I. INTRODUCTION
3.1 The purpose of this chapter is to provide a relatively brief review of the principal suggestions for reform which we made in our Discussion Paper in 1981, and of the responses which those suggestions have evoked from the Law Society as the body principally able for the current system. In doing so, we also summarise the main features of that response system. Further details of the current system, our suggestions for change, and subsequent responses are given in later chapters.
3.2 The chapter is divided into the following sections:
- Handling Trust Money;
- Recording and Accounting for Trust Money;
- Independent Scrutiny of Trust Accounts; and
- Investment of Clients’ Money.
We adopt the same division later in this Report when looking at the issues in greater detail and making our final recommendations.
II. HANDLING TRUST MONEY
3.3 Solicitors are required by law to pay certain money into a trust account in a bank. The principal statutory provision is as follows:
“All moneys received in New South Wales for or on behalf of any person by any solicitor shall be held by him exclusively for such person, to be paid to such person, or to be disbursed as he directs, and until so paid or disbursed the moneys shall be paid into a bank in New South Wales to a trust account, whether general or separate.” (s.41(1), Legal Practitioners Act, 1898).
3.4 This provision gives rise to a number of questions about the receipt and payment of money by a solicitor. We considered these questions in our Discussion Paper and made a number of tentative suggestions for change or clarification of the existing law. A goal underlying many of these suggestions was the introduction of greater clarity and formality into the handling of trust money, especially in situations where difficulties may arise in distinguishing between money which rightly belongs to the solicitor and money which has been entrusted to him or her by a client. They also concentrate on aspects which our investigations, and especially information provided by the Law Society and Yarwood Vane & Co.,1 indicate as common sources of difficulty.
A. Paying Money into Trust Accounts
3.5 Our principal suggestions concerning receipt of money were as follows. First, we suggested that the requirement to pay into a trust account should be explicitly confined, as it has been by accepted practice, to money received while acting either as a solicitor or in connection with practice as a solicitor. We proposed a specific statutory definition for this purpose.2
3.6 Secondly, we suggested that where a solicitor receives money for costs (ie. professional fees) and disbursements (ie. out-of-pocket expenses) to which he or she has not yet become entitled, the money should have to be paid into a trust account.3 In connection with this suggestion we proposed that in the absence of specific agreement to the contrary between solicitor and client, a solicitor should not become entitled to costs until he or she has rendered a bill (not necessarily in detailed form) but should be entitled to disbursements as soon as they are made, provided that they were made on the client’s instructions.4
3.7 Thirdly, we suggested that solicitors should be entitled in specified circumstances not to pay money into a trust account, even though they have received it on trust rather than as their own.5 This would apply, for example, where the money’s received in cash on trust for a client and is passed on as cash to the client without delay. We referred, however, to the possibility of requiring solicitors to keep a written record (perhaps known as a Direct Payments Register) of all their dealings with money that is entrusted to them but not paid into their trust account.
3.8 Fourthly, we suggested that, in order to avoid possible confusion, solicitors should not be permitted to pay into a trust account any moneys belonging to them personally, such as money paid for costs and disbursements to which they have already become entitled.6 We proposed an exception in relation to a cheque which is partly money belonging to the solicitor and partly money entrusted to him or her for the client s purposes.
