New Year brings changes to federal law affecting deposit insurance coverage for Interest on Lawyer Trust Accounts (IOLTAs)

With Congress failing to take action to extend unlimited coverage, as of Jan. 1, 2013, FDIC insurance available to IOLTA accounts is limited to the standard amount of $250,000 per owner of the funds (client), per financial institution, assuming that the account is properly designated as a trust account and proper accounting of each client’s funds is maintained.

Since November 2008, a series of temporary federal laws have operated to provide unlimited FDIC deposit insurance coverage for most IOLTA accounts. For the past two years, IOLTA and non-interest-bearing accounts enjoyed unlimited FDIC insurance coverage under Section 343 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. That provision was effective for two years with a sunset date of Dec. 31, 2012. 

Now, funds deposited in IOLTAs are no longer insured under the Dodd-Frank Deposit provision. However, because IOLTAs are fiduciary accounts, they generally qualify for “pass-through” coverage (the insurance coverage passes through the fiduciary-depositor to the client-owner’s funds) on a per-client basis. FDIC regulations provide that deposit accounts owned by one party but held in a fiduciary capacity by another party are eligible for pass-through deposit insurance coverage if:

  1. The deposit account records generally indicate the account's custodial or fiduciary nature; and
  2. The details of the relationship and the interests of other parties in the account are ascertainable from the deposit account records or from records maintained in good faith and in the regular course of business by the depositor or by some person or entity that maintains such records for the depositor.

FDIC Requirements for Pass-through Coverage

To meet the FDIC requirements, a lawyer should ensure that:

  • The fiduciary nature of the account is disclosed in the account title (e.g., Lawyer Doe  Client Trust Account);
  • The account contains the tax identification number of the Legal Foundation of Washington for IOLTA accounts (91-1263533); and
  • The identities and interests of the clients can be determined from records maintained in the regular course of business by the depositor (e.g., John Doe Law Firm). Properly accounting for client trust funds is crucial in identifying the fund amounts that belong to each client in the event an FDIC insurance claim is filed. At the minimum, proper accounting means identifying the client on whose behalf each deposit or withdrawal is made, keeping running balances in all account registers, and regularly reconciling the balance belonging to each client. For complete ethical requirements on maintenance of trust account records, see RPC 1.15B.

If an IOLTA does qualify for pass-through coverage as a fiduciary account, then each separate client for whom a law firm holds funds in an IOLTA may be insured up to $250,000. For example, if a law firm maintains an IOLTA with $250,000 attributable to Client A, $150,000 to Client B, and $75,000 to Client C, the account would be fully insured if the IOLTA meets the requirements for pass-through coverage.  However, if the clients have other funds at the same institution, those funds would be added to their respective shares of the funds in the IOLTA for insurance coverage purposes, with the aggregate balance insured up to $250,000. For example, if a law firm maintains an IOLTA with $150,000 attributable to Client A, and Client A has $200,000 deposited in a certificate of deposit at the same FDIC-insured depository institution, then Client A’s funds would only be insured for up to $250,000 and uninsured for the remaining balance of $100,000.

The Washington Rules of Professional Conduct  (RPC) and Rules for Enforcement of Lawyer Conduct (ELC) require a lawyer to hold client or third party funds in a trust account at an FDIC or National Credit Union Administration (NCUA) insured institution. Usually, such funds are held in a pooled interest-bearing trust account known as an IOLTA account, with interest paid to the Legal Foundation of Washington. If the client or third-person funds will produce a positive net return, the funds must be placed in a separate interest-bearing individual trust account (or pooled interest-bearing trust account) with interest paid to the particular client, unless the client or third person requests that the funds be deposited in an IOLTA account.

While the RPCs and ELCs require all client or third-person funds be held in an FDIC insured account, the rule does not specifically require all funds in the account be within the FDIC insurance limits. The rules do require, however, that when selecting a bank or other institution for trust account purposes, a lawyer must do so “in the exercise of ordinary prudence.” Lawyers should also note credit unions have unique issues regarding insurability. In some cases, NCUA rules may require that the individual clients for whom the lawyer is holding funds in trust belong to the credit union in order to qualify for the insurance coverage. Lawyers should consider discussing insurance coverage matters with a credit union representative.

Even though applicable ethics rules do not require that all of a client’s funds on deposit in a trust account be insured within the $250,000 FDIC insurance-coverage limits, as a matter of due diligence a lawyer should consider taking precautions, for example:

  • Informing clients about the location of the IOLTA account (or Separate Interest-bearing Individual Trust Account), and applicable FDIC insurance coverage limits (e.g., “The deposit insurance coverage applicable to your funds at [name of bank] is limited to $250,000. The $15,000 I am holding in trust for you counts towards that insurance coverage at [name of bank]. If you have additional funds in the same institution approaching or exceeding the insurable limit, you may wish to make other arrangements so that all of your deposits there remain insured.”)
  • Exercising ordinary prudence by taking reasonable steps to investigate a bank’s financial solvency if a lawyer has deposited client funds exceeding the FDIC deposit insurance coverage limits.
  • Dividing the funds into trust accounts at different financial institutions to maximize the client’s deposit insurance coverage if you hold more than $250,000 in trust for any one client.

If you have questions, please contact the WSBA Professional Responsibility Counsel via the Ethics Line, 206.727.8284 or the WSBA Audit Manager, 206.727.8242.

Resources

Useful links on the Washington Rules of Professional Conduct, managing client trust accounts, and FDIC insurance coverage:

IOLTA Information

Questions?

If you have questions about these changes, please contact:

WSBA Ethics Line
206-727-8284

WSBA Audit Manager
206-727-8242