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Bankers are up in arms over a New Jersey state Supreme Court order forcing financial institutions with attorney trust accounts to pay significantly higher interest rates to bolster the state’s IOLTA Fund. The court’s latest move, a June 15 notice to the bar that fixes a mandatory minimum rate at almost double what many banks pay, triggered a high-level meeting last Wednesday among leaders of the three branches of government, including Chief Justice Deborah Poritz. While bankers and others opposing the court’s order seem hopeful that a compromise can be worked out, they are not ruling out a legislative remedy or constitutional challenge based on a separation-of-powers argument. “We’re keeping our powder dry,” said one lawyer who represents banking interests, saying that in light of the meeting bankers are optimistic that the court will back off somewhat. At stake is about $15 million in additional payments to the IOLTA Fund (Interest on Lawyers’ Trust Accounts). The losers, of course, would be the banks and their shareholders. The winners would be Legal Services of New Jersey, which gets three-fourths of IOLTA’s money; the IOLTA Fund, which uses 12.5 percent for grants to programs for the disadvantaged; and the State Bar Foundation, which receives the final 12.5 percent and has wide discretion on how to spend it. Some of the foundation’s share – $1.81 million in 2004 – underwrites programs traditionally carried out by the state bar association, which controls the foundation. While last year’s net yield was 0.73 percent, the figure under the mandatory rate would likely be between 2 percent and 3 percent. The dispute has its roots in a March 2003 amendment by the court to the IOLTA court rule that “confirmed the responsibility of IOLTA’s trustees to develop and implement a standard that would establish a ‘reasonable return’ for IOLTA accounts.” That directive came after drops in interest rates for all depositors. The average net yield on IOLTA accounts had dropped from 1.42 percent in 2001 to 0.78 percent by 2003. As a result, IOLTA’s statewide take dropped from its 2001 peak of $18.9 million to $15 million in 2003. Higher balances pushed the 2004 total to $15.2 million. The court said then that it was concerned that some banks were paying “very low rates” on IOLTA accounts. But the biggest change in the 2003 directive was the court’s pronunciation that it considered the IOLTA Fund the bank’s customer. When IOLTA was created in 1988, the lawyer’s client was considered the customer. Just prior to that March 2003 amendment, the court also changed the IOLTA rule by switching the word “interest” in IOLTA to “income,” and changed the description of IOLTA accounts from interest-bearing accounts to non-interest-bearing accounts. The acronym now stands for Income on Non-Interest Bearing Lawyers Trust Accounts. The court said at the time that “income” is not the client’s but initially is the property of the banks. Bankers called the move a pre-emptive strike in case the U.S. Supreme Court ruled that all IOLTA funds nationwide violate the Fifth Amendment’s taking clause. But Melville Miller Jr., who heads legal services and sits ex-officio on the IOLTA board, said that he pushed for the change to clear up a limited issue of state property law. The high court upheld the constitutionality of IOLTA funds by a 5-4 vote in March 2003. In February 2004, IOLTA’s trustees reported to the court that their efforts to boost rates were only partially successful. Under the court’s guidelines, it’s the IOLTA Fund that sets the standard on what constitutes a reasonable rate. Not surprisingly, the nine-member IOLTA board is, and has always been, stacked. The state bar association, its foundation and legal services director Miller have ex-officio seats and voting power. The current board also has a former foundation president and a former association trustee. The trustees recommended to the court that banks get sent notices that if they don’t get their rates up to the mandatory standard, they will lose their authorization to participate. The recommendation, accepted by the court, gives banks a year to comply, after which the deauthorization process begins. Lawyers are then told by the Office of Attorney Ethics that they must shop for a new bank. Last March, according to the notice, the trustees filed a confidential report with the Administrative Office of the Court identifying banks that were not complying and laying out a graduated deauthorization process. ‘Last Resort’ While the issue has been on the table since 2003, it didn’t heat up until the confidential report, which contains comments from bankers and their associations as well as the enforcement recommendations. Discussions began in earnest after the report was filed with the court. Moreover, some banks have been getting letters of deauthorization as their one-year notices are up. About 100 participating banks handle 7,200 accounts. Michael Horn, who represents the New Jersey League of Community Banks & Thrifts, said bankers “are very concerned about having a third party determine a rate of interest for the banks.” Horn, a partner with Newark’s McCarter & English, said banks take many factors into consideration in setting rates, such as the amounts in an account, the time the funds remain on deposit and the level of service required. “Now a third party says that to service lawyers, one segment of the market, you must charge a minimum rate?” Horn said. He and others argue further that the move will be bad for many lawyers who have longstanding relationships with local banks. Horn said at least one bank is considering suing if the directive is implemented and the bank is kicked out of the program. He said there is a separation-of-powers issue at stake: “While the Supreme Court has the right to regulate the practice of law, can it reach out and regulate what banks charge?” Up until the June 15 notice, the mandatory rate was not published. The notice said the rate is 75 percent of a benchmark known as the 90-day Constant Maturity Treasury Rate, or 90-day CMT. That would make the mandatory IOLTA rate above 2 percent, with one banking lawyer placing the rate closer to 3 percent. The meeting last Wednesday was attended by H. Robert Tillman, the director of the state’s Division of Banking, and Douglas Wheeler, chief of staff for Acting Banking and Insurance Commissioner Donald Bryan. Representing the judiciary, besides Poritz, was administrative director of the courts Philip Carchman, Supreme Court clerk Stephen Townsend and the AOC’s governmental affairs director, David Anderson. The Legislature was represented by Sen. John Adler, D-Camden, and Assemblyman Neil Cohen, D-Union, who chairs the Assembly Financial Institutions and Insurance Committee. One source familiar with the discussions expressed optimism that a compromise will be worked out, saying one key issue is the difference between new banks, which could be hurt more dramatically by a rate cut, and established banks. Another is the difference between small and large banks, he said. Still, one banking lawyer called the ongoing feud “very contentious.” Another lawyer wrote to the IOLTA board in 2003, when the campaign to up the rates began, saying he considered the taking of the interest a hidden tax on other depositors as well as shareholders. He noted that everyone’s rate has dropped and questioned why banks should be forced to help the poor if the state and federal government won’t kick in more. “There’ve been a lot of discussions, and there’ll be more, but the key was to identify the issues,” said a source familiar with the talks who wishes to remain anonymous. This source added that the issue now is not whether a mandatory rate will stick but how much it will be. This article originally appeared in the New Jersey Law Journal , a publication of ALM.

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