I. INTRODUCTION
8.1 The present system of Law Society inspections and investigations has been outlined in the previous chapter. No substantial concern has been expressed to us about the system for conducting investigations, nor have we seen any cause for such concern. Accordingly, we concentrate in this chapter on the conduct of inspections, especially routine inspections. We do so under the following headings:
- merits of the present system;
- other considerations;
- possibilities for reform; and
- recommendations.
Some ancillary issues relating to inspections are considered in chapter 10.
II. MERITS OF THE PRESENT SYSTEM
8.2 The present system of Trust Account Inspectors, employed by the Law Society and engaged largely in conducting a routine inspection of each practice every year, provides substantial benefits for both the public and the profession By specialising solely in the area of solicitors trust accounts, Trust Account Inspectors are likely to become substantially more skilled than most other accountants in advising solicitors about the operation of such accounts and detecting irregularities or undesirable methods. Few accountants in private practice have acquired extensive experience or expertise in the area. Examination of solicitors trust accounts is different in many respects from most other types of work undertaken by accountants, including, for example, company audits.1 In the absence of comparable specialised experience, accountants are more likely to miss irregularities in the accounts, especially if the required examination is brief or the solicitor is adept at concealing the true state of affairs.
8.3 The fact that the inspectors are employed full-time by the Law Society makes it easier to ensure satisfactory levels of ability and performance than is possible in relation to a wide range of accountants in private practice chosen by the solicitors whose accounts they are to examine. The greater ease and speed of communication with a small team of Inspectors helps the Law Society to identify problems being experienced in the field, to initiate special checks of problem areas by, for example, changing its check-list for Inspectors or the frequency with which certain types of practices are inspected, and to develop and implement programs for advising and educating solicitors in trust account techniques. The Society has availed itself of these opportunities to a significant extent, at least in recent years.
8.4 The maintenance of due independence from the solicitor being examined is less likely to be at risk where the examination is conducted by an Inspector chosen and employed by the Law Society, rather than by an accountant who is engaged and paid by the solicitor. For example, in the former situation, there is no danger that, in order to attract and retain business, the examination may be conducted in a cursory fashion so that low fees can be charged, a reputation for being “difficult” can be avoided, and thus accounting business can be attracted and retained.
8.5 Although there is no conclusive evidence on the point, it seems reasonable to conclude that a system of examinations of a given rigour into all solicitors in the State can be conducted more economically by a team of Inspectors than by a wide range of accountants in private practice. The available economies lie largely in the development of specialised skills and in the opportunities for more efficient and rationalised allocation of resources. For example, one Inspector can be allocated to inspect all practices in a particular country town or region during one journey.
8.6 A point of considerable significance is that, as mentioned earlier, more than half of the 79 defalcations discovered in the last four years have been discovered by the Law Society’s own Inspectors.2 By contrast, for example, none have been reported to the Society as a result of accountants examinations.
III. OTHER CONSIDERATIONS
8.7 A number of solicitors to whom we have spoken in recent years have said that from their experience, routine inspections tend to be concerned largely with formalities and arithmetical accuracy rather than constituting a more penetrating examination of the accounts. Certainly, as mentioned earlier, there have been instances of defalcations or substantial irregularities going undetected by one or more routine inspections of the accounts in question and the fact that the great majority of such inspections are completed within a day may raise questions about their rigour. Also, it is common f or an inspection to be conducted by an Inspector who has not previously inspected the practice in question and lacks familiarity with its records and general manner of operation Indeed, the Law Society’s current policy is that firms should not be inspected by the same Inspector in successive years. By contrast, the practice may be examined by the same accountant for many years.
8.8 On the other hand, the check-list for Inspectors has been improved since some of the above-mentioned criticisms were expressed to us and is undergoing further revisions at present There can be little doubt that, given the present nature of that list and the specialised skills and independence of the Inspectors, routine inspections are likely to be more rigorous than many accountants’ examinations, at least in relation to small practices. In large practices, however, the complexity of the Organisation and its accounts, and the greater financial resources, often mean that accountants are engaged to conduct very comprehensive examinations which may be much more thorough than a routine inspection of the same practice by a Law Society Inspector.
