CHAPTER 1 CLIENTS TRUST ACCOUNTS

CHAPTER 1 CLIENTS TRUST ACCOUNTS Chapter 1 is the first of the required topics and covers the management of Clients Trust Accounts. 4

CHAPTER 1 - SECTION 1 CLIENTS' TRUST ACCOUNTS In general, clients trust accounts are bank accounts administered by real estate principal brokers and property managers on behalf of clients and other beneficiaries. They help to ensure integrity and transparency during the transfer of funds in real estate transactions. Managing a bank account sounds simple enough on the surface, but mastering all the rules governing these specialized accounts can be tricky, which is why the Agency has targeted a number of specific areas within the statutes and rules for us to review. Let s start with the basics and review relative Oregon Revised Statutes and Administrative Rules that govern them. In addition to this review, if you use or plan on using clients trust accounts in your business, it wouldn t hurt to reread the entirety of the statutes and rules we review here today. Oregon Revised Statutes The statutes related to this unit are: ORS 696.241 - Clients trust accounts; notice to agency; branch trust account; interest earnings on trust account; when broker entitled to earnest money; funds not subject to execution; rules. ORS 696.245 - Clients trust accounts; notice to bank; retention of copy. As a general overview, ORS 696.241 contains the meat of laws governing clients trust accounts for real estate professionals in Oregon. It covers: The definition of trust funds Who is responsible When they must be opened Where they must be opened Who must be notified How and when they must be notified How to handle interest bearing accounts The required separation of accounts How to handle disbursements ORS 696.245 has a narrower focus on: Bank notification Required forms Required timing Both statutes can be reviewed in full on a webpage from the Oregon Legislature at https:// www.oregonlegislature.gov/bills_laws/lawsstatutes/2013ors696.html. 5

Oregon Administrative Rules Oregon Administrative Rules (OAR) are created from and used in addition to the Oregon Revised Statues (ORS) by the Oregon Real Estate Agency to implement and administer the law. They carry the same weight as the statutes written by the Oregon Legislature. The administrative rules related to this unit are: Division 15 - Real Estate Broker Regulation OAR 863-015-0250 - Professional Real Estate Activity Records OAR 863-015-0255 - Clients Trust Account Records Requirements and Document Transmittal Requirements OAR 863-015-0260 - Records Retention OAR 863-015-0265 - Interest-Bearing Accounts OAR 863-015-0275 - Clients Trust Account Reconciliation and Records Division 25 - Property Management OAR 863-025-0025 - Clients' Trust Account and Security Deposits Account Requirements OAR 863-025-0030 - Tenant Security Deposits OAR 863-025-0035 - Records; Required Records; Maintenance; Production OAR 863-025-0040 - Record of Receipts and Disbursements OAR 863-025-0045 - Tenant Agreements OAR 863-025-0050 - Tenant Ledger OAR 863-025-0055 - Owner Ledger OAR 863-025-0060 - Cash Receipts OAR 863-025-0065 - Deposits and Funds Received Rules from both Divisions can be reviewed in full on a webpage from the Oregon Secretary of State through the following links: Division 15 - http://arcweb.sos.state.or.us/pages/rules/oars_800/ oar_863/863_015.html#division_15 Division 25 - http://arcweb.sos.state.or.us/pages/rules/oars_800/oar_863/863_025.html Learning Objectives So let s take some time now to review the 15 required learning learning objectives that the Agency has identified for this required topic and tie them back the statutes and rules we just outlined. Upon completion of this section the licensee should be able to: Learning Objective #1 - Define trust funds under ORS 696.241 as money belonging to others that is received or handled by a licensed real estate property manager or principal real estate broker in the course of conducting professional real estate activity and in the real estate licensee s fiduciary capacity. There s not much more to add here. The learning objective contains the definition of trust funds almost word for word from section (1) of ORS 696.241. 6

