The Fraud Examiner

The Money Laundering Risk Posed by Lawyer Trust Accounts

In December 2016, the Financial Action Task Force (FATF), an intergovernmental organization established during the 1989 G7 summit, released a report on the United States’ efforts to combat money laundering and terrorist financing. This report grades the United States in 51 categories based on how well the country is adhering to international standards. While the United States performed well overall, the FATF gave the lowest possible score in five categories, each of which singled out the lack of financial regulation for American lawyers.

A particular weak point was the lack of regulation regarding how lawyers handle client funds in interest on lawyer trust accounts (commonly referred to as IOLTA or IOLA). Congress passed regulation allowing the use of IOLTAs in the 1980s, following changes to federal banking laws that allowed certain checking accounts to bear interest. Attorneys use IOLTAs to hold either small or short-term client funds. The interest generated by these funds is then donated to charitable legal organizations (normally through a state IOLTA program).

Generally, when an attorney or a law firm is holding funds from a client (such as for a retainer or in preparation for the closing of a real estate or business transaction), a trust account is opened so the client can receive interest on the money. Like other trust accounts, these individual accounts must include the client’s taxpayer identification number and normally go through a Patriot Act screening.

However, if a lawyer is holding small or short-term funds, it usually does not make sense to open an individual account for the client due to the costs and time involved. Instead, the money is pooled with other client funds in an IOLTA. Because funds are commingled in these trust accounts, a client’s taxpayer identification number does not need to be disclosed. Instead, these accounts carry the name of the lawyer or law firm they belong to and normally use the taxpayer identification number for the state IOLTA program. This means that lawyers or fraudsters can use IOLTAs to potentially disguise the sources of illicit transactions.

Lack of Regulation

The American Bar Association (ABA) has long opposed rules that would require lawyers to help identify money laundering or terrorist financing. This is primarily out of concern for client confidentiality and attorney independence from federal oversight. The ABA fears that regulations requiring attorneys to help identify suspicious transactions could undermine the attorney-client privilege and jeopardize the confidentiality of the attorney-client relationship. As a result, there is very little regulation regarding how lawyers manage client funds or their trust accounts. This is in contrast to regulation in the United Kingdom and the European Union that has required attorneys to adhere to money laundering rules for more than a decade.

Similarly, the Bank Secrecy Act (BSA) introduced reporting requirements to the American banking industry in 1970. The primary purpose of the BSA is to require financial institutions to report certain transactions and to collaborate with the U.S. government to combat money laundering and fraud. Lawyers in the U.K and EU bear analogous responsibilities.

While the ABA resists the expansion of elements of the BSA to attorneys, it does offer guidance to help American lawyers identify questionable transactions. In 2010, the ABA issued a detailed document of suggested best practices intended to help lawyers detect and combat money laundering and terrorist financing. The FATF report acknowledges and commends the ABA’s guidance, but also indicates that it is unclear how many lawyers actually adhere to these suggested, voluntary practices. Law firms and solo practitioners are under no obligation to follow the ABA’s recommended practices, and many attorneys might not even be aware of them.

Abuse of Lawyer Trust Accounts

It is possible that many attorneys, especially those at small firms, are ill-informed of how clients might seek to take advantage of lawyer trust accounts. Even major law firms might inadvertently assist clients with money laundering.

For example, in a civil asset forfeiture case opened in July 2016, the U.S. Department of Justice (DOJ) alleged that major law firms were used to launder approximately $1 billion stolen from the Malaysian government into the United States. The scheme allegedly involved prominent multinational law firms Shearman & Sterling and DLA Piper.

While the government did not charge either firm with improper conduct, it alleges that Shearman & Sterling held $368 million of the illicit funds in an IOLTA, and DLA Piper held more than $218 million. The laundered money was allegedly used as part of an extravagant spending spree by Riza Aziz, the stepson of Malaysia’s current prime minister, and one of Aziz’s close friends, Malaysian financier and agent Low Jaek Jho. The money was spent on a private jet, a Beverly Hills mansion, Van Gogh and Monet paintings, and other lavish items. Additionally, Aziz’s film production company, Red Granite Pictures, Inc., allegedly used some of the money to help fund the production of “The Wolf of Wall Street.”

The DOJ asset forfeiture case is part of an ongoing scandal regarding the misappropriation of at least $3.5 billion of Malaysian government funds. Several foreign law enforcement agencies are investigating the alleged embezzlement of money from Malaysia’s state investment fund 1MDB by the current Malaysian prime minister as well as Aziz, Low and a number of other individuals with close ties to the government.