The Earnest Money That Took a Detour
Cascade Homes Realty is a two-broker firm. On Tuesday, March 3, buyer's agent Kim receives a $15,000 earnest money check from her buyer, drawn on the buyer's bank and payable to "Cascade Homes Realty." The firm's trust account checks are being reprinted, so on Thursday, March 5, Kim deposits the check into the firm's general business account. On March 10 the bookkeeper pays a $600 sign-printing invoice from that general account; the balance there includes the $15,000. On March 20 the transaction collapses because the inspection fails, and the buyer demands the money back. The firm wires $15,000 on March 27 from commissions received that week. Throughout, the designated broker has kept a $2,000 "reserve" in the trust account to cover bank fees and once used $300 of it to pay a notary.
1. Identify each violation in the fact pattern and name the principle each one breaks.
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Four problems, escalating in severity.
1. Deposit into the wrong account. Earnest money is trust funds from the moment it is received. Putting it in the general business account is commingling-the firm's money and the client's money in one pot-no matter how pure the intent. The Commission's trust rules require a designated trust account and prompt deposit; "the checks are being reprinted" is not an exception.
2. Paying firm expenses from the pot. The $600 sign invoice was paid from an account holding the buyer's $15,000. That is conversion of client funds, not just commingling. Later replacement does not undo it.
3. Restoring the money from commissions. Repaying the buyer only when commissions arrived proves the funds were never intact. That is a textbook conversion fact pattern and it is very hard to explain to an auditor.
4. The $2,000 "reserve." A small cushion for bank service charges is one thing. A $2,000 standing balance of firm money in trust, disbursed to pay a notary without a transaction ledger entry, is commingling plus an undocumented disbursement. Legitimate closing costs come off a transaction ledger, documented, not out of a slush fund.
2. What records and controls should have existed?
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At minimum:
- One designated trust account, with the bank and account number on file with the firm's records.
- Monthly three-way reconciliation: adjusted bank balance equals book balance equals the sum of all individual client ledgers.
- A separate ledger per transaction and per client, showing every receipt and disbursement.
- A receipt for every deposit, identifying the property, the parties, the amount, and the date received.
- Sequential checks with a disbursement journal, and dual authorization for wires-wire fraud is the single most common way trust funds vanish.
- Written release instructions before any payout. A buyer's demand alone is not authority. The purchase and sale's release mechanism requires both parties' agreement; if the parties dispute entitlement, the firm holds the funds and interpleads rather than guessing whose money it is.
None of this is exotic. The firm's failure was not a recordkeeping lapse; it was the absence of a control that would have made the lapse impossible.
3. What is the firm's exposure, and what should the designated broker do now?
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Exposure runs three ways: license discipline (the Department can fine, suspend, or revoke; trust violations are the highest-risk category in brokerage), civil liability to the buyer and potentially the seller, and potential criminal exposure for conversion. The designated broker's supervisory failure is its own violation even though the broker never touched the money.
Do now, in this order:
- Stop all trust account activity by the current signers and change credentials.
- Reconstruct every client ledger from bank records, not from memory.
- Restore any shortfall from firm funds immediately and document the restoration.
- Retain counsel and consider voluntary disclosure to the Department-voluntary disclosure before an audit or a buyer complaint is materially better than after.
- Audit every other transaction Kim and the bookkeeper touched in the same period. One detour is rarely the only one.