October 23, 2012

Anatomy of a Law Practice Audit

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January/February 2011 Issue | Volume 37 Number 1 | Page 24


Anatomy of a Law Practice Audit

Few visitors to a law office are less welcome than law practice auditors. They are generally there because a lawyer is in trouble with the state bar, and they will dig deep into electronic and paper records to get to the bottom of the complaint. Alas, the root cause is frequently poor (or nonexistent) business and practice management procedures.

There’s a rather shocking dearth of literature on law practice audits, which is unfortunate because these audits are a very serious and highly detailed process for the lawyers who undergo them. We know because we serve as law practice auditors in the state of Virginia.

Usually, the process commences because the lawyer has entered into an Agreed Disposition with Terms (there are, of course, different names for the agreement in different states) and may have received a private or public reprimand from the bar, or even had his or her law license suspended. The terms of the agreement command the lawyer to engage the services of a law practice auditor, pay for those services, open all of the firm’s computer and paper records to the auditor, and comply with all of the auditor’s recommendations. Generally, the auditor will make a follow-up visit to ensure compliance afterward.

While hopefully you will never have to face the specter of an official practice audit in your own law firm, knowing how these audits generally work should serve as a cautionary tale for all lawyers. So here, to fill the void in existing information, is an anatomy of the process. A caveat: The exact nature of auditing practices varies widely from state to state, so be mindful that the following, while illustrative of the process, is Virginia-centric.

Ins and Outs of the Interview Phase

Once the contract has been signed and a retainer provided, the auditor sets up a meeting with the lawyer. The first step at the meeting is to sit down and interview the lawyer about various things surrounding the complaint (or complaints) at issue. The conversation might, though, open with things that set the lawyer at ease. For instance, the auditor may gather information about staff, law school, number of years at the firm’s current address and other noncontroversial inquiries. This gives a behavioral baseline against which to compare when more sensitive questions are asked.

And the reason for that baseline? Most often, the auditor will look for telltale signs of deceit during the rest of the interview, much as a detective would. There are those, for example, who cannot meet your eyes, look skyward for inspiration, blink rapidly, change stories in midstream, contradict themselves, stammer, have rapid changes in voice tone or pitch, excessively clear their throat, grow wide-eyed, pale or red, use a defensive tone or become sarcastic. If particular questions elicit this sort of behavior, it helps to identify something the auditor may want to follow up on.

For instance, if a lawyer exhibits such signs when asked if clients other than those who made a bar complaint have also complained about a failure to return phone calls, auditors will know they need to check the phone-message records in the files. If asked whether clients are apprised of the lawyer’s transfer of trust account funds to the operating account and an evasive answer ensures, then it’s time to zero in on a comparison between those transfers and the monthly invoices.

So, after the basic initial inquiries, the auditor will then ask the lawyer to explain what happened in the complaint(s) at issue in the agreed disposition. This is where it gets interesting. The lawyer has already been found guilty of committing an ethics violation. And in some cases, he or she has also been found guilty of not cooperating with the disciplinary process by failing to provide the requested documents—or even failing to show up for disciplinary hearings. Yet many will still make a tortured attempt to explain, to lessen the degree of fault, to blame other circumstances in their lives or the like. No two cases are ever the same, but the answers to the “what happened” question tend to give quick insight into an attorney’s character.

Follow-up questions about other similar (or different) complaints from clients will also be part of the process. And, depending on the ethics rules in the state, the auditor will ask about the following:

  • How fees are handled
  • How often the trust account is reconciled
  • Whether engagement letters are used
  • Whether e-mail communications are used with clients
  • Whether e-mail communications are addressed in engagement letters
  • Whether closing letters are used
  • How time is kept
  • How billing is accomplished
  • What tickler systems are in use
  • What law office functions are done by software programs
  • How the return of phone calls and answers to letters and e-mails are monitored
  • Whether the lawyer receives or pays any referral fees, and the like

Usually, auditors also find it is instructive to interview the lawyer’s assistant, which tends to go one of two ways: The assistant is clearly protective of the lawyer and hesitant to divulge anything, or is cognizant that the auditor is there on behalf of the bar and will tell all, whether or not it is to the lawyer’s detriment. Even if the -assistant seeks to protect the lawyer, the auditor will usually hear a tale that is somewhat different from the tale the lawyer told, which again points to avenues of possible investigation.

How the Office’s Files Tell Their Own Story

A critical part of a law practice audit is investigating the office’s computers, including everything from timekeeping and billing records to document management processes—and -beyond. Auditors will specifically look for information involving the cases that gave rise to the complaints as well as other client matters that the lawyer may have mentioned during the interview. But also amazingly critical are the paper files, which still rule in many solo and small firms.

One of the first things that gets checked is the lawyer’s timekeeping mechanism. Signs of trouble here can include repeated entries that seem meaningless, such as “researched case,” “reviewed documents” or the like. And frequently, time entries raise suspicion because they are all in one-hour or half-hour segments.

When questioned, many lawyers will say that they made a “best guess” as to time—often because it wasn’t recorded contemporaneously. Quite often, unfortunately, the entries are so vague that the client cannot reasonably be expected to understand what the charges were for.

Looking through files in a troubled practice usually reveals the associated signs of client discontent. There may be angry or threatening phone messages from clients, which a legal assistant dutifully recorded on pink slips. There may be letters of complaint or threatening legal action, documenting what the writer believes was done wrong in the case. Most frequently, the complaints involve a failure to return phone calls or answer letters, excessive fees that the client wasn’t expecting, missed filing dates, the failure to show up in court, and even showing up in court with incorrect paperwork.