3.9 The Law Society responded to our Discussion Paper in December 1981.7 It did not disagree fundamentally with the first three suggestions referred to above, although it proposed certain amendments.8 The Society did, however, disagree with the fourth suggestion. It considered that solicitors should be entitled to keep some of their own money in their trust account.9 As we explain later in this Report the present law on this question has been clarified somewhat by the Court of Appeal in a decision handed down after our Discussion Paper, and the Law Society’s response thereto, had been published.10
B. Withdrawing from Trust Accounts
3.10 We canvassed in the Discussion Paper the possibility of requiring that withdrawals from a trust account be made only upon written direction of the person on whose behalf they were received.11 We did not, however, suggest adoption of a general requirement of this kind.The Law Society agreed with this view.12
3.11 We also considered questions concerning solicitors paying money from their trust account to their general account for costs or disbursements. We suggested that such payments should be permissible only where either
(a) they are authorised in writing by the client; or
(b) (i) in the case of costs, a bill has been rendered and the client has had one month in which to object to it; or
(ii) in the case of disbursements, they were made on the client s instruction.13
The Law Society considered that these restrictions were excessive (principally, it would seem, in relation to the “one month” requirement) but on the other hand could be evaded readily by requiring clients to sign standard written authorisations at the outset.14
III. RECORDING AND ACCOUNTING FOR TRUST MONEYS
A. Computerised Accounting
3.12 Solicitors are subject to detailed rules concerning the manner in which trust account records are to be kept. Most of these rules are contained in the Solicitors Trust Account Regulations,15 which were developed for manual systems of accounting. Although capable of application to some mechanical systems, they are unsuited to systems using electronic data processing, which are becoming increasingly common in solicitors’ firms and elsewhere in the community.
3.13 In our Discussion Paper we indicated our agreement with the Law Society’s view that the existing Trust Account Regulations need extensive re-drafting in order to both accommodate and regulate modern electronic accounting methods.16 We considered, however, that the regulations should remain specific in nature rather than as the Law Society proposed, doing little more than require that solicitor s accounting systems must be approved by the Society. Two sets of draft regulations, one embodying our suggested approach and the other drafted by the Law Society, were reproduced in our Discussion Paper.17 The Society adheres to its view as to the appropriate form of regulations for this purpose.18
B. Statements of Account
3.14 Where solicitors receive money on behalf of clients in relation to claims arising from death or personal injury, they are required, broadly speaking, to provide the clients within a specific time with a statement of account indicating in an auditable form the amount received and the manner in which it has been disbursed.19 We suggested in our Discussion Paper that this obligation should be extended to require solicitors to send a statement of account to each client from whom or on whose behalf they have received money on trust, irrespective of whether a claim arising from death or personal injury was involved.20 We also suggested that such a statement should have to be sent at quarterly intervals as well as at the completion of the matter. The Law Society agrees that a statement should have to be sent upon completion but does not believe that quarterly statements should be required.21
IV. INDEPENDENT SCRUTINY OF TRUST ACCOUNTS
A. A Basic Issue
Accountants’ Examinations
3.15 At present solicitors are required to provide the Law Society with an annual report by a public accountant who has examined their trust accounts.22 The report must deal with certain specified matters and, amongst other things, must state whether the accountant considers that the trust account records are “of the nature and in the form” required by the Trust Account Regulations and “appear to have been regularly written up and properly kept.23 Solicitors are required to keep their accounts in such a form as “to enable them to be conveniently and properly audited”,24 but they are not required to have them audited.
3.16 It is generally accepted by both solicitors and accountants that the type of accountant’s examination that is currently required is not very rigorous and certainly does not involve as much scrutiny as would an audit conducted in accordance with the general legal principles and professional accounting standards which apply to audits. The differences between the current type of accountants’ examinations and audits are considered in greater detail in chapters 7-10 below.
Law Society Inspections
3.17 The Law Society maintains a staff of inspectors who undertake random inspections of solicitors trust accounts throughout the State and inspections of trust accounts which the Society believes may not be in order. These inspections are conducted in accordance with internal Law Society procedures and culminate in reports to the Society which usually concentrate upon whether the trust account records comply with the “book-keeping” requirements of the Solicitors Trust Account Regulations.25
Suggestions for Change
3.18 In our Discussion Paper we suggested that the current type of accountant s examination does not provide sufficient scrutiny and that, in the interests of clients, the general public and the profession itself, accountants should be required to audit the trust accounts rather than merely examine them.26 We suggested also that Law Society inspections should be more “intensive” and “concentrate more on substance than form”, and that Law Society inspectors should be given wider powers of investigation.27 We did not consider, however, that it would be practicable or desirable for the independent scrutiny of trust accounts to depend solely on Law Society inspections to the exclusion of accountants’ examinations or audits.