8.9 The following table shows the substantial expansion of the Law Society’s inspection activities in recent years, and the levels of defalcation over the same period.3
| | No. of Inspectors employed by the Law Society | Estimated Cost of Inspectors | Compensation paid by Fidelity Fund for loss of trust moneys |
| | | | |
| 1976 | 4 | $25,000 | $1.2m |
| 1978 | 6 | $80,000 | $1.4m |
| 1980 | 8 | $137,000 | $4.4m |
| 1982 | 7 | $289,907 | $1.6m |
| 1984 | 12 | $380,000 | $2.9m |
There is room for considerable debate about the significance of these figures. On the one hand, it may be argued that the absence of a significant decline in the level of defalcation indicates that the expansion of inspection activities has been of little value. On the other hand, it may be argued that the expansion probably prevented an even worse incidence of defalcation. Moreover, the benefits of greater expenditure on Inspectors, and of improved inspection techniques, may take considerable time to flow through and indeed may uncover more defalcations and therefore erroneously appear to be increasing, or at least not decreasing, the incidence of defalcation.
8.10 It is important to bear in mind when considering possible reforms in this area that one option, whether in addition to or instead of changing the inspection system, is to require accountants examinations to be more rigorous than at present. We look at this option in detail in the next chapter and point out that in most other parts of Australia a more penetrating and thorough examination is required and certain rules have been made to enhance accountants independence from the solicitors whose accounts they are examining.
8.11 A further consideration relevant to the quality of routine inspections is the difficulty of attracting good applicants for Inspectors’ positions, and of retaining for substantial periods the services of those who are appointed. This difficulty has been, and is continuing to be, experienced by the Law Society of New South Wales and its counterparts elsewhere. The work of an Inspector is highly specialised in an area in which other prospects are limited, involves a considerable amount of repetition and travel which many people would find unappealing, and is not very highly remunerated.
8.12 We suggested earlier that in one sense it may be more economical to use Inspectors, rather than a wide range of accountants in private practice, to scrutinise trust accounts on a State-wide basis.4 But it should be noted that under present arrangements more than half of the cost of the team of Inspectors is met from interest earned on clients trust money5 and the remainder is met by solicitors compulsory contributions, whereas accountants’ examinations are paid for entirely by solicitors. Of course, solicitors’ expenditure may be passed on by them through the fees which they charge clients.
8.13 Two further points about the present efficacy of inspectors merit consideration. First Inspectors, unlike Investigators but like accountants conducting examinations, lack statutory power to insist on examining records other than trust accounts, such as general accounts and office files.6 Secondly, there is currently no significant degree of contact between the Inspector responsible for inspecting the accounts of a particular practice and the accountant responsible for examining them. The development of such contact would be likely to improve the quality and efficiency of both the inspection and the examination as well as giving Inspectors (and through them the Law Society) valuable opportunities to assess the calibre of accountants examinations.
IV. POSSIBILITIES FOR REFORM
8.14 A number of possible reforms in the present system of Inspectors and routine inspections can be identified by looking at other jurisdictions. One possibility is to abolish the system of accountants examinations and rely principally or solely on inspections by Law Society Inspectors. Eventual adoption of this approach was under consideration several years ago in Queensland.7 Another possibility is to retain the present system of routine inspections and to increase the rigour and frequency of accountants examinations. This could produce a degree of supervision more akin to the present system in Queensland, where each practice must undergo four thorough accountants examinations each year.8
8.15 A third possibility is to have fewer, more rigorous inspections, and to require accountants examinations to be more thorough. This would be somewhat akin to the position in Victoria, where inspections are conducted jointly by two Inspectors and usually take about two days, and each practice is inspected about every three years. A fourth possibility is to make little use of inspections but require accountants’ examinations to be more thorough. This is broadly the approach adopted in England.10 The nature of the accountants’ examinations in these and other jurisdictions is described in greater detail in the next chapter.
8.16 In our Discussion Paper we made no suggestions for change in the frequency or thoroughness of routine inspections (save that sole practitioners should be inspected at least once each year),11 but we did suggest that accountants examinations should have to be sufficient to constitute an audit, and thus be much more rigorous than is currently required. Since we published our Paper the Law Society has increased the thoroughness and frequency of its routine inspections and has developed proposals for an accountants examination which would be more thorough but would not constitute an audit. Our suggestions in the Paper in relation to accountants examinations, and responses which they elicited, are discussed in the next two chapters.
8.17 We suggested in our Discussion Paper that Inspectors should have the same powers as Investigators to examine solicitors accounts and files in addition to their trust account records.12 The Law Society13 has said that it has “no objection to our suggestion, and the Joint Legislation Review Committee of the two principal associations of accountants positively agrees with the suggestion.14
8.18 We also suggested that Inspectors and Investigators should be entitled to examine “the audit programme, working papers and other documents used or prepared” by an accountant examining a solicitor s trust account, and to “confer” with the accountant in relation to his or her examination.15 This suggestion was based on a provision in South Australia.16 The Law Society17 and the Joint Legislation Review Committee18 have expressed the same views about this suggestion as about the one referred to in the previous paragraph.
