FDIC and IOLA/IOLTA Funds: Are there holes in your safety net?

As fiduciaries, attorneys are often tasked with safe-guarding client funds. In fact, at least 37 of the 50 states have a requirement that attorneys maintain an IOLA/IOLTA account for that purpose. It is arguably a requirement in all 50 states because even the states that don’t participate in the IOLA/IOLTA program, nonetheless, require funds to be segregated in a similar manner.

Most attorneys endeavor to fully comply with these rules. However, except for perhaps in a special elective course, most law schools don’t train attorneys on the nuances of IOLA/IOLTA accounts. Nor do most law schools explain how safe or unsafe client funds are when deposited in an IOLA/IOLTA account. Even fewer law schools train attorneys on the ethical rules related to maintaining an IOLA/IOLTA account beyond the prohibition on commingling attorney and client funds.

One of the hallmarks of the IOLA/IOLTA program is that the interest on the account, which would ordinarily go to the account holder, is instead redirected to a not-for-profit organization to help further legal aid, education, and other client-centered services. Attorneys may know that, but are less likely to know the exact record keeping items they are required to maintain, and for how long they are required to maintain them. (In NY the requirement is 7 years)

Also, unless an attorney works in the banking industry, they may have only a cursory understanding of the protection that FDIC offers funds in an IOLA/IOLTA account. Most attorneys loosely understand that it is some form of insurance, but don’t know much more beyond that.

So where does FDIC come in? The Federal Deposit Insurance Corporation (FDIC) is an independent government agency that protects funds against bank failure. That is a really critical component to understanding some pretty big holes in the FDIC safety net. FDIC will protect only against losses that are caused by actions or failures on the part of the bank, not losses that are incurred as the result of some other third party’s actions, and not losses that are incurred due to attorney error.

FDIC does not protect against criminal activity, fraud, or forgery committed by third parties. In fact, the liability structure under the Uniform Commercial Code (UCC) is in many respects antithetical to what common sense would lead an attorney to assume. Despite our lack of secret service training on how to identify fraudulent instruments, according to the UCC it is incumbent upon the attorney in most instances to exercise careful diligence before depositing and/or disbursing funds from a financial instrument.

This diligence includes verifying checks by calling the bank upon which the check is drawn upon wherever possible, only refunding checks to the same account from which the check is drawn, and perhaps most importantly, verifying with their bank that funds are truly “cleared,” and not just “available,” before disbursing. (Get it in writing, you will thank me later).

Fraud, forgery or any other context where the attorney may be held responsible for lost funds, are dramatically exacerbated in an IOLA/IOLTA context when the attorney unwittingly disburses funds that are only provisionally “available,”  because if the funds don’t clear, the bank will want to claw back funds. In this instance it really matters where you bank. 

Some banks, like M&T Bank for example, have a dedicated staff trained on IOLA/IOLTA rules, and a digital platform specifically designed to ensure that attorneys can annotate each transaction, by specific client with bank-verified and protected reconciliation functions. 

Other banks may actually try to claw back your IOLA/IOLTA funds despite it being a violation of participation in the IOLTA program. If they do or even attempt to do so, attorneys must immediately seek a temporary restraining order and preliminary injunction by emergency application to safeguard their client funds, incurring time and expense that could have been avoided by waiting and getting written confirmation of “cleared,” funds.

These are just the considerations for clients with funds under $250k, but what about funds over that amount? FDIC won’t cover IOLA/IOLTA funds above $250K, so how do attorneys safeguard the interests of those clients?

Here’s the rub – many states require attorneys to keep client funds in an IOLA/IOLTA. However, if by doing so you are acting against the best interests of your client because their funds aren’t FDIC insured, that arguably violates the duty of loyalty to your client. Attorneys in the past have tried to craft their own creative solutions, not always for the best.

The Temporary Liquidity Guarantee program, which was created in 2008 and expired in 2012 provided full FDIC coverage on non-interest-bearing deposit accounts regardless of the dollar amount and for that reason, although not directly compliant, attorneys in the past may have “creatively,” been inclined to use them for this purpose in an effort to further their clients’ interests. You don’t have to bend or break the IOLTA rules or Rules of Professional Responsibility to safeguard client funds.

Listed here are a couple of the current options available to New York attorneys when it comes to funds over $250K, if they want to ensure FDIC or other protection on all of their client’s funds, each with their own advantages and disadvantages.

One option is to divide the funds across multiple IOLA/IOLTA accounts opened with multiple banks. There is no restriction on the number of IOLA/IOLTA accounts an attorney can have. However, because IOLA/IOLTA accounts require time and sometimes expense to open, attorneys regularly escrowing funds over $250K on behalf of a single client, should consider establishing relationships at multiple financial institutions for this purpose. 

An important consideration before undertaking this approach is the recordkeeping and reconciliation rules are required no matter how many accounts you have or how frequently you use them. For that reason, diligent record keeping and employment of account management software would be best practice for this approach.

Alternatively, attorneys regularly escrowing funds in excess of $250k can seek their own insurance policies to guard against loss of client funds. In many instances, the coverage the attorney can personally acquire will go beyond the protection offered by FDIC. Fidelity bonds for example, provide coverage for fraudulent or dishonest acts, whereas FDIC does not. This comes with the added expense for the policy as a downside.

Whether you employ one of these methods or another, always remember that transparency with your clients about risk is something you must disclose and discuss with them in advance of accepting client funds. A detailed explanation regarding the risks to their funds, and the protections employed, as well as any expenses that may be incurred or passed through to them, must be included in either your letter of engagement, or in a separate signed disclosure. This ensures the client has informed consent, and you have proof of informing the client prior to accepting the funds.

IOLA/IOLTA requirements vary widely by state. In addition to doing your own research and due diligence, partner with a bank that has expertise in this area like M&T Bank, which offers concierge banking assistance to their attorney clients to ensure they maintain compliance with both the IOLTA program requirements and the Rules of Professional Responsibility. So, while there may be a few holes in the FDIC safety net, they can be successfully managed with the right tools and guidance.