There are clearly multiple lessons to be learned here, including this one: While engagement letters may not be required under the rules, they are certainly desirable as a way of clarifying the scope of work and financial arrangements with clients. When they do not exist in an office, auditors always recommend their use. Likewise, the use of closing letters is always a best practice in ensuring that clients have a final understanding that their case has been closed—and a final financial reconciliation is as well.

What Lurks Beneath

In many cases, just looking around the office can give clues as to why the lawyer’s practice is in trouble. Although you would think lawyers in trouble with the bar would tidy up before a law practice audit, not all of them do. As an example, in one notable case, the office had built-in bookcases literally covered with papers and books stacked every which way in great disarray. The attorney’s desk and drawers were a mess. Things were simply crammed haphazardly everywhere. The filing cabinet behind his desk held unpaid bills stacked so high that some of them had fallen to the floor. And upon closer inspection, a good many of the bills had not been opened—no good news to be gleaned from them, apparently. Of those that were opened, they were all overdue and some were threatening collection action.

Very often, it is clear that the lawyer’s business and personal life are completely intertwined in credit card charges for home furnishings, vacations and other clearly non-business expenses. Moreover, a look at the business tax return and the personal tax return will often make it clear that personal expenses were charged against the business and never adjusted to show up as income on the personal tax return.

In too many cases, the sad fact is that the lawyers being audited are unable to get themselves organized, to establish the proper tickler systems, to enter time promptly, or even to get bills out in anything resembling a reasonable time frame. In one stunning case, the lawyer sent out no bills at all, so his clients had no way of knowing what they were being charged or when monies were being transferred from the trust account to the operating account.

In fact, many of these lawyers seem not to know that they are financially drowning because they don’t keep the proper records and are unable to determine whether their business is profitable or not. The resulting financial pressures often make it more tempting to cut corners or to commit overtly unethical acts, such as putting unearned monies directly in the operational account rather than the trust account, sometimes in the belief that if they have a document saying that a flat fee was earned upon receipt, they will be okay. Obviously not so—as almost all state rules make very clear.

Others simply put monies in the operational account because they are seemingly oblivious to ethics rules, or perhaps so desperate to make payroll and pay bills that they feel they have no choice and simply hope that their acts would go undiscovered.

Some honestly do not know how to reconcile the accounts and must be taught. Others seem to regard it as a chore and thus avoid it. A lot of audit time is spent explaining the clear meaning of the ethics rules and how to comply with them.

Raiding trust accounts, unfortunately, is not uncommon. It is imperative in doing a law practice audit to review all trust accounts. Generally, where an account is being raided, auditors will see large withdrawals over a fairly short period of time, and a look at the invoices (if they exist) will not seem to justify the withdrawals. In many instances, the invoices will not indicate the withdrawals, so the client is completely unaware that funds have been disbursed. Plus, in some cases, long after a case has closed, the client has monies left in the account, but the lawyer stops sending out notices of the credit balance and simply coverts the funds to his or her own usage.

A great deal of evidence in these cases is on the computer—increasingly so as time goes on—and in most cases, the computer bears witness to the chaotic problems in the office. The technology environment is not secure, the virus and malware protection has probably lapsed, there may be no anti-phishing or spyware protection, or perhaps every piece of technology in the office has been left on default settings, well known to those who wish to steal identities or data.

Commonly, too, computer backups are haphazardly made, if at all. Moreover, it is not uncommon to find clients’ credit card data unencrypted on the computers—or, worse yet, on paper notes stuck in files where any prying eyes can see them. And in some cases, lawyers are using software so old that it is effectively obsolete and will not allow them to perform their work competently. At this point, you have a pretty clear picture of the situation.

The Upside Comes in Rectifying the Situation

It is not wise to generalize too much, since each case is different. Auditors must get a sense of the lawyer as a person and note what questions evoke a reaction and check records relating to those questions. What they find in electronic records may lead them to paper records, or vice versa, and frequently some ethics violations not contemplated in the original complaint appear as the audit continues.

The approximate on-site time for a typical law practice audit is four to six hours for the first visit and two to four hours for the follow-up audit. Occasionally a third audit is required. The bulk of the auditor’s work involves studying the electronic and paper records involved in the case, which are brought back to the auditor’s office for study, and then compiling a detailed report of the results. It is not uncommon for the reports to be 15 to 20 pages and to contain dozens of recommendations for how the lawyer should rectify the problems in the practice.

The upside of the story, however, is that most of the lawyers involved in these cases are “salvageable.” Their poor business practices meant they spent a lot of time scurrying to cover up errors or had to refund monies. Also, despite their unethical conduct, many were cheating themselves because they charged flat fees and had no idea how many hours they had to work to earn that flat fee. Post-audit, by following the recommended steps, most lawyers report that they are now making money and that their practices are ethically “clean as a whistle.” This is, of course, the desired result.

On the other side of the coin, there are some lawyers who simply need to be in another business because they cannot be trusted to meet the high ethical standards required in the legal profession. Even there, law practice audits are invaluable because they ferret out these lawyers, amassing a body of evidence of their misdeeds upon which bar counsel can then act.

Ultimately, for every law office, a regular self-audit is a good thing. Shutting one’s eyes to the problems that may exist does not resolve them. And remember, the state bars are there to assist lawyers who find themselves in trouble—the bar doesn’t cavalierly suspend or revoke law licenses. The audit process is lengthy and serious, but every effort is made to allow the lawyer to come into ethical compliance while at the same time protecting the public. It’s a delicate balance, and while it can always be improved, it works pretty doggone well.

About the Authors

Sharon D. Nelson and John W. Simek are President and Vice President, respectively, of Sensei Enterprises, Inc., a computer forensics and legal technology firm based in Fairfax, VA. They are coauthors of The 2010 Solo and Small Firm Legal Technology Guide (ABA, 2010).