the level of fees being charged.

10.49 We know of no other jurisdiction in which special training is mandatory for accountants who examine solicitors trust accounts. However, a report by the Professional Standards Review Committee of the Institute of Chartered Accountants recommended in 1978 “the introduction for those engaged therein of compulsory lectures on specialist audits such as those of stockbrokers’ and solicitors accounts”.⁶⁷ In 1977 the Dawson Committee in Victoria recommended that, in addition to providing accountants with an advisory Audit Program for solicitors’ trust accounts, the accountants’ associations “should periodically offer short courses of instruction in the examination of solicitors’ trust accounts”.⁶⁸

10.50 In New Zealand, a firm of accountants commissioned by the Law Society to review the existing systems for examination of solicitors’ trust accounts in that country reported that

“the audit of a solicitor's trust account is an onerous and difficult task, particularly with the smaller legal firms. Accordingly it is usually necessary for the auditor to understand the procedures and legal requirements involved in running a practice.”⁶⁹

The report recommended that consideration be given to the introduction of a special practising certificate for accountants examining solicitors’ trust accounts, but added that

“when first introduced, the standard of competence required to obtain the certificate could not be raised significantly without affecting the adequate supply of people willing and able to undertake these audits.”⁷⁰

10.51 In our Discussion Paper we suggested that, as at present, all registered public accountants should be qualified to conduct accountants’ examinations.⁷¹ The Law Society appears to agree with this suggestion.⁷² The Joint Committee of accountants⁷³ agreed, although it expressed concern that if the responsibilities involved in examining solicitors’ trust accounts became too onerous, especially in relation to the expression of opinions involving questions of law, it might be necessary for examinations to be conducted by persons “who have the skills of a solicitor as well as an accountant”.⁷⁴

Recommendation

10.52 We accept that the examination of solicitors trust accounts is a difficult task and requires some areas of knowledge which accountants are unlikely to acquire in carrying out other work such as company audits. On the other hand, many accountants have to become familiar with specialist types of work and specialist jargon, even within, for example, the general field of company audits. Moreover, if onerous special training became a pre-requisite for appointment to examine solicitors trust accounts, there might be serious adverse effects on the availability and cost of those who are qualified for such appointment, especially in country areas.

10.53 We have recommended earlier that certain specific checks in the course of examining solicitors’ trust accounts should be required by statute, and that others should be included in advisory Audit Programs and Circulars sent to all accountants carrying out such examinations.⁷⁵ We have also recommended that the Law Society’s Inspectors should be entitled to examine audit programs and working papers used by particular accountants for their examination.⁷⁶ In our view, these measures, together with a modest requirement for attendance at special seminars on solicitors trust accounts, would meet much of the need for special training and guidance. Unless these measures prove to be insufficient, we do not believe that it would be desirable to introduce any form of special certificate as a pre-requisite for appointment to examine solicitors trust accounts.

10.54 Accordingly, we recommend that

• accountants’ examinations should have to be conducted by accountants registered under the Public Accountants Registration Act, 1945;
• the Law Society, in conjunction with the principal associations of accountants, should organise at least once each year a seminar relating to examination of solicitors’ trust accounts;
• accountants who are responsible for examining such accounts should be required to attend at least one of these seminars every two years.

D. Other Work for the Solicitor

The Present Situation

10.55 Accountants who have been appointed to examine a solicitor’s trust accounts may also carry out other work for the solicitor. Indeed, they may be an employee of the solicitor. Whether as an employee or otherwise, they may be wholly or partially responsible for preparing the accounts which they are then required to examine and report upon.

Discussion

10.56 An accountants examination obviously cannot be relied upon as a form of independent scrutiny of the accountants examining accounts which he or she prepared. Problems of independence can also arise if the accountant, although not responsible for preparing the accounts, is closely involved in the solicitor’s affairs as a result, for example, of preparing his or her tax returns.

