Preventing Financial Mismanagement In Law Firms

By Larry Chester, President, CFO Simplified

Every business needs to be careful about the procedures that they put in place to keep control over and protect the assets of the company. That may involve management of cash, payables and receivables, payroll, their computer system, employee access and more.  And in most businesses, there is one person at the top that takes full responsibility for everything that happens within the business. Law Firms can be different. Many Law Firms operate as a group of entrepreneurs that are part of a loosely managed organization providing each lawyer with an umbrella of administrative services and back-office operations. This allows lawyers to do what they do best — take care of the legal obligations of their clients.

And whether a Law Firm is led by a Managing Partner, or an Executive Committee, the basic tenets of managing and protecting the assets of the firm are the same. The difficulty is that often an office manager, or senior member of the accounting team is responsible for maintaining the financial security of the firm with little or no oversight. The greatest danger here isn’t the skill or knowledge of the office manager or similar individual, it is the lack of oversight, no matter how superficial, that is the greatest danger.

Here are some things to watch out for.

Cash Handling and Banking Procedures:

• Nearly all banks have some level of electronic protection available to their business clients. Procedures like positive pay, notification of automatic banking transactions, verification of outgoing wires and payments. This isn’t a time to be overly sensitive to bank charges.
• Weak controls over cash handling can make law firms vulnerable to theft or embezzlement. When checks come into the office, there should be definitive procedures on how that money is cataloged and deposited.
• Inadequate monitoring of banking procedures may result in unauthorized transactions. It’s not just a matter of putting the bank controls in place, but of following them as well.

Client Trust Accounts (IOLTA):

• Mismanagement of client trust accounts can lead to serious ethical and legal consequences.
• Failure to promptly reconcile and monitor trust accounts may result in non-compliance with legal and ethical standards.
• Because of the compliance implications, reconciliation and oversight of these accounts is even more important than comparable oversight of the firm’s bank accounts. After all, the money in these accounts doesn’t belong to your firm. It belongs to your clients.

Bank Reconciliation and Oversight:

• Regularly reconcile bank statements with internal financial records to identify any discrepancies promptly. This process helps catch errors, fraud, or unauthorized transactions.
• In this age of automatic banking, dual authorization for transactions is more a procedural activity than a secure means of protecting the account.  But even at the procedural level, it provides greater security, especially when dealing with large transfers or electronic wires. Using a dual authorization system for significant financial transactions adds an extra layer of security and oversight.

Internal Controls and Segregation of Duties:

• Segregation of Financial Duties: Divide financial responsibilities among different staff members to prevent any single person from having too much control over financial processes. This segregation of duties reduces the risk of fraud or errors going undetected.
• Rotate responsibilities among staff. This provides two benefits. First, it assures that inappropriate transactions would be caught by an employee not involved in the transactions, and second, it provides significant cross training to provide backup for vacations and job changes.
• Regular Internal Audits: Conduct internal audits to assess the effectiveness of internal controls. Even though procedures might be written down, it’s a good idea to review these with staff on a regular basis to assure that they are still being followed. Standard procedures are only helpful if they are strictly observed.

Expense Control and Monitoring:

• Detailed Expense Tracking: Implement a robust system for tracking and categorizing all expenses. This includes regular reviews of expenditures to identify any anomalies or unauthorized transactions.
• Prompt filing and approval of expense reports provides a prompt way of identifying coding and reconciling individual expense reports. This provides two benefits:
  • Accuracy of coding for any individually made expenditures.
  • Identification of any “personal” expenses that would be caught by an outside audit as inappropriate, and therefore become personal income.
• Expense Approval Procedures: Institute clear protocols for approving expenses. This ensures that all expenditures align with the firm’s budget and strategic objectives. Unauthorized spending can be a red flag for financial mismanagement.

Cybersecurity for Financial Transactions:

• Secure Online Banking by implementing strong cybersecurity measures for online banking activities. This includes secure login procedures, regular password updates, and multi-factor authentication to protect against unauthorized access.
• Training for employees on recognizing and preventing cyber threats is key. Phishing attacks, in particular, can target financial information for not only your firm, but your clients as well, and educating staff on cybersecurity best practices is crucial.
• Institute a Cyber Challenge program, whereby an outside service will send phishing emails and other “threats” to employees to see if they will fall for the security breach. Increasingly, thieves use requests from “senior management” for wire transfers, changes in bank accounts for payroll, gift card purchases, etc., as a means of fraudulently gaining access to funds or company accounts.

Financial Management and Month End Close:

• Inadequate financial oversight can lead to discrepancies and financial mismanagement. Oversight doesn’t mean that you need to be an accountant.  There are just a few things that you need to watch to make sure that everything is being done properly.
• Bookkeeping practices must be monitored to assure that procedures are followed and the close is properly completed.
• This is a critical factor in assuring that financial controls are in place. The month end close isn’t just a means of making sure that the bank account is reconciled, and that payroll is properly posted. It’s a matter of reviewing the financial reports, cross-checking the payables and making sure that it’s all being done properly.

Every managing partner in a law firm or member of the executive committee has a responsibility to their firm, their partners and all of their employees to make sure that the finances of the firm are being properly managed. It’s not just a matter of assuring that nobody is stealing from the firm, it’s also a matter of assuring that things are being done properly. That the firm is in compliance and is profitable, that the KPIs are all heading in the right direction, that the trends are all positive. It’s important to take a strategic view of how the firm is meeting its ongoing goals and an understanding of whether the firm is still on the track to reach its goals.

If you need help setting up a monthly review process for your firm, give us a call.  We’re here to listen and help.

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