3.19 The Law Society responded that the accountants exammination requirements should be made “more rigorous and demanding” in certain ways which it outlined, and that inspections by the Society’s own inspectors should become more frequent and thorough, but that audits should not be required.28 The Society has subsequently introduced more frequent (and somewhat more thorough) inspections by its own staff. Since 1982 the Society’s inspectorial staff has increased from 7 to 12,29 and in 1983 the Society adopted as a goal, which it has almost achieved, that every solicitor’s practice in the State should be inspected each year.
B. Ancillary Issues
3.20 Having suggested in our Discussion Paper that annual audits should be required, we then considered a number of ancillary issues. We mention some of them here and discuss them in detail in chapters 9 and 10 below.
3.21 First, we suggested that, in addition to the general checks and reports which are inherent in the nature of an audit, the auditor should be subject to certain specific statutory requirements.30 For example, he or she should be required to
- make an unforeshadowed examination of the records on at least one occasion each year;
- report any transaction between the solicitor (or associated company) and a client; and
- report whether he or she has checked the solicitor’s system of transferring money for professional costs from the trust account to the general account
No such requirements currently apply to accountant s examinations. The Law Society said that it did not oppose some of these suggestions, but it expressed no opinion about others.31
3.22 Secondly, we suggested that generally speaking, any registered public accountant should be eligible for appointment by a solicitor to act as his or her auditor, but that notices of appointment and termination of appointment should have to be given to the Law Society, and the Society should be entitled (subject to appeal to the Supreme Court) to refuse to accept reports from particular nominated auditors whom it considers to be sub-standard.32 At present, accountants who are responsible for the annual examination and report in relation to a particular firm commonly do general accounting work for that firm as well We suggested that, in order to have demonstrable independence in their auditing role, accountants should not be permitted to do any other professional work for solicitors for whom they are conducting the prescribed annual audit.33 The Law Society disagreed with this latter suggestion and also said it did not wish to have power to reject certain nominated auditors.34
3.23 Thirdly, we suggested that solicitors should be required to open and retain files in relation to all work which involves the handling of money entrusted to them.35 This proposal was aimed at enabling auditors to establish necessary background to entries in the trust account records. Accordingly, we suggested also that auditors should have access to these files, where necessary, in order to facilitate their examination of the trust account records concerning the client and matter to which the files relate.36 We suggested also that auditors should have access to solicitors’ general accounts37 in order to check the accuracy of entries in the trust account records and to establish whether all money which should have been paid to the trust account was so paid. The Law Society agreed with the latter suggestion but said that it was not persuaded that the suggested requirements about opening and retaining files were warranted.38
3.24 Fourthly, we suggested that auditors should be empowered to seek verification from a solicitor s clients of the correctness of particular trust account records relating to them, and should be required to report whether such verification has been sought.39 The Law Society agreed with this suggestion40 and subsequently has conducted limited experiments with client verification procedures. These are discussed in chapter 10 below.
V. INVESTMENT OF CLIENTS’ MONEY
A. Introduction
3.25 Solicitors in New South Wales are commonly asked by clients to play some role in investing the latter s money. Often the intended investment is a loan secured by a mortgage.
3.26 In some instances the money is received and invested by the solicitor through the solicitors’ trust accounts. Accordingly, it must be dealt with in accordance with the rules applying to those accounts and is subject to independent scrutiny of the type described earlier in this chapter. In other instances, however, the money is received and invested by a nominee company, or private finance company, which is controlled by the solicitor. Such companies are not subject to the system for regulation of solicitors’ trust accounts nor, at least in relation to nominee companies, to the regimes of control applicable to, for example, banks, building societies or public finance companies.41
3.27 It is not known precisely how much money is invested by one or another of these methods in New South Wales but it undoubtedly runs into tens, or even hundreds, of millions of dollars each year. As we mentioned earlier,42 investment transactions of these kinds, especially those where a nominee company or private finance company is involved, have been a major source of losses to clients in recent years as a result of dishonest or negligent action by solicitors.
