The profession, clients and the SRA alike would struggle to cope with the regulator’s radical change to the definition of ‘client money’.
It is hard to engage the majority of solicitors in lively debate about the solicitors accounts rules.
The current rules are complex, lack clarity and complying with them comes at considerable cost to practitioners. The Solicitors Disciplinary Tribunal 2015 report published in June revealed that 19% of cases before it involved a breach of the accounts rules.
The obligation to protect client assets and money is a cornerstone of the profession’s reputation. Failures to comply with the accounts rules are backed by disciplinary process and redress through compulsory insurance. Any client loss arising from an act of dishonesty, not covered by insurance, is underwritten by the whole profession.
The Compensation Fund compensates where there is no available insurance.
Ahead of a consultation by the Solicitors Regulation Authority, the Law Society asked its membership what sort of reforms it would like to see. A majority of respondents supported retaining the existing rules or a simplified and shortened version. There was very little appetite for more significant change.
The publication on 1 June of the SRA’s consultation, ‘Looking to the Future: Accounts Rules review’ offers a far more radical alteration than anticipated with the proposal to change the definition of ‘client money’.
The new definition would allow money received from or on behalf of a client to be treated as the firm’s money where it presents money to be used for any fees and disbursements for which the solicitor is liable. This would cover, for example, counsel’s or experts’ fees but not taxes such as stamp duty or inheritance tax. It also covers money paid on account of solicitor’s costs.
At first blush this may seem attractive as it would boost the cashflow of firms pending payment of expenses or invoicing of costs. Notwithstanding these superficially attractive possibilities, the full impact of this change does not appear to have been addressed by the SRA.
Until the solicitor’s work has been carried out (unless otherwise agreed) payment to the benefit of the solicitor is not due. If money is paid to be held on account of costs or disbursements to be incurred, this money is regarded as held on trust for the client. Creditors of a firm including banks, suppliers and investors will undoubtedly want clarity as regards what money held in the firm’s name belongs to the firm and what is held on trust.
That will be swiftly followed by requirements for security or new terms for supply or credit. The solution to avoid mixed funds would then appear to be to have two office accounts.
The rationale suggested by the SRA is that reducing the total amount passing through or held in the client account may for some firms avoid the need for an annual client account audit.
To put this in perspective one only has to consider the situation where a firm operates in overdraft or avoids dipping into deficit on its office funds through the use of funds ‘earmarked’ for third-party payment. It is naïve to assume that suppliers will not alter their terms to put legal liability on clients and then in case of insolvency, for claims to mounted on the Compensation Fund.
It is hard to believe that insurers would ignore their risk of increased exposure and the confidence of other stakeholders would be impacted. There is significant risk to the profession in loss of reputation. The SRA has not considered the impact on the Compensation Fund or experts and counsel.
It does not appear that software providers have been consulted as to the likely cost of adapting software required to operate the new system. Many of the respondents to the Law Society discussion expressed concern at more upheaval, cost to the firm in updating software, implementing new procedures and staff training.
So where does the benefit lie? Certainly not to the clients who will become unsecured creditors (the SRA’s suggestion that current consumer protections and the use of credit cards for payments will eliminate the risks is clearly incorrect).
The answer lies in the main thrust of the reforms by the SRA in the Code of Conduct itself – ‘Looking to the Future - flexibility and public protection’. The SRA states it ‘will address the problem of access to justice’. It sees the reforms as a means of meeting the government agenda of innovation and the view that there is widespread ‘unmet need’ of the public and small businesses for legal services.
Under the new framework proposed, regulated solicitors will be able to practise as solicitors in any unregulated business, offering legal advice and other unreserved services direct to the public. One of the difficulties of this model is the handling of client money – solicitors in such entities would not be able to operate a client account.
For the most part the redefinition of client monies to exclude fees would avoid the need for such entities to operate a client account.
However, should the need arise for such entities to deal with the occasional need to handle client monies, presumably it would be supported by permitted use of a third party managed account (TPMA), a second proposal in this reform.
A TPMA is company operating an escrow service to receive funds from clients, which are required in relation to ongoing legal services. The funds would remain in pooled segregated bank accounts for the term of the legal services. The SRA first considered the use of such accounts in 2015 but delayed its decision.
Early indicators were that there was little appetite from the profession, which saw this method as a high cost per transaction and as offering no greater safety than an ordinary solicitor client account. Fears were expressed that such a requirement would become compulsory. Successive governments have expressed a fondness for a centralised client account so that the interest could be used to offset legal aid costs.
There is no suggestion that there is any intention to make this compulsory but 88% of those responding to the Law Society discussion paper indicated that it was felt unlikely the profession would take this up. Once again how such services will interact with the Compensation Fund has not been considered.
So what are the new rules – the SRA consultation presents a very simple draft set of accounts rules and explains that these will be supported by an online toolkit comprised of guidance and case studies. The toolkit and guidance have not been published and therefore it is very difficult to judge whether or not such rules will reduce the administrative burden on solicitors.
The six pages of rules now stem from four principles:
i. keeping client money separate from the firm’s money;
ii. ensuring client money is returned promptly at the end of a matter;
iii. using client money only for its intended purpose;
iv. proportionate requirements for firms to obtain an annual accountant’s report.
Fewer firms will need to obtain accountants’ reports but reporting accountants will need to get to grips with the new rules and guidance and any increased cost to them will be passed on to their clients.
Introduction of these changes as a whole, would cause expense and difficulty to the profession, client protections will be reduced and third parties such as banks, experts, counsel and others impacted. If it is not possible to simplify the rules in a way that reduces administrative burden, the current rules should be retained.
Finally, in May of this year the Legal Services Board (LSB) published its review of the SRA. The LSB noted that it had, ‘expressed concern about the need for supporting evidence and analysis to justify a change in approach, in some of the SRA’s applications to us to alter its regulatory arrangements’.
Once again the consideration of the impact of these changes is poorly considered.
The LSB also noted that the number of consultations undertaken by the SRA risked ‘consultation fatigue’ and it also states that the wholesale review of the Handbook, ‘may be too much for firms (and the organisation) to cope with’.
Ultimately that is the main failing of the SRA. In pursuit of a dream of radical reform, designed to give unquantifiable benefit, it ignores the needs of 10,000-plus firms and their clients. The profession will struggle to cope with such a radical change but so too will a regulator that has yet to achieve a satisfactory rating in any but one category assessed by the LSB.
Rarely does a Gazette article end with a quote from a baseball player but in the words of Lawrence ‘Yogi’ Berra, ‘it’s déjà vu all over again’.
The SRA consultation closes on the 21 September and can be found here.
Linda Lee is chair of the Law Society’s Regulatory Affairs Board. She is a regulatory lawyer and consultant at RadcliffesLeBrasseur