10.57 The Dawson Committee in Victoria recommended in 1977 that the examining accountant should not be permitted to carry out any other work for the solicitor except auditing of other accounts (such as the general account) and “such advisory or consulting duties as are consequential upon” these tasks, unless the Law Institute approves otherwise.⁷⁷ This proposed limitation subsequently became law in Victoria.⁷⁸

10.58 In our Discussion Paper we suggested a restriction similar to the Victorian one to which we have referred.⁷⁹ The Law Society has disagreed with this suggestion,⁸⁰ but it has been endorsed by the joint Committee of accountants who said that the examining accountant should not be a client of the solicitor or act in any other capacity as an accountant for example in the preparation of the solicitor s tax returns”.⁸¹ The Auditor-General has commented as follows

“The proposal that the auditor should not have other connections with the solicitor is... strongly supported. The independence of the auditor is vital to the successful discharge of the proposed duties. It is reasonable for the Law Society to see that there maybe economic advantage in having the audit work performed by an accountant who has been involved in the preparation of the accounts. That involvement itself is the key to the danger. One who has helped construct an accounting base or the information brought from it inevitably loses the independence critically to review and comment on it.”⁸²

Recommendation

10.59 We recommend that, save with the approval of the Law Society, accountants who have been appointed to examine a solicitor’s trust accounts should not be permitted to carry out any other work for that solicitor except

• the auditing of other accounts maintained by the solicitor in the course of his or her practice;
• advisory or consulting duties consequential on his or her function as the examining accountant or as auditor of other accounts of the practice.

They also should be prohibited from acting as the examining accountant for any solicitor of whom they have been an employee at any time within the two years prior to the period covered by the examination. Examining accountants should be required to state in their reports that they have not contravened these prohibitions.

10.60 This recommendation would not prevent accountants from conducting examinations even though, at the request of and in close collaboration with the solicitor being examined, they carry out a considerable amount of work for clients of the solicitor. Although such a link may seriously compromise the independence of the accountant, we do not consider that it would be reasonable or practicable to make it the subject of a general prohibition. On the other hand, a very close link of this kind might constitute, in combination perhaps with other factors, grounds for the Society to exercise the power to withhold or withdraw approval which we have recommended earlier.⁸³

E. Delivery of Reports

The Present Position

10.61 Under the present system in New South Wales, the prescribed form of report by an examining accountant is headed “To: The Law Society of New South Wales” but, in practice, the report goes to the solicitor who, if he or she wishes, then submits it to the Law Society.⁸⁴ If the solicitor does not submit it, he or she will have to obtain and submit another report in the prescribed form (whether or not from the same accountant) in order to obtain a renewal of her annual practising certificate.⁸⁵

Discussion

10.62 The present system enables solicitors not only to suppress an unfavourable report entirely but also, if they decide to pass on such a report to the Society, to conceal irregularities by altering, destroying or manufacturing certain trust account records or other evidence. In some jurisdictions, such as Victoria,⁸⁶ the accountant must report to a specified independent authority (usually the Law Society) and provide the solicitor with a copy. Of course, in those Jurisdictions where the solicitor cannot remove the examining accountant without approval, there is not the same risk as in New South Wales that an unfavourable report may be suppressed entirely and a replacement then obtained from another accountant

10.63 In our Discussion Paper we suggested that the accountant should have to report to the Law Society and send a copy to the solicitor.⁸⁷ The Law Society agreed that the report should be made to it but added that

“there is an argument against a copy being given to the solicitor, namely that if irregularities are disclosed the solicitor will be given an opportunity of tampering with those records which might be required as evidence for the purpose of disciplinary proceedings.”⁸⁸

The Joint Committee of accountants supported our suggestion and, in response to the concern expressed by the Law Society, pointed out that the accountants working papers and report would contain evidence of the state of the records, particularly if they were the subject of a qualification in the report”.⁸⁹

Recommendation

10.64 We believe that the present arrangements for delivery of reports are thoroughly inadequate and that in order to ensure that reports are neither suppressed nor tampered with they should be sent directly to the Society rather than via the solicitor. This procedure would also help to impress upon accountants their public responsibility to provide independent scrutiny in accordance with statutory requirements rather than to provide a personal service for the solicitor.

10.65 In our view, there is merit in the Law Society’s concern about immediate delivery to the solicitor of a copy of the report. Whilst we accept that some evidence may nevertheless be available from other sources, the solicitor may be able to alter or manufacture sufficient evidence to cast doubt upon or provide a credible explanation for, any irregularities reported by the accountant.

10.66 We recommend that accountants should be required to submit their report directly to the Law Society, and that the Society should then be responsible for forwarding a copy of the report to the solicitor unless it considers that the report should be withheld in the interests of preventing, detecting or preserving evidence of irregularities. The accountant should not be entitled to disclose his or her report to the solicitor without the approval of the Law Society.

