Late Save: Restoring FDIC Backing for IOLTAs Averts an Ethics Dilemma
Posted Apr 01, 2011 07:10 am CDT
Programs covering interest on lawyer trust accounts have taken a pounding lately. IOLTA programs—which exist in every state plus the District of Columbia and the Virgin Islands—have become a key source of funding support for civil legal aid to the poor and initiatives to improve the justice system. But in the past three years, funding from IOLTA programs has plummeted by nearly two-thirds as bank interest rates on savings accounts dwindled to almost nothing.
Total funding from IOLTAs around the United States dropped from $371 million in 2007 to $124 million in 2009, according to data collected by the ABA’s IOLTA Clearinghouse. In Texas alone, funding dropped by 75 percent, from $20 million to $5 million, says Lora J. Livingston, a state district court judge in Austin who chairs the ABA Commission on Interest on Lawyer Trust Accounts.
Then last year, an inadvertent action by Congress—or, more accurately, an act of omission—nearly rendered IOLTAs untenable for lawyers to use because of ethics as well as financial concerns.
The problem was that Congress did not address IOLTAs in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. A provision of the act, which went into effect on Jan. 1, extended unlimited backing by the Federal Deposit Insurance Corp. to non-interest-bearing accounts. Before Dodd-Frank was passed, FDIC backing for those accounts had been capped at $250,000 each.
But Dodd-Frank did not extend similar protections to IOLTAs, even though they had existed before. The oversight would have forced lawyers to steer clear of unprotected accounts, even though they are mandatory in 43 states and the District of Columbia.
“We had serious concerns that lawyers would be in a bind,” says Betty Balli Torres, president of the National Association of IOLTA Programs and executive director of the Texas Access to Justice Foundation. “Ultimately, protecting the client is paramount. Some lawyers would have chosen to move [client money] to a non-interest-bearing account. For us, that would have meant a significant drop in revenue.”
Rule 1.15 of the ABA Model Rules of Professional Conduct requires that a lawyer keep funds belonging to a client in a separate account from the lawyer’s own funds or those belonging to another party. The rule does recognize an exception for funds the lawyer deposits into the client account “for the sole purpose of paying bank service charges on that account, but only in an amount necessary for that purpose.” The lawyer also may deposit legal fees and expenses that have been paid in advance, to be withdrawn by the lawyer only as fees are earned or expenses incurred. (The Model Rules are the direct basis for lawyer ethics codes in every state except California.)
“A lawyer should hold property of others with the care required of a professional fiduciary,” states the comment to Rule 1.15.
Generally, a client must approve the manner in which his or her money is being held by the lawyer. IOLTAs are built on an exception to that general rule because, by and large, they don’t require lawyers to confer with clients before depositing client funds into them, primarily because the amounts are so small. But without FDIC protections for IOLTAs, lawyers might feel compelled to avoid putting even small amounts of client funds in those accounts, at least without first making a disclosure to the clients. (Some states include IOLTA provisions in their versions of Model Rule 1.15, while other states address IOLTAs through supreme court orders or legislation.)
It might be said that the IOLTA system is based on the nickel-and-dime concept. If the client funds are substantial enough to earn interest income for the client after administrative costs, they generally aren’t deposited in an IOLTA fund. But for smaller amounts of client funds, IOLTAs provide a place for attorneys to “park” the money for short periods of time. The actual interest earned on each account is relatively small—especially these days—but a few dollars here and a few dollars there add up, say IOLTA proponents. Small amounts of these monies fund bar foundations, law school scholarships and other needs, but most of them help fund legal services to low-income individuals.
“It is a very important part of the very diverse puzzle you have to put together for civil legal aid funding in this country,” says Don Saunders, director of civil legal services at the National Legal Aid & Defender Association in Washington, D.C.
When the IOLTA loophole in the Dodd-Frank act became apparent, the ABA, state bar groups and bar foundations, the National Association of IOLTA Programs, banking associations and other groups mobilized to inform members of Congress of what was at stake.
“In terms of timing, it couldn’t have been worse,” Torres says. “There’s no good time to lose money for legal services. But in terms of the historically low interest rates, it would have been devastating.”
IN THE NICK OF TIME
Gaining passage of a follow-up bill to close the IOLTA loophole in Dodd-Frank was no easy task, says Livingston. “There were a number of fronts on which we had to be prepared,” she says. “ ‘Here’s what we’re going to have to say. Here’s who we’re going to have to tell it to.’ As things in Congress changed rapidly, ‘Here’s what we need to say to the banks. Here’s what we need to say to the IOLTA community.’ That was a massive effort.”
The effort was crucial even though most IOLTAs would have been unaffected by the loophole in Dodd-Frank because most of them probably hold far less than the $250,000 cutoff amount for FDIC protection, Torres says. But it is those large accounts that produce most of the interest that goes to IOLTA programs. “The impact wouldn’t have been huge numbers of lawyers,” she says. “It would have been the fact that their accounts are making the bulk of the money.”
The bill to fix the loophole required a two-thirds majority in the House because it added $12 million to the federal budget in its first year and $5 million the second year, causing pay-as-you-go rules to kick in. That turned out not to be a problem, as the House passed the bill unanimously on Nov. 30.
In the Senate, Saunders says, “the biggest challenge was that we were in the lame-duck session, which was crazy, and we had a stand-alone bill,” which ended up requiring a unanimous vote. Under Senate rules, trying to pass the IOLTA change by simple majority would have required reopening the entire Dodd-Frank act to possible amendment.
“Getting a unanimous vote in the Senate on whether it was day or night was difficult to do in the lame-duck session,” Saunders says. “Dodd-Frank was such a political football. To get unanimous consent on any bill that dealt with the Wall Street reform act, it was a zoo.”
The bill to extend unlimited FDIC backing to IOLTA passed with mere hours left in the congressional session, and President Barack Obama signed it into law Dec. 29. “We were all writing our what-do-we-do-now memos,” Saunders says, “which we were very happy to can when it passed.”