Chapter 35 - Handling Escrow Funds
A broker has how many days to notify the Commission when they set up any escrow or trustee account?
14 days
What is the retention period for maintaining escrow account records?
3 years
Within how many days must the broker deposit the escrow funds into a lawful escrow account maintained by the real estate broker?
7 days
Types of Records at Broker Should Retain
Agency agreements and disclosures Listing agreements and any extensions thereto Real Property Seller Disclosure Statement, when applicable Purchase agreements and any addenda thereto Estimated closing cost disclosures, when applicable The Closing Disclosures (typically are provided by the lender or by the settlement agent) Checkbooks and checkbook registers Checks - canceled, voided, and unused Financial institution statements and reconciliations Deposit slips - originals and/or duplicates Bookkeeping system - general ledger and sub-ledger Any other documents pertinent to the transaction.
Records: Inspection
All escrow account records and transaction files are subject to audit and examination by authorized personnel of the Real Estate Commission. When Commission examiners request documents and/or access to inspect escrow accounts, the broker is obligated to comply. On demand, the Commission may examine the accounts and records at any time. Brokers should keep the files and records in a neat and orderly fashion. Brokers must make books, accounts, and records available for audit, examination, inspection, and copying by a Commission representative during regular business hours. Typical documentation requested during an audit includes copies of all transaction files, bank and reconciliation statements for all escrow accounts, and salespersons' licenses and broker-agent independent contractor (employment) agreements. Upon request, paper copies of a document must be provided to the Commission at the licensee's expense. [DC Code §42-1704(c)]. The examiners do not review the general business records of the broker, and it is recommended that those records be maintained separate from the escrow account records. The Commission may suspend or revoke the license of any real estate licensee if he or she knowingly destroys, alters, conceals, mutilates, or falsifies any of the books, papers, writings, documents, or tangible objects that are required to be maintained or that have been sought in connection with an investigation or examination of a real estate licensee by the Commission.
Handle Escrow Money Properly
All escrow funds are to be deposited in a timely manner, whether the funds were received as part of a sale or lease negotiation or as a property management function. Before the funds are actually deposited into a bank escrow account, they should be adequately secured in a locked cash box, locked filing cabinet, or other secure location from where they are not likely to "disappear." A broker should have a clear office policy regarding the care of the escrow funds from the time they are received to the time they reach the bank. This policy should be carefully monitored within the office. While providing real estate brokerage services, real estate salespersons or associate brokers who accept escrow funds on behalf of their broker, promptly must give the escrow funds to their broker. Within 7 days the broker must deposit the escrow funds into a lawful escrow account maintained by the real estate broker. If agreed by both buyer and seller in writing, a title company or settlement attorney may hold the initial deposit. The escrow funds can only be used for purposes authorized by the funds' owners and the licensee must maintain accurate, complete, lawful, and up-to-date records.
Handling Escrow funds: Disbursements
All funds received by brokers at or before closing are considered escrow funds and must be deposited and disbursed from the escrow account at the time of closing. Therefore, all funds pertaining to a particular real estate transaction should be disbursed on the date of closing. Brokers and third-party closing agents cannot disburse any funds or pay any expense prior to a real estate closing without the written consent of all parties having an interest in the funds. This consent must authorize the broker to use all, or part, of the escrow funds to pay certain closing expenses prior to closing.
What is an electronic signature?
An electronic signature (e-signature) is as any electronic process signifying an approval to terms, and/or a document, presented in electronic format.
Define escrow account.
An escrow account is a bank account managed by a person on behalf of a beneficiary.
Disbursements. Earned Compensation at Closing
Brokers can NEVER be paid any part of their compensation or consideration, prior to the closing of the real estate transaction. Brokers are not entitled to compensation or consideration until the transaction is closed or otherwise consummated. Any commission splits to other real estate brokers or sales associates are not paid from the escrow account. All commission splits with sales associates or a cooperating selling broker must be paid from the listing broker's operating account and not the escrow account. When the selling broker receives compensation, it should be deposited directly into the operating account of the selling broker and disbursed, if necessary, from there.
Handle Escrow Money Properly: Disposition
Brokers must keep thorough and accurate records to account for escrow money and maintain all records of escrow money in a secured area within the broker's office. When the duty of the broker to maintain escrow money in an account terminates, the broker accounts for all escrow money and reconciles the escrow account. The law directs the broker to retain the funds in an escrow account until one of the following circumstances occurs: The real estate transaction for which the escrow money was entrusted is consummated or terminated. The escrow holder of real estate broker receives proper written instructions directing withdrawal or other disposition of the escrow money. A court orders the disposition of the escrow money.