IV. DUTIES TO DISCLOSE REASONABLE SUSPICIONS

The Present Position

10.67 Solicitors are required by statute to report to the Prothonotary of the Supreme Court and “facts or circumstances which give rise in [their] mind to a reasonable suspicion that the trust funds of some other solicitor (not being [their] client) are not in order”.⁹⁰ The report must be made in the form of an affidavits upon receiving such an affidavit⁹¹ the Prothonotary may bring it forthwith before the Supreme Court for consideration of disciplinary action, or may refer it to the Law Society “for such inquiry and action if any, as it thinks fit.”⁹²

10.68 We have been informed by the Prothonotary that in a typical year he receives one or two such affidavits. Usually, we understand, the affidavits are reliable and lead to the imposition of disciplinary or other sanctions. None of the 79 defalcations discovered by the Law Society during the last four years came to its notice as a result of solicitors’ affidavits to the Prothonotary, although one was brought to the attention of the Prothonotary, and thence the Law Society, by a solicitor who did not submit an affidavit.⁹³ A further four were disclosed by solicitors, other than the defaulting solicitor, directly to the Law Society rather than via the Prothonotary.⁹⁴

10.69 There is no comparable duty on bankers, accountants or other persons who may have access to solicitors’ trust account records, except in so far as arises from the form of report specified by accountants’ examinations.

Discussion

10.70 When a serious defalcation occurs, it is by no means uncommon to hear a number of solicitors say that they had known or suspected for some time that the particular solicitor was dishonest or incompetent. No doubt some of these comments arise from the wisdom of hindsight but there are, nevertheless, strong grounds for believing that many solicitors fail to comply with the duty of disclosure which we have described above. It is perhaps inevitable that some solicitors will be unduly reluctant to disclose reasonably-held suspicions, but the formalities involved in the currently prescribed procedure may aggravate this reluctance.

10.71 Accountants who are responsible for examining solicitors’ trust accounts are, of course, in a good position to detect irregularities. At present, their duties of disclosure are very limited and apply only to disclosure in an annual report (which the solicitor may be able to suppress) rather than in an immediate report made directly to the Law Society. Banks are also in a good position to detect irregularities and to do so more promptly than accountants, whose contact with the solicitors’ practice is far from continuous. Considerable criticism has been directed recently at banks which allegedly failed to take appropriate action in response to extraordinary transactions involving a Queensland solicitor s trust account.⁹⁵ It was eventually discovered that the solicitor had been responsible for defalcations exceeding $2 million. We understand that in New South Wales no defalcations have been discovered in recent years as a result of information initially reported by an accountant or bank.

10.72 In Queensland, solicitors are under a duty of disclosure similar to the current duty in New South Wales, save that the report is to be made to the Law Society and need not be in the form of an affidavit.⁹⁶ In Ontario, the Law Society has ruled that, generally speaking, solicitors are under a duty to bring to the attention of the Law Society “any instance involving or appearing to involve professional misconduct or conduct unbecoming ... or reflecting on the honour of the [profession]” where there is a “shortage of trust funds”.⁹⁷

10.73 In several jurisdictions, accountants responsible for examining solicitors’ trust accounts are under certain duties to make prompt disclosure to the Law Society without waiting to do so in their annual report. For example, in the Australian Capital Territory they must, as soon as practicable, report in writing” to the solicitor and “immediately afterwards” to the Law Society, if they have

reason to believe -

(a) that there is any loss or deficiency of trust moneys;

(b) that there has been any failure to pay or account for trust moneys; or

(c) that there has been a failure to comply with any provision of [the Legal Practitioners Act relating to trust moneys].”⁹⁸

10.74 In Queensland, branch managers of banks holding trust accounts “designated or evidenced as such” are under a statutory duty to inform the Department of Justice and the Law Society

“forthwith whenever the trust account is overdrawn or whenever a cheque drawn on the trust account is dishonoured by reason of insufficiency of funds in the trust account.”⁹⁹

In South Australia, banks are required to report to the Attorney- General and the Law Society any deficiency in a solicitor s trust accounts.¹⁰⁰ In Western Australia, however, banks are “ not obliged to inquire into the application of moneys deposited to” solicitors’ trust accounts and are in no way liable in respect of any misapplication of those moneys”.¹⁰¹

10.75 In our Discussion Paper we suggested that the statutory duty which currently applies to solicitors should be amended so that the report must be in writing but not necessarily in the form of an affidavit, and must be made to the Law Society.¹⁰² We suggested that the duty, as amended, should apply also to examining accountants and to bankers.¹⁰³ The Law Society has indicated that it agrees with these suggestions.¹⁰⁴

Recommendations

10.76 In our view, a duty on solicitors, bankers and accountants to make prompt disclosure of reasonable suspicions that a solicitors trust account is not in order could play a significant role in preventing and detecting defalcations and other serious mishandling of trust moneys. The need for such a duty is emphasised by the unacceptably and uniquely high incidence of defalcations in this State. On the other hand, it is important that the duty should not be so extensive as to be unduly onerous, nor so vague as to be of little utility.