3.28 In our Discussion Paper we identified four principal reforms which might be introduced in this area, namely
- tighter controls over the structure and operation of solicitor’s nominee companies;
- tighter controls over the structure and operations of solicitors private finance companies or a prohibition of such companies;
- a compulsory register of all investment transactions involving solicitors, their nominee companies or their private finance companies; and
- a requirement that no withdrawals from solicitors’ trust accounts for the purposes of investment should be made without written directions from the client.
B. Nominee Companies
3.29 The nature and purposes of solicitors’ nominee companies are discussed in chapter 11 below. They are, in essence, intended purely to facilitate lending and borrowing procedures, especially where there are multiple contributors to one loan. They usually have nominal assets only and earn no income.
3.30 We suggested in our Discussion Paper that these companies can fulfil valuable functions but should be subject to the rules applying to solicitor’s trust accounts, including the proposed audit requirement.43 We also suggested certain special rules governing their accounts and their relationship with solicitors trust accounts. We suggested that they should be owned and operated solely by solicitors (or members of their family) and that actions of the company should be regarded as also being actions of the solicitors and thus subject to professional rules and discipline.
3.31 The Law Society indicated broad support for our suggestions concerning nominee companies and subsequently proposed detailed draft regulations on the subject.44
C. Private Finance Companies
3.32 We discuss in chapter 11 the nature, purposes and operations of solicitors’ private finance companies. These companies were common in New South Wales during the 1970s. One of their principal features was that, since solicitors usually sought to make a profit through these companies by lending money at higher interest rates than they paid to the client from whom they borrowed it, there was a considerable likelihood that when advising or acting for their clients in relation to the transaction they might be affected by a conflict between their own interests and those of their clients. This danger was aggravated if, as was not uncommon. the private finance company made substantial loans to people, or business enterprises (such as property development companies), that were closely associated with the solicitor. In 1979, however , the Law Society introduced certain restrictions on the operation of private finance companies, one of the purposes of which was to prevent such conflicts of interest from arising.45
3.33 In our Discussion Paper we canvassed the possibility of prohibiting solicitors from operating private finance companies.46 We suggested, however, that rather than being prohibited they should be subject to the same controls on their structure and operations as we had suggested for solicitors’ nominee companies, and to certain other rules including a requirement that the solicitors personally guarantee repayment of money deposited with their companies. We also raised the possibility of certain other controls such as specified minimum assets/liabilities ratios, and prescribed criteria for securing loans.
3.34 The Law Society said that it did not necessarily disagree with many of our suggestions but that they needed further discussion.47 The Society subsequently made inquiries of each solicitor in the State in order to ascertain the prevalence of private finance companies and apparently concluded from the responses that by 1982 they had become very rare and accordingly there was no pressing need for tighter controls.48
D. Register of Investments
3.35 Investment transactions by solicitors on behalf of clients are not always recorded by them in such a way that they can be conveniently and effectively audited. Neither the solicitor nor, more importantly, the client may have a clear record of what has happened and what their respective rights and duties are.
3.36 In our Discussion Paper we suggested that solicitors should be required to record in a special register prescribed details of all securities and investments relating to mortgage transactions which involve them, their nominee companies or their private finance companies.49 The Law Society subsequently suggested extending the proposed register to cover not only mortgages but also “any other transaction regulating the lending of money, whether on a secured or unsecured basis where the solicitor is the lender or is authorised to receive re-payments.50 The Society envisaged that the requirement should apply also to solicitors’ nominee companies and perhaps to their finance companies.