8.19 A number of changes could be made in relation to the specific types of check which Inspectors and Investigators are required, or at least empowered, to make. For example, they could be required to check a random sample of transfers from the trust account to the general account in respect of costs, in order to ascertain whether the correct procedures have been followed. We look at specific checks of this and other kinds in chapter 10.
V. RECOMMENDATIONS
8.20 The Law Society has made, and is continuing to make, significant improvements in its system of routine inspections of solicitors’ trust accounts by its own Trust Account Inspectors. We believe that this system has a vital part to play in the prevention and detection of trust account irregularities, especially because of the opportunities which it provides for highly specialised, economical and coordinated scrutiny of the profession’s trust accounts, and for an emphasis on education and prevention Law Society inspections have been the principal source of detection of defalcations in recent years.
8.21 We do not consider however, that it would be appropriate for us to recommend further major changes in the inspection system at this juncture. Our reasons may be summarised as follows. First, the inspection system has already been developed as much, or further, than in any other jurisdiction yet there is no appreciable evidence of a decline in the incidence of defalcations. Before devoting substantially increased resources to the system, it would be preferable to consolidate and refine the changes introduced in recent years and wait a few more years to see whether benefits flow through in the form of substantially reduced defalcations.
8.22 Secondly, and by the same token it is too early to conclude that the recent changes will not justify the resources devoted to them. Indeed, although there is a lack of hard proof, we believe that the changes have been generally worthwhile. Thirdly, there are considerable practical difficulties involved in seeking sufficient funds, and an appropriate calibre of well-remunerated recruits, for a substantially expanded system of Inspectors and inspections. Fourthly, for reasons discussed in the next two chapters, we believe that the present system of accountants examinations in this State is patently inadequate, and worse than in any other Australian jurisdiction We believe that the major emphasis in the near future should be on reform of these examinations rather than of inspections.
8.23 Accordingly, we recommend that the Law Society should ensure that it achieves within the next year its recently stated objective of inspecting every practice in the State once each year, and should maintain that frequency of inspection thereafter. The Society should ensure that this increased frequency is accompanied by further refinement of inspection techniques. Implementation of these recommendations may involve the employment of additional Trust Account Inspectors. A number of specific techniques which Inspectors could be required or empowered to employ are the subject of discussion and recommendations in chapter 10.
8.24 In order to enable Inspectors to trace and analyse effectively the manner in which trust moneys have been handled and recorded, we recommend that Inspectors should have the same extensive powers as Investigators now have to require solicitors to provide documents (such as office files and general accounts) and other information which relates to the solicitor’s practice. For similar purposes, and to encourage fruitful liaison and co-ordination between Inspectors and accountants conducting examinations of the same practices, we recommend that Inspectors should have access to any check-fist, audit program, working papers and other documents used by the accountant responsible for examining a particular practice’s trust accounts, and should be expressly entitled to confer with the accountant. Inspectors should be entitled and encouraged to show their reports on a particular practice to the accountant responsible for examining that practice, but they should not be required to do so because in some instances the disclosure might hamper prevention or detection.
8.25 We have referred earlier to the high incidence of defalcations amongst sole practitioners.19 In our view, this serious problem calls for special attention and, accordingly, we recommend that, at least during the next few years, the Law Society should inspect sole practices more frequently than other practices and/or ensure that inspections of sole practices are particularly thorough.
FOOTNOTES
1. See further discussion of this point in Chapter 9.
2. See para.7.8 above
3. Information supplied by the Law Society at the request of the Commission.
4. See para.8.5 above.
5. See paras.2.4 and 2.10 above.
6. See paras.7.2, 7.11 above.
7. See “Address of Retiring President, Mr. G.A. Murphy, Queensland Law Society Journal (1980), vol. 10, p.241, at p.242, where it was described as “the ultimate objective (and this is very long term)” of the Queensland Law Society.
8. See chapter 9 below, esp. para.9.48
9. See chapter 9 below, esp. paras.9.41, 9.4 3, 9,49.
10. See Solicitors Act 1974 and Accountants Report Rules 1975.
11. See Discussion Paper. paras.6.24-6.34 and 7.1.
12. Discussion Paper, para.6.32.
13. Law Society’s Response, para.4.3
14. Joint Committee Reply, para.4.
15. Discussion Paper, para.6.32
16. Legal Practitioners Act 1981, s.34(1).
17. Law Society’s Response, para.4.1
18. Joint Committee Reply, para.4.
19. See para.2.25 above.