10.77 We recommend that solicitors and accountants conducting examinations of solicitors’ trust accounts, should be under a general statutory duty to report promptly to the Law Society any facts or circumstances which have given rise in their minds to reasonable suspicions that

• a solicitor has faded properly to pay or account for trust moneys, or is highly likely to do so in the immediate future;
• a solicitor has committed a material breach of the statutory provisions relating to the handling and recording of trust moneys;
• a solicitor’s trust account is overdrawn or has debit trust ledger balances for which no satisfactory explanation has been provided; or
• cheques drawn on a solicitor’s trust account have been dishonoured due to an insufficiency of funds in the account.

We recognise that this duty is in some respects vague and general, though not as much so as the current duty on solicitors. Nevertheless, we believe that it is sufficiently defined to have practical effect and not to be unduly onerous on those who are subject to it.

10.78 We also recommend that banks should be under a general statutory duty to report promptly to the Law Society

• whenever a solicitor’s trust account is overdrawn; or
• whenever a cheque drawn on such an account is dishonoured.

In order to assist bankers to comply with this duty, we recommend that all trust bank accounts held by a solicitor should have to include the words “ Solicitors Trust Account” in their title.

10.79 In order to encourage compliance with the duties described in the above two paragraphs and also to provide due protection for the solicitor being reported upon we recommend that any report made by solicitors, accountants or bankers should remain confidential to the Law Society save to the extent that it is necessary to disclose it in the course of disciplinary or court proceedings or in order to comply with duties of disclosure to the police. This would not, of course, prevent the Society from instituting its own inspections or investigations into the matters raised in the report, but the Society should not be entitled to make any other decision adverse to the solicitor (such as cancellation of a practising certificate) on the bas’s of the report rather than on evidence gathered by other means and disclosed to the solicitor.

FOOTNOTES

1. See N. Mainwaring, “Client Verification”, Law Society Journal (N.S.W.), (July 1984), vol.22, p.355.

2. For the form of letter, see Ibid.

3. Accounting Research Centre Report, p.13.

4. See, e.g., Barr, Burgess and Stewart, “Review of Trust Account Audits” (1978), paras.4.05-4.07 (a report for the New Zealand Law Society)

5. See note 10.6.1 above.

6. See their report in our Background Paper - V, pp.81-82.

7. See, e.g., Law Society Journal (N.S.W.), (Sept 1984) vol.22, pp.501-503. See also the reply by the Society’s Chief Executive Officer, at p.619.

8. Rules of Practice 1977, r.31.

9. Id., r.31(2).

10. Dawson Committee Report, p.11.

11. Ibid.

12. See Barr, Burgess and Stewart, “Review of Trust Account Audits” (1978).

13. Id., para.4.87.

14. Id., para.4.14.

15. See, in relation to client verification and solicitors’ nominee companies, New Zealand Law Society, “Solicitors Nominee Companies and Contributory Mortgages’, p.7.

16. Discussion Paper, para-6.89.

17. Law Society’s Response, para.5.20.

18. Joint Committee Reply, para.5.

19. See paras 10.4-10.5 above.

20. See para.8.24 above.

21. See para.10.11 above.

22. See paras.6.31-6.32 above.

23. See para.7.18 above.

24. See chapter 5 above.

25. See paras.4.36, 6.31-6.32 and 6.34 above.

26. See esp. Trust Accounts Regulations 1973, reg.11.

27. See esp. Solicitors (Audit and Practising Certificates) Rules 1965, r.16, Form 2.

28. Rules of Practice 1977, esp. r.30.

29. Accountants Report Rules, 1975, esp. r.4.

30. See, e.g., Rules of Practice 1977 (Tas.), r.30(3)(d); Accountants Report Rules, 1975 (Eng.), r.41(l)(d).

31. See, eg.Trust Accounts Regulations 1973 (Qld.), reg. 11(9); Solicitors (Audit and Practising Certificates) Rules 1965 (Vic.), Form 2, cl.6.