Real estate brokers should maintain a sufficient "paper trail" regarding the escrow funds. Name three records that brokers must maintain.
Checkbooks and checkbook registers Checks - canceled, voided, and unused Financial institution statements and reconciliations Deposit slips - originals and/or duplicates Bookkeeping system - general ledger and sub-ledger
Explain difference between commingling and conversion.
Commingling is the illegal act of mixing a broker's personal funds with those of a client or a beneficiary. Conversion is using money in the escrow account for the benefit of anyone other than the rightful owner.
List typical documentation requested during an audit made by the Commission.
Copies of all transaction files, bank and reconciliation statements for all escrow accounts, and salespersons' licenses and broker-agent independent contractor (employment) agreements.
How does the DC Code define escrow funds? .
DC Code §42-1702(6B) defines escrow funds as earnest money deposits for purchase of residential and commercial property and security deposits for rental of residential and commercial property
Provide an example of commingling.
Depositing escrow money into the broker's general or personal bank account rather than into the escrow account.
What are Non-Escrow Funds?
Do not confuse commissions, general operating funds, and rents from broker-owned real estate with escrow funds. This money is non-escrow funds and cannot be deposited into escrow accounts. Non-escrow funds are a broker's personal funds and any company funds received by the broker for services performed, such as brokerage commissions, leasing fees, property management fees, etc. These funds belong to the company/broker and must always be maintained separately from escrow funds. These funds should not be mixed with escrow funds. Because most financial institutions levy a service charge on a checking account, the Commission permits a broker to keep a nominal amount of his or her personal funds to cover these charges. The personal funds are to be used for the accounting of transaction fees assessed against the escrow account. Transaction fees are more commonly identified as monthly service charges, check printing charges, insufficient fund check charges, etc. However, brokers should not keep excessive amounts of their personal funds in the escrow account because that could cause the trust nature of the account to be placed in jeopardy. Company operating accounts are established in the name of the broker or company and should be used to hold only broker or company funds. No escrow funds should ever be deposited into these accounts. The bank records should indicate that the account is owned by the broker or company and the records should reflect that entity's federal tax identification number.
What is another name for a "checkbook register"?
General ledger
What type of funds must be available for disbursement at the time of closing a real estate transaction?
Good funds
Records: Storage on Alternative Media
Historically, the records were paper files for transaction files or, in the case of computerized bookkeeping systems, on computer. However, with the advance of technology, records can now be stored securely on alternative forms of media, e.g. compact disk, optical disk, microfilm, the Cloud, thumb drive, etc. The Commission allows alternative media storage of required records if the records can readily be printed when requested by the Commission and that the records, once stored on the alternative medium, cannot be rewritten. Records may be retained in electronic form if specified criteria are met. A record may be stored electronically if: the stored record cannot be erased or edited. the stored record is made or preserved as part of, and in the regular course of, the broker's business. the original record from which the stored record was copied was made or prepared by the broker or the Broker's employees at or near the time of the activity described in the record. the custodian of the record can identify the stored record, the mode of its preparation, and the mode of storage. the electronic storage system contains a reliable indexing system that provides convenient access to the document or record, appropriate quality control of the storage process, and chronological arrangement of stored documents or records.
Escrow account Bookkeeping. Computerized Systems
If brokers use a computerized bookkeeping system, it must provide the same bookkeeping records as if the broker were maintaining a manually posted bookkeeping system. The system must always be posted current. The computer program must be capable of generating a general ledger that accounts for the income and expenses relating to all transactions on a day-to-day basis, and sub-ledgers that account for the income and expenses relating to each specific transaction on a day-to-day basis. The ledger and sub-ledgers must be a debit/credit/ledger balance format, with a specific ledger balance identified after each bookkeeping entry. The computer program must also be capable of generating, upon request, a current Trial Balance that identifies the ledger balance of escrow funds for a specific transaction as of a specific date. This Trial Balance report should be attached to the financial institution statement and used only to check that the sum of the individual sub-ledger funds equals the reconciled financial institution balance and the checkbook balance. The Trial Balance report, and any other financial-type report, will not be accepted as a bookkeeping system itself, because it does not identify the specific bookkeeping entries that were required to arrive at the ledger balance. The Trial Balance report will be used only as supporting documentation for the bookkeeping system.