Learning Objective #2 - Describe who can open a clients trust account and who must open a clients trust account. Learning objectives 2, 3 and 4 all refer to sections (2) and (3) of ORS 696.241. Section (2) states that A licensed real estate property manager, or a principal real estate broker who engages in the management of rental real estate, shall open a clients trust account. Management of rental real estate requires the must open in the learning objective. Statute 696.241 (3b) states that A principal real estate broker may deposit trust funds in a licensed neutral escrow depository. This is the can. Principal brokers have an option to use either a licensed neutral escrow depository or a clients trust account for for trust funds. Learning Objective #3 - Explain that clients trust accounts must be opened and maintained in the state of Oregon. The fact that these accounts need to be opened and maintained in the jurisdiction of the Oregon Real Estate Agency is highlighted in sections (2) and (3) of ORS 696.241. For the purpose of clients trust accounts, they state that licensees shall open and maintain in this state one or more separate federally insured bank accounts that are designated clients trust accounts under ORS 696.245. Learning Objective #4 - Explain that a licensed real estate property manager or a principal real estate broker who engages in the management of rental real estate must open and maintain at least one clients trust account. This is directly related to learning objective #2 and is pulled from the same section of law. ORS 696.241 (2) says A licensed real estate property manager, or a principal real estate broker who engages in the management of rental real estate, shall open and maintain in this state one or more separate federally insured bank accounts that are designated clients trust accounts under ORS 696.245. Learning Objective #5 - Explain that a principal broker or licensed real estate property manager must notify the Agency using elicense within 10 business days if a clients trust account is opened, closed or transferred. According to ORS 696.241 sections (4) and (6), licensees must in fact notify the Agency within 10 business days of an account being opened, closed or transferred. Learning Objective #6 - Describe the process for opening and closing a clients trust account through elicense. This is associated with learning objective #5 and can be found in ORS 696.241 (4). Notification of an account opening must include the following information: The name of the bank; The account number; The name of the account; The date the account was opened; and 7

A statement by the licensed real estate property manager or principal real estate broker authorizing the Real Estate Commissioner or the commissioner s representative to examine the clients trust account at such times as the commissioner may direct. Per the Agency, these notifications are to be processed through their online elicense portal at https://orea.elicense.irondata.com/. Clients trust accounts are managed on elicense through your personal licensees account. After logging in, simply click on Online Services at the top right of your screen and then click on Open/Close Client Trust Account(s) Learning Objective #7 - Describe how to correctly name a CTA. Per ORS 696.241 (2), (3a), (9) and (10), trust funds must be deposited into an account under a name that includes a designation as a clients trust account. Per OAR 863-025-0025 (10d) in the Property Manager Division of the Administrative Rules, if the account is a security deposits account, the account should include the words "clients' trust account security deposits, but also may include additional identifying language. Learning Objective #8 - Explain the requirements of the Notice of Clients Trust Account form, including who must sign it and record keeping requirements. ORS 696.245 (1) & (2) require that at the time a clients trust account is opened, a licensee must notify the bank in writing of the purpose of that account. The notice must be acknowledged and signed by a representative of the bank and kept on file by the licensee for 6 years following the closing of the account. The notice must substantially follow the form provided by the Agency at http:// www.oregon.gov/rea/reg/docs/notice_of_clients_trust_account.pdf. Learning Objective #9 - Explain who may be a signer on a clients trust account. The principal broker and property manager are responsible for clients trust accounts, although they may assign additional authorized signers. An exception is outlined in OAR 863-025-0025 (9). A property manager may not allow an owner to be an authorized signer on a clients' trust account or security deposit account and may not allow an owner to deposit, hold or disburse funds in a clients' trust account or security deposit account. Learning Objective #10 - Describe record keeping requirements for clients trust account records. Under OAR 863-015-0250 (3), A real estate broker must transmit to the real estate broker's principal real estate broker within three banking days of receipt any money, checks, drafts, warrants, promissory notes, or other consideration and any documents received by the licensee in any professional real estate activity in which the licensee is engaged. Absent the 8