32. See eg. Trust Accounts Regulations 1973 (Qld.), reg. 11(15); Solicitors (Audit and Practising Certificates) Rules 1965 (Vic.), reg.32B,

33. Law Society of South Australia, Legal Practitioners Trust Accounts Manual, p.41.

34. Id., pp.44, 46, 47, 51, 58-61.

35. Barr, Burgess and Stewart, “Review of Trust Account Audits” (1978), para.4.48.

36. Dawson Committee Report, p.9.

37. Id., p.10.

38. Discussion Paper, para.6.76.

39. Law Society’s Response, para.5.12.

40. Discussion Paper, para.6.78.

41. Law Society’s Response, para.5.14.

42. Joint Committee Reply, para.16.

43. Ibid.

44. For a suitable definition of this phrase, see Law Society of N.S.W., “Special Bulletin to All Members: Borrowing Transactions” (No.2 of 1979), p.4.

45. See para.10.29 above.

46. See Solicitors Trust Account Regulations, reg.8.

47. Id., reg.8(5).

48. See paras.6.31-6.32, 6.34 and 9.74-9.76 above.

49. Rules of Practice 1977, r.29.

50. Legal Practitioners Regulations 1982, reg.35.

51. Trust Accounts Act 1973, s.14.

52. Legal Practitioners Regulations 1982, regs.35, 40.

53. See, eg. Legal Practitioners Regulations 1982 (S.A.), reg.41, Solicitors (Audit and Practising Certificates) Rules 1965 (Vic.), r.11.

54. Legal Practitioners Regulations 1982, reg.41.

55. Ibid.

56. Solicitors (Audit and Practising Certificates) Rules 1965, r.11.

57. Id., r.5(2).

58. Accountant’s Report Rules, 1975, r.3(2).

59. Legal Practitioners Regulations 1982, reg.35(2)(c).

60. Discussion Paper, para.6.66.

61. Ibid.

62. Joint Committee Reply, para.12.

63. Solicitors Trust Account Regulations, reg.8.

64. See Public Accountants Registration Act, 1945, s.18; and Public Accountants Registration Board, “Registration as a Registered Public Accountant: Guidelines on Accounting and Auditing Experience”.

65. See, eg. para.10.49 below.

66. For discussion of the special difficulties which may be involved in examining solicitors trust accounts, see, e.g., the Dawson Committee Report, pp.5, 9; Joint Committee Reply, paras.11, 12.

67. “Report of the Professional Standards Review Committee” (1978), Summary, p.16.

68. Dawson Committee Report, p.9.

69. Barr, Burgess and Stewart, “Review of Trust Account Audits” (1978), para.4.45.

70. Id., para.4.46.

71. Discussion Paper, para.6.67.

72. Its submissions to the Commission are not entirely clear or consistent on this point: see “Statutory Interest Account and Solicitors’ Trust Accounts’ (1979), pp.14-15, and Law Society’s Response, paras.5.9 and 5.10.

73. Joint Committee Reply, paras.11, 12.

74. Id., para. 11.

75. See paras.10.29-10.32 above.

76. See para.8.24 above.

77. Dawson Committee Report, pp.6-7.

78. Solicitors (Audit and Practising Certificates) Rules 1965, r.5(3).

79. Discussion Paper, para.6.70.

80. Law Society’s Response, para.5.11.

81. Joint Committee Reply, para.13.

82. Letter to the Commission dated 16th November 1983.

83. See para.10.44 above.

84. Solicitors Trust Account Regulations, reg.8 and Form 2.

85. Id., reg.8.

86. Solicitors (Audit and Practising Certificates) Rules 1965, reg.17.

87. Discussion Paper, para.6.77.

88. Law Society’s Response, para.5.12.

89. Joint Committee Reply, para. 15.

90. Solicitors’ Practices Rules, r.14.

91. Ibid.

92. Ibid.

93. Information supplied by the Law Society at the request of the Commission.

94. Para.7.8 above.

95. See eg. The Weekend Australian, 10th-11th November 1984, p,16,

96. Queensland Law Society Rules, rule 77.

97. Law Society of Upper Canada, Professional Conduct Handbook, ruling 33.

98. Legal Practitioners Ordinance 1970, s.62. See also, for example, Solicitors (Audit and Practising Certificates) Rules 1965 (Vic.), r.16(2A), Trust Accounts Act 1973 (Qld.), s.17 which includes a duty to report any matters which “may adversely affect the financial position of the I solicitor] to a material extent .

99. Trust Accounts Act 1973, s.27.

100. Legal Practitioners Act, 1981, s.36.

101. Legal Practitioners Act, 1893, s.35(1).

102. Discussion Paper, para.6.41.

103. Ibid.

104. Law Society’s Response, para.4.4.