Broker's Escrow Account
It must be designated as an escrow account in the name of the broker as trustee. It must be maintained with a bank or recognized depository located in the District. It must be insured by one of the following: (1) Federal Deposit Insurance Corporation (2) Federal Savings and Loan Insurance Corporation (3) National Credit Union Administration (4) Credit Union Insurance Corporation Each escrow account must be registered with the Real Estate Commission. Whenever possible, the broker should use an employer's tax identification number instead of a personal social security number to establish an escrow account. Although it is not mandatory, it is suggested that each broker involved in the management of real estate establish a separate escrow account for all property management activities, in addition to the escrow account established for real estate brokerage activities.
Escrow Account: Interest
Money held in an escrow or trust account for 90 days or more shall earn interest beginning on the 91st day until the day that the transaction is consummated or terminated. Interest owed is earned at the highest of the following rates: the legal maximum rate under federal law for interest on ordinary savings deposits in commercial banks; the rate on the account in which the escrow is deposited; or the rate on the certificate of deposit or other security given as the escrow or trust. The financial institution cannot subtract a service fee of more than $15.00 from the interest into which the escrow or trust funds are deposited. [DCMR 2702.9 to 2702.11].
List two types of non-escrow money.
Non-escrow funds are a broker's personal funds and any company funds received by the broker for services performed, such as brokerage commissions, leasing fees, property management fees, etc
Broker Responsibility for Escrow Accounts
Proper accounting for escrow funds and adequate record keeping are basic to the management of a brokerage office and the legal responsibility of the broker. Failure of a real estate broker to properly manage or account for escrow funds belonging to others can result in license revocation whether that failure is one of ignorance or negligence, whether intentional or unintentional. The broker is personally responsible for the supervision and maintenance of the escrow accounts and records. Therefore, the broker must take an active role in supervising the acts of all persons who handle escrow funds and escrow account records. This could be achieved by performing a bank statement reconciliation and a trial balance at random intervals during the month to monitor the proper handling of escrow funds. Inadequate records or failure to maintain control of the escrow funds can result in internal theft, commingling of funds, misuse of escrow funds, litigation, and/or disciplinary action. The use of an outside recordkeeping or accounting service does not eliminate the need for broker supervision or substitute for the broker's fiduciary responsibility. Brokers are responsible for notifying the Real Estate Commission Office, in writing, whenever an escrow account is closed. The written notification should include the account number, the name of the financial institution, and the date on which the account was closed or will be closed.
Disbursements. "Good Funds" at Closing
Real estate brokers, as well as other entities authorized to close real estate transactions, are required to have "good funds" available for disbursement at the time of closing a real estate transaction. "Good funds" Lawful money of the United States; Wired funds when unconditionally held by the real estate closing agent; Cashier's checks, certified checks, bank money orders, or teller's checks issued by a federally insured financial institution and unconditionally held by the real estate closing agent; or United States treasury checks, Federal Reserve checks, federal home loan financial institution checks. The closing agent must ensure that sufficient funds are available, at all times, to cover any check issued on the date of issuance.
Records - Retention Period
Since the retention period for escrow accounts is 3 years, it is logical to retain all transaction documents for three years. Typically, the retention period runs from the date of the closing of the transaction or from the date of the listing if the transaction is not consummated. A licensee who provides property management services should keep records for 3 years following the termination of a management agreement. The Commission can discipline a licensee for the failure to properly maintain escrow account records. DC Code §47-2853.197(22). "Failed to keep an escrow or trustee accounting of funds deposited with him or her relating to real estate and business transactions, and to maintain records for a period of 3 years, showing to whom the money belongs, the date of deposit, the date of withdrawal, to whom paid, and other pertinent information as the Commission may require by regulation; the records to be made available to the Commission on demand or upon written notice given to the depository."
Escrow Funds
The DC Real Estate Commission periodically conducts financial compliance audits of real estate brokerages. The primary focus of audits is the handling of escrow funds by licensees and compliance with DC laws and regulations. The proper handling of escrow funds is one of the most common problems that brokers have. Often, the problem is that brokers do not have the expertise to maintain proper accounting records and end up with shortages in their escrow accounts. First, a licensee must be able to identify escrow funds and distinguish it from non-escrow funds. DC Code §42-1702(6B) defines escrow funds as earnest money deposits for purchase of residential and commercial property and security deposits for rental of residential and commercial property. The standards for receiving and handling escrow funds, are contained in the Code of the District of Columbia and the Regulations of the DC Real Estate Commission. These laws and regulations establish the requirements you must meet when handling escrow funds in escrow accounts. They establish the safeguards required to maintain the integrity of the escrow account. Click and open Escrow Accounts. After reviewing, return to your course.
