How to mitigate accounting and legal risks in law firm bookkeepingHow to mitigate accounting and legal risks in law firm bookkeeping

Dewey & LeBoeuf, once one of the largest and most prestigious law firms in the world, collapsed in 2012, filing for bankruptcy with over $245 million in liabilities.A firm that employed over 1,000 lawyers across 26 offices worldwide—gone, almost overnight.

But the financial collapse wasn’t the only disaster; the firm’s top executives faced criminal charges for fraud, falsifying business records, and securities violations.

How does a firm so big, with the best legal minds, end up drowning in regulatory violations, accounting failures, and lawsuits?

The answer is surprisingly simple: poor financial controls, weak compliance practices, and failure to mitigate legal risks. Dewey & LeBoeuf made huge financial commitments, especially by guaranteeing multi-million-dollar partner compensation packages, without ensuring they were legally and financially sustainable.

When the 2008 financial crisis hit, clients cut back on legal spending, and instead of fixing internal inefficiencies, the firm manipulated financial records to hide losses. When the truth came out, executives were indicted, lawsuits followed, and the firm collapsed under its own weight.

So, how can law firms—large or small—protect themselves from the same fate? Let’s explore the most common legal risks in law firm bookkeeping and, more importantly, how to mitigate them before it’s too late.

1. Strengthen internal controls to prevent fund misuse

Weak internal controls in a law firm can create chaos, opening the door to fraud, costly mistakes, and serious legal trouble. Without proper checks in place, money can go missing, invoices can be mishandled, and client trust funds can be mismanaged—sometimes by accident, sometimes on purpose.

Even slacking off on financial duties can be dangerous. If employees aren’t held accountable, small errors add up, financial reports become unreliable, and the firm loses control of its own money.

Worse yet, if trust accounts aren’t managed properly, state bar regulators can step in and some lawyers have been disbarred just for bookkeeping mistakes.

Here’s how to avoid this from happening:

Divide financial responsibilities to prevent fraud

No single individual, whether a partner, accountant, or administrator, should have sole authority over authorizing, recording, and executing financial transactions.

Here’s how you can do it:

Separate duties: One person should be responsible for approving expenses, another for recording them, and a third for making the payment. This ensures multiple sets of eyes are on every transaction.
Assign oversight roles: A senior partner or an external accountant should review bank statements and transaction logs each month to spot inconsistencies.
Rotate financial roles: Periodically switch financial duties among staff so that no one person has long-term, unchecked access to firm accounts.

This way, fraud becomes much harder to pull off, and errors are caught before they become major financial risks.

Require dual authorization for high-value transactions

Every large transaction, such as fund transfers exceeding $10,000, should require two senior-level approvals to prevent unauthorized withdrawals or fund misallocations. Many banking platforms and legal accounting software allow you to set dual authorization for payments, ensuring no one can send money without a second confirmation.

Ban personal use of firm accounts

A strict zero-tolerance policy should be in place for using law firm accounts for personal expenses. If a lawyer or staff member needs to cover a business cost out-of-pocket, they should submit a formal reimbursement request rather than casually charging the firm’s account. This prevents blurred financial boundaries that could lead to financial misrepresentation and compliance violations.

Use appropriate accounting software

Manually tracking every transaction in a law firm is nearly impossible. If you’re only reviewing expenses at the end of the month, you might miss fraudulent transactions, accidental overpayments, or misclassified expenses. Solutions like Clio, LeanLaw, and PCLaw can flag irregular transactions and generate automated financial reports to help law firms maintain visibility over their cash flow. Limit who can approve, edit, or delete transactions within the software, preventing unauthorized changes.

2. Ensure full tax compliance to avoid IRS penalties

Tax mistakes can be costly for law firms—not just financially, but legally. A simple misclassification of income, an overlooked tax filing, or a late payroll tax payment can trigger IRS audits, hefty fines, and potential legal consequences.

How much can a tax violation cost your firm?

Late filing penalties: The IRS charges 5% per month on unpaid taxes, up to 25% of the total tax due.

Failure-to-pay penalty: 0.5% per month on unpaid taxes, up to 25%.

Under-reported income penalties: If a firm underreports its taxable income by more than 10%, the IRS imposes a 20% penalty on the unpaid amount.

Failure to pay employment taxes: If a law firm does not properly withhold and pay payroll taxes, the IRS can impose fines, interest, and personal liability on managing partners.

Steps to take:

Conduct monthly tax reviews. Reviewing billing records, revenue classifications, and payroll tax filings every month prevents miscalculations that could trigger IRS audits or fines.
Keep detailed financial records for at least seven years. The IRS can audit tax returns dating back six years if they suspect fraud, making proper documentation essential.
Take help from an expert in law firm bookkeeping. Partner with experts providing specialized bookkeeping for law firms like CoCountant. These are professionals who help law firms ensure compliance with IRS tax laws, ABA accounting standards, and state bar regulations.

3. Conduct regular financial audits to detect risks early

Even the most organized law firms can fall victim to hidden financial risks, whether it’s billing errors, unnoticed trust account discrepancies, or even internal fraud. The only way to catch these issues before they spiral out of control is through regular financial audits.

Steps to take:

Schedule independent audits annually. Having an external audit from a certified public accountant (CPA) or forensic accountant who specializes in law firm finances once per year provides an objective review of financial records.
Conduct monthly internal audits. Reviewing payroll records, trust accounts, and expense reports on a monthly basis helps detect irregularities before they become major liabilities.
Use AI-driven financial monitoring. Modern accounting tools with machine learning algorithms can automatically flag suspicious patterns, double billings, or unauthorized withdrawals.

4. Safeguard client trust accounts with automated reconciliation

Mishandling client funds is one of the most common reasons why attorneys face disbarment. In fact, the ABA Journal states that more than 1,700 California lawyers were suspended for failure to comply with new trust account rules.

This stat is your biggest reminder of why proper trust account management is non-negotiable. Law firms must comply with ABA Model Rule 1.15, which requires lawyers to separate client funds from business operating accounts.

Steps to take:

Perform three-way reconciliation. Trust account balances must match both the individual client ledgers and bank statements—a three-step verification process that prevents errors and fraud.
Limit access to trust accounts. Only authorized personnel should have access to client funds, and transactions should require dual verification.
Use automated fund tracking. Legal accounting tools track, categorize, and reconcile trust deposits automatically, reducing compliance risks.

The takeaway?

Financial mismanagement doesn’t start as a crisis—but it always ends as one. A minor bookkeeping error, a trust account discrepancy, or a misclassified tax payment can quickly escalate into an audit, a lawsuit, or even disbarment.

The solution? Stay proactive. Law firms must stay compliant, conduct regular financial audits, and enforce strict internal controls to prevent costly mistakes. With increasing IRS scrutiny and stricter state bar regulations, ignoring these risks isn’t just careless—it’s dangerous.

The firms that thrive aren’t just great at practicing law; they’re great at protecting their finances. Is yours?