E. Written Directions
3.37 As mentioned earlier,51 solicitors are not required to have written directions from clients in order to make payments from their trust accounts. One of us suggested in the Discussion Paper that, in light of the serious confusion and losses which have arisen from withdrawals made by some solicitors for the purposes of investment, no withdrawals for those purposes should be permitted without the client s written directions in advance.52 The Law Society subsequently proposed a draft regulation which would require written directions in a wide range of investment transactions.53
FOOTNOTES
1. See chapter 2 above.
2. See Discussion Paper, paras.4.10-4.20.
3. Id., paras.4.26-4.39.
4. Id., paras.4.39, 4.73.
5. Id., paras.4.45-4.48.
6. Id., paras.4.49-4.52.
7. “Solicitors’ Trust Accounts and the Solicitors’ Fidelity Fund” (1981) (hereafter referred to as “Law Society’s Response”).
8. Id., paras.2.1-2.8.
9. Id., para.2.9.
10. See paras.5.7-5.11.
11. Discussion Paper, paras.4.54-4.58.
12. Law Society’s Response, para.2.10.
13. Discussion Paper, paras.4.59-4.73.
14. Law Society’ s Response, para.2.11.
15. Made under the Legal Practitioners Act, 1898.
16. Discussion Paper, paras.5.14-5.27: Law Society of N.S.W., “Statutory Interest Account and Solicitors’ Trust Accounts” (Submission to N.S.W. Law Reform Commission 1979), p.14.
17. See Discussion Paper, Appendices I and 11.
18. The Society’s current draft is reproduced in Appendix III of this Report. In relation to “book-keeping” regulations intended to accommodate computerised accounting, it does not differ significantly from the draft published in our Discussion Paper.
19. Solicitors (General Regulations, reg.28 (made under the Legal Practitioners Act, 1898).
20. Discussion Paper, paras.6.42-6.45.
21. Law Society’s Response, para.4.5.
22. Solicitors Trust Accounts Regulations, reg.8.
23. Id., Schedule, Form No.1 (see Appendix II to this Report).
24. Legal Practitioners Act, 1898, s.42(2).
25. See, in particular, the Law Society’s Check-List for Inspectors.
26. Discussion Paper, paras.6.3-6.23, 6.46-6.63.
27. Id., paras.6.24-6.34.
28 .Law Society’s Response, paras-5.1-5.5.
29. Information supplied by the Law Society at the request of the Commission.
30. Discussion Paper, paras.6.71-6.76.
31. Law Society’s Response, para.5.12.
32. Discussion paper, paras.6.64-6.68.
33. Id., paras.6.69-6.70.
34. Law Society’s Response, paras.5.10-5.11.
35. Discussion paper, paras.6.79-6.84.
36. Id., paras.6.79-6.80.
37. Id., paras.6.85.
38. Law Society’s Response, paras.5.15-5.18
39. Discussion Paper, paras.6.76, 6.87-6.81.
40. Law Society’s Response, para.5.20.
41. See paras. 11.31, 11.38 below.
42. See paras.2.22-2.23 above.
43. For the suggestions in this paragraph, see Discussion paper, paras. 7.11-7.18.
44. Law Society’s Response, paras. 6.2-6.3; and see draft Solicitors Trust Account Regulations, reg. 15, in Appendix III of this Report.
45. See paras. 11.5, 11.6, 11.40 and 11.41 below.
46. For the suggestions in this paragraph, see Discussion Paper, paras.7.19-7.39.
47. Law Society’s Response, paras. 6.4-6.5.
48. See para 11.43 below.
49. Discussion Paper, paras. 7. 40, 7.46.
50. Law Society’s Response, para. 6.6 See also draft Solicitors Trust Account Regulations, reg,15, in Appendix III of this Report.
51. Para. 3.10 above.
52. Discussion Paper, para 4.57.
53. See draft Solicitors’ Trust Account Regulations, reg.14, in Appendix III of this Report.