Federal Deposit Insurance Corporation's Requirements
The custodial account must be clearly identified as an "Escrow account." The bookkeeping records of the broker must be accurately maintained and posted on a current, or daily, basis for the purpose of determining the financial interest of each principal on an ongoing basis. The following excerpt from 12 CFR Part 330 - Deposit Insurance Coverage - Interpretation of the Rules and Regulations of the Federal Deposit Insurance Corporation deals with the recognition of deposit ownership in custodial accounts.
Name a requirement to establish an escrow account.
The escrow account must be established in an FDIC-insured financial institution located within the District and clearly be identified as an escrow account.
"330.5 Recognition of Deposit Ownership in Custodial Accounts"
The opinion of the Board of Directors has been requested as to whether a fractional or percentage computation of the interests of owners of commingled funds on deposit in custodial accounts in financial institutions insured by the Federal Deposit Insurance Corporation meets the requirements of 330.1. Section 330.1 provides that if the name and interest of an owner of any portion of a specifically designated custodial deposit is disclosed on the records of the person in whose name the deposit is maintained, and such records are maintained in good faith and in the regular course of business, such owner will be recognized for all purposes of claim for insured deposits to the same extent as if his name and interest were disclosed on the records of the financial institution. The Board of Directors has concluded that, if the records of the depositor, maintained in good faith and in the regular course of business, reflect, at all times, the name and ascertainable interest of each owner in a specifically designated custodial deposit, such interest may be determined on a fractional or percentage basis. This may be accomplished in any manner which indicates that where the funds of an owner are commingled with other funds held in custody and a portion thereof is placed on deposit in one or more insured financial institutions, his interest in a custodial deposit in any one insured financial institution would represent at any given time the same fractional share as his share of the total commingled funds."
Name one circumstance that allows the broker to release escrow money from an escrow account.
The real estate transaction is consummated or terminated. The escrow holder of real estate broker receives proper written instructions directing withdrawal or other disposition of the escrow money. A court orders the disposition of the escrow money.
Describe how a record can be stored electronically.
The stored record cannot be erased or edited. The stored record is made or preserved as part of, and in the regular course of, the licensee's business. The original record from which the stored record was copied was made or prepared by the broker or the broker's employees at or near the time of the activity described in the record. The custodian of the record is able to identify the stored record, the mode of its preparation, and the mode of storage. The electronic storage system contains a reliable indexing system that provides convenient access to the document or record, appropriate quality control of the storage process, and chronological arrangement of stored documents or records.
Records: Canceled Checks and Deposit Slips
Until the advent of "paperless" transactions, the records retention requirement included not only the bank statements, but also the canceled checks and deposit slips. Today, financial institutions have online banking, which allows their customers to download bank statements and images of canceled checks. They also will provide clients with micro-images of the canceled checks or deposit slips in lieu of returning original documents. If the images of the canceled checks and deposit slips are too small and hard to read, brokers should include sufficient information pertaining to the transaction on the original deposit slip and check so that the image of the canceled check or deposit slip can be properly traced to the real estate transaction. Typical information should include the date of the document; the correct dollar amount; the name of the buyer/tenant or seller/landlord; and the property address.
Handle Escrow Money Properly: Disputed Earnest Money Deposits
When a transaction is not consummated, disputes can arise between the seller and the buyer over the return or forfeiture of the earnest money deposit (EMD). When the seller refuses to complete the transaction or if it is not the buyer's fault that the sale does not close, then the EMD will be refunded to the buyer. Typically, the purchase agreement specifies that the EMD funds are returned to the buyer if the parties cannot agree on inspection repair issues, if the buyer is unable to obtain financing, or if the property does not appraise for at least the purchase price. However, if the buyer, after acceptance of the offer, does not follow through with the transaction, the EMD may be forfeited to the seller. In general, brokers will require a mutual release before releasing the earnest money deposit if there is a dispute. In the event the real estate transaction does not close, any funds that are "in dispute" remain in the broker's escrow account. The broker keeps the disputed funds in the escrow account until a written release is received from the buyer and seller directing the broker how to disburse the funds. However, if a civil action is filed, the broker may pay the funds into the court or retain the funds until the court tells the broker how to dispose of the funds.
