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    Residual balances: is your law firm compliant?

    Does your law firm promptly clear residual balances from client accounts as soon as there’s no valid reason to hold the funds? If not – you could be breaching the SRA Accounts Rules 2019.

    The Solicitors Regulation Authority (SRA) has previously emphasised that their main concern is where large residual balances remain unaddressed for extended periods. However, even smaller residual balances can indicate more serious internal issues within law firms, potentially putting compliance at risk.

    Audit director, and legal specialist, Claire Layton, explains more…

    The regulations

    Rule 2.5 of the SRA Accounts Rules 2019 states:
    “You ensure that client money is returned promptly to the client, or the third party for whom the money is held, as soon as there is no longer any proper reason to hold those funds.”

    We are commonly asked: “What does ‘any proper reason’ mean?”, and although there is no specific definition, it typically refers to situations where the legal work has been completed and the remaining funds in the client account are no longer allocated for completion of the matter.

    This rule is closely related to Rule 3.3, which prohibits using client accounts to provide banking services to clients or third parties. Specifically, it states:
    “You must not use a client account to provide banking facilities to clients or third parties. Payments into, and transfers or withdrawals from a client account must be in respect of the delivery by you of regulated services.”

    Failure to comply with Rule 2.5 may also result in a breach of Rule 3.3, so firms must carefully consider why they are continuing to hold client funds if no regulated services are being provided.

    Additionally, under Rule 8.3, the Compliance Officer for Finance and Administration (COFA) or a designated manager must sign off on a three-way client bank reconciliation at least every five weeks. This reconciliation compares the balance on the bank statement, the cash book, and the matter listing. It also states:
    “You should promptly investigate and resolve any differences shown by the reconciliation.”

    During this process, the matter listing will show the last movement of funds and time postings, which should alert compliance officers of any non-moving balances.

    Issues with internal procedures?

    Residual balances may indicate issues with a firm’s internal procedures, systems or controls, therefore, there should be clear processes in place for closing files and dealing with any client money at the end of matter. A qualified accountant’s report could initially flag the issue to the SRA, and this could lead to further investigations into the firm’s compliance.

    Monitoring work in progress (WIP) and irrecoverable time that has been sitting in the ledger for a significant period could suggest that a matter is essentially closed. When COFAs or managers sign off on bank reconciliations, they should question whether they are satisfied with non-moving balances that appear on the matter listing each month.

    Residual balances also increase the risk of a practice known as ‘teaming and lading’, where individual balances may seem insignificant, but collectively they add up to a substantial sum. If there’s a shortfall in the client account, these residual balances could be used to cover it, even if the total amount held for a specific client is insufficient. This means that funds from dormant ledgers may be improperly used to pay out on live matters.

    Residual balances can go unnoticed for months or even years, but when the breach eventually surfaces, the consequences can be severe. It’s therefore essential for law firms to regularly monitor and reconcile these balances to stay compliant.

    Get in touch

    If you would like to discuss your specific circumstances in more detail, relating to residual balances, SRA accounts rules or something else, get in touch with our legal specialist, PM+M director, Claire Layton, by clicking the button below.

    Written by:
    Claire Layton
    Director - Audit, Accounting + Advisory
    For more information about anything in the above article, please get in touch using the button below.
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