Accountancy & Management: Fraud in law firms brings 40m pounds compensation claims: Neasa MacErlean finds auditors sharing blame for the increasing misdeeds of solicitors

NEXT month the Solicitors Complaints Bureau will publish its annual report for the past year, indicating how much money the profession had to pay to bail out the defrauded clients of solicitors.

Fraud by solicitors is increasing. So is concern that the auditors are failing to spot potential disasters. As in the corporate world, the auditors get a share of the blame for the collapses.

The amounts are not small. It is estimated that last year the Law Society's compensation fund received claims totalling pounds 40m from members of the public who had been defrauded by their solicitors.

Most of the money had gone missing in the most straightforward way. Short of cash to run their practices, the solicitors had 'borrowed' money from funds held on behalf of their clients.

As with large corporate frauds, one of the first questions to be asked is whether the auditors were caught napping. Bob Butler, head of the Law Society's monitoring unit, believes that in a small but signficant number of cases they were.

He says: 'We have found that on a number of occasions the reporting accountants gave firms a clean bill of health when, if you look more closely, there is no way they could have done that if they had done the job properly.'

Most of the accountancy firms have performed their 'fairly routine task' properly, he believes. But even if just 1 per cent are negligent the problems can be enormous. Last year's pounds 40m claims resulted from the actions of just 76 firms - less than 1 per cent of the total number of 10,000 practices in England and Wales.

The Law Society has now decided to step up its own monitoring activities. During 1993 the monitoring unit will make 650 surprise visits to firms deemed most at risk from fraud, sole practitioners in particular.

First task of the inspectors will be to examine for themselves procedures for handling client money. On the occasions they find something is awry they will examine the role that independent accountants played.

Mr Butler has already seen cases of blatant negligence. Firms have been given a clean bill of health despite the fact that there were holes in their accounts and books that did not balance.

The cause is usually a simple one, he says: 'In most cases it would be the fact that the accountants have put someone junior on to the job. The partner has not exercised reasonable control and things have been missed.'

Every year the Law Society disqualifies two or three accountants from performing the audit role. But in future it will refer these and other troublesome cases to their professional bodies - the Institute of Chartered Accountants in England and Wales and the Chartered Association of Certified Accountants.

Auditing law firms should, in theory, be a straightforward job. The Law Society requires only that the accountants examine accounts relating to client funds.

But, despite the fact that they frequently hold huge sums of money on behalf of clients, the accounting and financial awareness of many solicitors is extraordinarily poor.

Rafi Brasher, the bank manager who specialises in law firm accounts at Coutts in London, says: 'Solicitors have only become modernised in the past 10 years, and those are the ones at the forefront.' Many firms, he says, are still wary of their own computerised systems and run a parallel set of manual ledgers.

Claims on the compensation fund rose by nearly a third last year. The Solicitors Indemnity Fund - a parallel fund to the compensation fund - received claims for about pounds 12m, mostly claiming negligence but some also alleging dishonesty.

Some accountancy firms believe that the Law Society itself should take a share of the blame.

William Barnes, of Touche Ross, a specialist in law firm auditing, says: 'The society has not been very rigorous in the past in following up qualified audit reports on a regular basis.'