As part of the broker handling escrow funds, if the property does not go to settlement and there is a dispute about the escrow funds, the broker:
follows the law.
Bookkeeping system
implies that a separate record be maintained in some type of organized fashion. Both manual and computerized bookkeeping are based on the same principles, conventions, and concepts of accounting. However, manual bookkeeping uses pen and paper to record transactions, and computerized bookkeeping uses of computers and accounting software to enter transactions electronically. Regardless of the system used, brokers must maintain a bookkeeping system that clearly and accurately accounts for all escrow funds received and disbursed, and to ensure that a balance is identified on the general ledger and each sub-ledger after each bookkeeping entry.
escrow account
is a bank account managed by a person on behalf of a beneficiary. The person who manages the escrow account is known as the trustee. An escrow account is set up to separate a client's funds from the broker's funds. Broker's escrow accounts are established in the name of the company/broker but must have the words "escrow account" or "trust account" on the bank statement and on the printed checks. The bank must clearly understand that funds in these accounts do not belong to the broker's company or the broker in order to eliminate the possibility of attachment in the case of a judgment, IRS action, or other liability that may arise to the company or broker. These accounts are used to hold client funds only. DCMR 2702.4 requires brokers to notify the Commission within 14 calendar days when they set up any escrow or trustee account. The notice must include the following information: Name of escrow account. Account number. Financial institution where account is located. Address of institution. Licensee's name, address, telephone number, and license number; and Written authorization from the escrow holder or trustee allowing the Commission to examine all documents held by the financial institution related to the escrow or trust accounts listed on the form. [DCMR 2702.5].
sub-ledger
is a permanent record that records the chronological sequence in which escrow funds are received and disbursed by the broker on behalf of a buyer and a seller, as related to a single real estate transaction. On each sub-ledger page, the broker should record the name of the seller, the name of the buyer, and the address of the property being sold.
general ledger
is a permanent record that records the chronological sequence in which escrow funds are received and disbursed by the broker on behalf of all clients. This is commonly referred to as a "checkbook register."
electronic signature (e-signature)
is as any electronic process signifying an approval to terms, and/or a document, presented in electronic format. Increasingly, encrypted digital signatures are used in e-commerce and in regulatory filings as digital signatures are more secure than a simple generic electronic signature. Licensees who obtain transaction documents that contain an electronic signature pursuant to the Uniform Electronic Transactions Act (Section 1633.1 et seq. of the Civil Code) or the Electronic Signatures in Global and National Commerce Act must keep a copy of the documents, including the electronic signatures.
Commingling
is the illegal act of mixing a broker's personal funds with those of a client or a beneficiary. Commingling can occur in unintentional ways. For example, a broker who has earned a commission or management fee but leaves the money in the escrow account instead of transferring the money to the company operating account, may be guilty of commingling. When commissions or other fees for brokerage services are earned and payable, they become the broker's money. Such fees should be paid to the broker's operating account before disbursement of any commissions payable to sales associates. Examples of Commingling Depositing escrow funds into the broker's general or personal bank account rather than into the escrow account. Depositing personal or company funds into the escrow bank account. This violates the law even if separate records are kept.
Conversion
is the illegal act of using money in the escrow account for the benefit of anyone other than the rightful owner. This can occur when the broker "overdraws" the account balance of a client to pay a fee on behalf of another client. Any amount over the balance belonging to the client whose fee was paid will belong to another client. Thus, when money belonging to one client is spent on behalf of another client, conversion occurs. Conversion can occur if a broker refunds the earnest money, rent, or security deposit of a buyer/tenant before that buyer's/tenant's check has cleared the bank on which it was drawn. This is because until a check actually clears the bank on which it was drawn, the funds are not considered deposited. Therefore, a broker who refunds money before the check clears is using the money of one client to benefit another. Brokers and their associates should be reminded that violations of the Licensure Law and Commission Regulations pertaining to the improper handling of escrow funds could result in the suspension or revocation of their real estate license by the DC Real Estate Commission.
Bookkeeping
is the systematic recording of a company's transactions in appropriate books of account. Brokers may use a manual or a computerized bookkeeping system. Most brokers use computerized bookkeeping systems, but you should know the minimal requirements for any bookkeeping system.