buyer s written instructions to the contrary, the real estate broker must transmit all earnest monies to the principal real estate broker within three banking days of receipt. Under OAR 863-015-0250 (4), If a real estate broker or principal broker receives a check as earnest money in a transaction, he or she may hold the check un-deposited until the offer is accepted or rejected, provided that the written sale agreement states that the real estate broker or principal broker is holding the check un-deposited and further states where and when the check will be deposited upon acceptance of the offer. Furthermore, from sections (7) through (12) of OAR 863-015-0025: (7) For all funds received under sections (3) and (4) of this rule, the principal broker must comply with the following requirements: (a)account for all funds received, (b)maintain a copy of any check received, and (c)maintain a dated, acknowledged receipt for any check returned to the offeror. (8) Every deposit made under ORS 696.241 must be made with deposit slips identifying each offer or transaction by a written notation of the file reference assigned to the offer or transaction. (9) Principal brokers must maintain a complete ledger account and record all funds received in their professional real estate activity. This ledger account must show: (a)from whom the funds were received, (b)the date the funds were received, (c)the date the funds were deposited, (d)where the funds were deposited, and (e)when the transaction has been completed or the offer has failed, the final disposition of the funds. (10)If a real estate licensee is a principal in an offer or transaction, all earnest money or other deposits must be handled as provided in OAR 863-015-0145. (11)Checks used to disburse funds from a clients trust account must be pre-numbered, issued from one numbering sequence, and bear the words "Clients' Trust Account" upon the face thereof. Principal brokers must account for all checks, including voided checks, as a part of the records they maintain. (12)Principal brokers must record and track the transfer of promissory notes and other forms of consideration by a ledger account or by other means including, but not limited to, written proof of transmittal or receipt retained in their offer or transaction file. Learning Objective #11 - Describe the type of funds that may be held in a clients trust account. Again, trust funds are monies belonging to others that are received or handled by a licensed real estate property manager or principal real estate broker in the course of conducting professional real estate activity and in the real estate licensee s fiduciary capacity. The purpose of clients trust accounts is to preserve clients monies, such as earnest money deposits and property management funds, and keep them segregated from the broker's general operating and personal funds. 9

The practice of mixing these funds is referred to as commingling and is illegal. Conversion is using money in the trust account for the benefit of anyone other than the rightful beneficiary. Also, in accordance with OAR 863-025-0025 (Property Manager): (3) Only the following funds may be held in a clients' trust account: (a)funds received by the property manager on behalf of an owner; and (b)interest earned, but only if the account is a federally insured interest-bearing account and the property management agreement complies with OAR 863-025-0020(3). Learning Objective #12 - Describe what is required in order to disburse funds from a clients trust account. Per OAR 863-015-0255: (11)Checks used to disburse funds from a clients trust account must be pre-numbered, issued from one numbering sequence, and bear the words "Clients' Trust Account" upon the face thereof. Principal brokers must account for all checks, including voided checks, as a part of the records they maintain. (14)All funds deposited into a clients' trust account established under ORS 696.241 and not disbursed or transferred to a neutral escrow depository pursuant to the sale agreement may only be disbursed: (a)to individuals, as directed by order of court of competent jurisdiction; (b)to individuals, as directed in writing by one or more principals; or (c)to the court, upon filing by the principal broker of an interpleader action for disputed earnest money funds. Learning Objective #13 - Describe the requirements to transfer funds from an owners ledger account to one or more different owners ledger accounts. From OAR 863-025-0025: (13)A property manager may only transfer funds from an owners' ledger account to one or more different owners' ledger accounts if: (a)each of the affected owners authorizing the transfer have signed and dated an agreement authorizing such transfer that is separate from any property management agreements; (b)at the time of the transfer, the property manager enters the transfer information on each affected owners' ledger account, including but not limited to the amount of the transfer, date of the transfer and the source or destination of the transferred funds, as appropriate; and (c)the property manager gives each owner a separate monthly accounting on the transfer or includes the accounting of the transfer activity in the regular monthly report to the owner. Learning Objective #14 - Describe the components of a 3-way reconciliation and how often a reconciliation must be performed. This can be understood through a review of OAR 863-015-0275. A principal real estate broker must reconcile each clients trust account at least once each month. The reconciliation must comply with all of the following conditions: 10

