Facing up to the potential for embezzlement

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Published on 3/12/07

I am a firm believer that running a law firm in a businesslike way improves the professionalism of legal practice. A profitable law practice is much more likely to avoid ethical problems regarding client funds.

Moreover, a law firm run as a business will also approach business operations with the kind of checks and balances that eliminate financial irregularities.

This is confirmed by Tom Collins, chairman of Juris, Inc. (a legal consulting firm and a strategic partner of my firm, LawBiz Management Co.). As a CPA who has worked with businesses of all types, Tom notes that he has never encountered a single case of embezzlement outside of the legal community and has found it relatively commonplace among law firms.

There are several factors making law firms more susceptible to misappropriation of funds, such as part-time executive management, lack of business competency in the organization, and decentralized authority to approve and sign disbursements.

Tom cites a KPMG survey reporting that the average embezzlement incident goes on for 18 months before detection. More than half the time the loss is exposed only through a tip or by accident; fewer than 10 percent of embezzlers are caught as a result of external audits.

Fraudulent checks, credit cards, payroll, petty cash and outside vendor accomplices are all favorite tools of the law-firm embezzler, who often is a trusted staff person who seldom takes a vacation.

Common sense best practices of cash flow management can protect a firm from embezzlement:

  • Deposit all client checks immediately and in person at your bank, even if the amount paid does not match what you billed. Negotiate or correct the variance later;
  • Don't allow the person who opens the mail to also create the bank deposits;
  • Don't allow the person who deposits the money to also do the bank reconciliations;
  • Reconcile your bank statements immediately upon receipt. This facilitates immediate recognition of irregularities that may be more than just transactional errors;
  • Review all vendors bills, approve them and only then authorize checks for payment. Sign the checks yourself - don't delegate this function.
A special warning to any lawyer with a sole or small practice: maintain separate payroll and general accounts, placing in the payroll account the full amount of gross payroll (including employee portion of taxes) on the day that payroll is due.

It is never a good idea to use payroll money to operate the firm. Employers have been known to "borrow" payroll and payroll tax funds in the hope that enough accounts receivable will be collected to cover them before presentment. If they fail to receive the funds expected and cannot cover payroll and taxes sufficiently, the result will be civil and potential criminal penalties.

Maintain the general account only with a minimum amount of money, such as $2,500. The actual amount depends on the nature and amount of checks and deposits that pass through your bank account each month.

Instruct the bank to segregate all funds in excess of this amount at the end of each day and "sweep" or transfer those "excess" funds into a money market (interest bearing) account until needed. To do otherwise creates potential for grave risk.

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