(1) The reconciliation must have three components: (d)the bank statement balance, adjusted for outstanding checks and other reconciling bank items; (e)the balance of the receipts and disbursements journal or check book register as of the bank statement closing date; and (f)the sum of all the balances of the individual trust account ledgers as of the bank statement closing date. (2) The balances of each component of the reconciliation must be equal to and reconciled with each other. If any adjustment is needed, the adjustment must be clearly identified and explained. A reconciliation form can be found on the Real Estate Agency s website at http:// www.oregon.gov/rea/reg/docs/trust_account_reconciliation.pdf. Learning Objective #15 - Explain that the Agency conducts random audits of clients trust account reconciliations and violations may result in administrative action including license revocation. Make no mistake, the Real Estate Agency has full authority to conduct random audits, investigate complaints and take administrative and disciplinary actions to protect the consumer and profession. Intentional or unintentional mismanagement of trust funds, clients trust fund accounts and the record keeping around them can lead to a number of corrective actions by the Agency which could absolutely include license revocation. Don t take your fiduciary responsibilities lightly. Additional Notes and Review To this point we ve used statutes and administrative rules to help review specific areas of clients trust fund management that the Agency has targeted for review through their learning objectives. In this section we ll go just a little deeper in our review of some to those same topics with addition notes and examples. Clients Trust Accounts A brokerage may have any number of clients trust accounts such as: A trust account for each branch office A trust account for property management A trust account for security deposits from property management NOTE: FOR PROPERTY MANAGEMENT, TWO TRUST ACCOUNTS SHOULD BE SET UP (ONE FOR GENERAL PROPERTY MANAGEMENT AND ONE FOR THE SECURITY DEPOSITS FOR TENANTS). Money held for others can be deposited into a neutral third party trust account, often referred to as an escrow trust account or deposited into a brokerage s trust account. Funds may not be transferred from an escrow trust account to a brokerage s trust account or vice versa without written permission of the principals. A brokerage may place trust funds in an interest bearing account if: 11

The account is federally insured The account is designated as a client s trust account There has been prior written notice from all parties that have an interest in the trust funds Note: Written approval must be given by parties that have an interest in the funds. The approval must state the interest earnings from the account and to whom the interest will be paid. This interest may be paid to the seller, the buyer or the principal broker. Records A principal broker must keep a record of all funds received. They must: Account for all of the funds received Make copies of any check that is received Maintain a copy of the receipt for the deposit (a copy of the receipt also goes to the person the earnest money is being held for) Example: John, a broker for ABC Realty collects an earnest money check from his buyers. The purchase and sale agreement contract states that the earnest money must be deposited within two days of mutual acceptance. The earnest money check is payable to ABC Realty. John complies with this timeline and submits the check to his office. John forgets to tell the office manager, who is also in charge of the trust account, that the check was an earnest money check. The office manager deposits the check into the brokerage s regular checking account and not into their trust account. The brokerage is guilty of commingling the funds. Disbursements Checks from the trust account must bear the words clients trust account and be prenumbered. All voided checks should be retained. Funds from a brokerage s trust account may only be disbursed: To persons, as directed in writing by the parties To persons as directed by court order To a court of law for an earnest money dispute. This is accomplished when the principal broker files an interpleader action with the courts. Money cannot be disbursed from a trust account until a check clears. EXAMPLE: ABC Real Estate Investments was holding earnest money funds in trust for the Brown/Smith transaction. The transaction terminated because the Smith s did not approve of the structural inspection. While the purchase and sale agreement stated that the earnest money was to be returned to the buyer if they did not approve of the structural inspection, a check could not be disbursed to the Smith s until their check cleared. If the Smith s check bounced, the trust account would not have the funds it thought it had. In this case, if a check was disbursed to the 12

Smith s, funds would have been disbursed from other client s funds. This is illegal and is called conversion of funds. Maintenance of Records A principal broker must maintain a ledger of all trust account activity for deposits and disbursements called a receipt and disbursement journal and must: Account for all checks (including voided checks) Track all forms of consideration including promissory notes Be responsible for all transmittals So that the principal broker can trace funds, they must maintain a ledger account. This is a separate record of all transactions for a particular account. A broker must issue a receipt (in duplicate) for all funds received and keep a copy the receipt in a transaction file and give the other receipt to the payor. Deposits to the trust account should be filled out in duplicate. One copy will go to the bank and the other copy should be retained by the broker. The bank will stamp the broker s copy. The bank will send a statement for each trust account every month. At least once per month the broker must reconcile each client s trust account. This reconciliation has three components: The bank statement, adjusted for any outstanding checks The balance of the receipts and disbursements as of the bank statement closing date The sum of all of the balances of the individual trust account ledgers as of the bank statement closing date. All 3 balances must be equal to each other. The purpose of reconciliation is to explain the difference in the bank statement and the receipts and disbursement balance which takes into account checks that were written and have not cleared the bank. The checks that have cleared the bank are compared to the record of disbursement. The broker must then document the reconciliation, showing the reconciled bank balance which equals both the sum of the clients ledger accounts and the balance shown in the record of receipts and disbursements. He can use a reconciliation form developed by the Agency or the reverse of the statement provided by the bank. The Agency form requires him to subtract the total amount of outstanding checks (checks written prior to the date of the statement, but which do not appear on the statement) from the bank s statement balance. Then he enters the account balance as shown in his records. If the result of the subtraction produces a figure equal to his account balance, the bank statement is reconciled. Aside from an occasional deposit in transit, which is handled in the same manner, there should be no other reconciling factors. A broker must: Identify and reconcile any discrepancies 13

Sign and date the completed reconciliation Retain the reconciliations, bank statements, receipt, ledgers and journals for six years. Security Deposits This provision gives the landlord some protection against loss from property damages caused by the tenant or loss caused by a default from the tenant. In Oregon, a security deposit can only be charged if the lease or rental agreement is in writing. If a security deposit is charged a checklist about the condition of the property is required. This checklist must be signed by both the landlord and the tenant. All security deposits are required to be kept in a trust account by the landlord or an authorized representative of the landlord. At the end of the rental period or lease period the landlord must return the deposit and inform the tenants specifically why all or part of the deposit is being retained. A landlord may keep a portion of the deposit to cover unpaid rent, property damage or cleaning, but cannot retain a deposit due to normal wear and tear. All non-refundable deposits must be specified in the lease. Examples of this might be a cleaning fee for carpets or a pet deposit. Common Violations and Case Study The following is from the Oregon Real Estate New-Journal February 2015: The Oregon Real Estate Agency randomly selects clients trust accounts (CTAs) to audit by mail. Licensees who hold selected CTAs must submit records to the Agency. The Agency then reviews the documents for compliance with statute and rule. Several common violations were found in the CTA Mail-in Audits completed in 2014. The Agency is addressing these violations in this article to assist property managers and principal brokers in making sure their CTA records comply with law. (1) No monthly three-way reconciliation. (OAR 863-025-0025) Licensees must complete a three-way reconciliation monthly. They must maintain the reconciliation with the supporting documents for six years. The three components of a reconciliation are: (a)the check register or a receipts and disbursement journal (b)the owners ledgers or tenants ledgers (c)the bank statement (2) No documentation for check register or receipts and disbursement journal entries. (OAR 863-025-0040) Each check written from a CTA must be documented in the check register or the receipts and disbursements journal with the following: Date check was written Check number Payee Purpose of disbursement Owners identifying code Each deposit into a CTA must be documented in the check register or the receipts and disbursements journal with the following: Date funds were received 14

Amount of the funds Purpose of funds Identity of the person who tendered the funds Date the funds were deposited. (3) No detail provided for owners ledgers. (OAR 863-025-0055) Licensees must not only report the owners ledgers month end balances, but they must also provide the details for each ledger. For each deposit of funds, the ledger must include: The amount of funds received The purpose of the funds and identity of the person who tendered the funds The check number, cash receipt number or a unique series of letters and/ or numbers that established an audit trail to the receipt of funds The date the funds were deposited For each disbursement, the ledger must have: The date the funds were disbursed The amount of funds disbursed The check number or bank-generated electronic tracking number The payee of the disbursement The purpose of the disbursement The balance after each recorded entry (4) Commingling the licensee s funds in the CTA. (ORS 696.247, OAR 863-025-0025 and OAR 863-025-0065) Licensees mixed their personal monies with their clients funds in the CTA. This includes running their personal rental income through the CTA to allowing banking fees to be charged to the CTA. (5) Incorrectly named CTA bank account. (ORS 696.241 and OAR 863-025-0065) A majority of the CTAs are named incorrectly, many using the word Clients without an apostrophe. All CTAs must be labeled as a Clients Trust Account, with an apostrophe after the s. (6) No Notice of Clients Trust Account form. (ORS 696.245) Licensees must maintain a completed Notice of Clients Trust Account form, signed by a bank representative. (7) Failure to notify the Agency within 10 days of opening or closing a CTA. (ORS 696.241). Licensees are required to keep an up-to-date list of CTAs in their elicense account. This meets the notification requirement." Case Study The following is an administrative action in the matter of the real estate of Cody Clark Halsey. In 2007, Halsey purchased Cascade Community Management, LLC (CCM) and listed CCH Enterprises as the Manager and Halsey as a member with the Oregon Secretary of State. Halsey was also listed with the Secretary of State as the president and secretary of CCH Enterprises. In 2008 CCH Enterprises, Inc. the parent company for CCM, purchased Peters and Company Real Estate Management. Then Peters and Company formally changed their name to Noah and Associates Community Management, Inc. with Halsey listed as the president. Halsey was licensed as a property manager doing business under the registered name of: CCM, CCH Enterprises Inc., and Noah and Associates Community Management Inc. 15

In May of 2014 the OREA received information that Halsey may be embezzling funds from CCM clients by deducting expenses from owner accounts for invoices that were not paid to vendors. In an investigation, a client named Van Horn who owned 5 properties in Portland and 1 in Milwaukie was billed for utility payments allegedly made by CCM for his property in Milwaukie. Van Horn was charged for payments made to the Portland Water Bureau, but Milwaukie gets service from the City of Milwaukie and not from Portland Water Bureau. The investigation also revealed that Van Horn had been paying his water bill over the phone with his credit card every month. All client's trust account three-way reconciliation was prepared by Brenda Bryan on behalf of Halsey. The journal showed they were made payable to the Portland Water District for Van Horn. Halsey was asked via the investigation to provide copies of the front and back of 5 checks. All 5 of these checks were made payable to CCM that amounted to about $60,000 according to Halsey who admitted to the crime. Note: While the Trust Account, client ledgers and 3-way reconciliation had been performed by someone other than Halsey, he was still ultimately responsible for them as a licensed property manager. Violation By creating false checks payable to the Portland Water Bureau when the property was serviced by a different service provider, and then creating and signing checks payable to CCM for the same amount, Halsey violated the law which states z'a licensee may be subject to discipline if they have demonstrated incompetence or untrustworthiness in performing any act for which the licensee is required to hold a license. Further review of the owners ledger of the trust account provided by Halsey show multiple examples of owner ledgers being charged twice for the same check number and did not comply with the requirements of OREA and the law. Also, the 3 way trust account reconciliation showed a discrepancy of a negative $46,650.51 which was also a violation of the law. The tenant's security deposit ledger had also been tampered with. Note: A 3 way trust account reconciliation must take place each month and the balances are not allowed to be in the negative. Explanations given by Halsey for the discrepancies stated that numerous checks had cleared the bank twice, but had only been entered on the ledger once. This was not true. Disciplinary Action 16

Based on the findings OREA revoked Halsey's property manager license on the grounds that there was significant damage or injury and incompetence in the performance of professional real estate activity or exhibits dishonesty or fraudulent conduct. OREA also reserved the right to investigate or pursue additional complaints or allegations that may be received in the future regarding Halsey. Note: Revocation is permanently the taking away of a licensing as opposed to suspension, which is the temporary removal of a license. Note: The student is encouraged to read the details of this case at: http://www.oregon.gov/rea/ docs/oren-j/oren_j_august_2015/halsey_cody_2015.pdf. Check your understanding Use this link to open a short quiz: https://www.bookwidgets.com/play/z34rg Copyright 2016 Simplify CE, LLC 17