Brought to account

The future of client accounts is under the spotlight, with the capacity for fraud and solicitors keeping interest two of the key issues.

Philip Hoult reports

The rules governing the use of solicitors' client accounts are set for a wide-ranging shake-up over the next two years, as the Law Society looks to combat dishonesty among the solicitors' profession and boost its public image.

The first of potentially several changes was proposed last month, when the Society's regulation review working party published a new draft accounts rule to prevent client accounts being used by money launderers as quasi-bank accounts.

And the Society is also reviewing the practice of solicitors' retaining de minimis sums of interest on individual client accounts.

The new rule - contained in the working party's 'Minimising the risk of money laundering' consultation paper (see [2003] Gazette, 25 April, 31) - would ban the use of solicitors' accounts unless the solicitor has received instructions relating to an underlying transaction, or for the provision of services regarded as the normal business of a solicitor's practice.

In exceptional circumstances, solicitors would be able to receive money if they have satisfied themselves as to the identity of the client, checked and documented its source, and are satisfied as to the good intentions of the client and that there is nothing improper or illegal in receiving or holding the money.

Alison Crawley, director of regulation policy at the Law Society, says the draft rule reflects the position that the Solicitors Disciplinary Tribunal is already taking in situations where solicitors have effectively closed their eyes to what is happening with their accounts.

'The tribunal has been saying that solicitors should not allow themselves to be used as a bank account and not know what is going on,' she says.

'If the Law Society sees money washing through and suspects something, it will intervene.'

Indeed, in one case heard in September 2001, the tribunal imposed a 5,000 penalty on a solicitor for just such behaviour, describing the respondent as 'unwise' for accepting instructions and receiving into the client account a sum of money, when he had not been instructed in any underlying transaction.

There can, Ms Crawley admits, be difficulties over whether something is a genuine underlying transaction.

The important thing, she says, is for solicitors to establish that there is a legitimate reason for holding the money.

The regulation review working party cites several reasons in favour of the new rule.

These include the suggestion that the rule would serve to reinforce the existing money laundering regulations, that effective regulation can in some cases be better than relying on criminal prosecutions, and that solicitors appear in some cases to be providing what in effect amount to banking facilities.

'What is proposed is something we endeavour ourselves to implement anyway,' says Geoff Prevett, partner in charge of compliance at City firm Eversheds.

'We try very hard to make sure that we keep control over where money comes from and where it goes to.'

However, the working party also recognises that there are powerful arguments against the introduction of the new rule.

Not least is the fact that implementation of the second European Money Laundering Directive by June this year means that most solicitors will be required to comply with new money laundering regulations anyway.

These regulations, when combined with the Proceeds of Crime Act 2002, which from 24 February 2003 included a 'failure to report' offence - where practitioners will be judged on whether a reasonable solicitor should have been suspicious in all the circumstances - arguably make the new rule unnecessary.

There is also a view that dishonest solicitors will continue to ignore the rules, whatever regulations are put in place.

For these and other reasons, there are many lawyers who think that the Society is in danger of creating too heavy a regulatory burden.

'Naturally we would all support attempts to protect people from this sort of mischief,' says Donald Williams, a consultant and former partner at Linklaters who now heads the City firm's compliance team.

'But like all these things, when you come to write it down there are difficulties that are not foreseen at the time of drafting.'

'One of the main aspects is that you have got to make jolly sure that you do not put in bells and whistles that apply to English solicitors, but make us uncompetitive in relation to our European and US rivals,' Mr Williams adds.

'The key question is that if the law is already there, why do we need a practice rule that says "please observe the law"? To that extent, it does not seem necessary.'

Ronnie Fox, senior partner of City firm Fox Williams, says the only real advantage of having the rule is to show, if it needs to be shown , that the Society is in favour of solicitors complying with money laundering regulations.

In this regard, solicitors have come under fire from the National Criminal Intelligence Service on several occasions in the past for an apparent reluctance to report suspicious transactions compared to other businesses and professions, and the rule might help address this perception.

However, Mr Fox argues that this is not a sufficient reason to justify changing the rules.

'I do not think that it is the function of the Law Society to enforce general rules that apply to solicitors and other people,' he says.

'For example, it does not say anywhere in the Law Society accounts rules that you should not murder people.

It is not the function of the Law Society to enforce those sorts of rules.'

The consultation period for the new draft accounts rule ends on 1 July and so it remains to be seen whether it will be put forward to the Law Society Council for adoption and in what form.

But it is not the only change that could be put on the table.

The Society plans a review of the client account to combat dishonesty in the profession, looking at whether individual solicitors should continue to be allowed to hold client accounts or whether there should be centralised arrangements.

Also at stake is the question of interest on client accounts.

Solicitors are allowed to keep interest rather than return it to clients in certain circumstances - such as when the money passes in and out of their accounts in a short period, or for de minimis sums.

Depending on the nature or size of a firm's practice, this could amount to a significant amount of money, and there are questions on why solicitors should be entitled to keep it.

The situation is, the Society admits, 'unusual' compared to other countries, though it does comply with existing legislation.

The rationale for the status quo is that to a small degree it reduces solicitors' overheads and therefore reduces the cost to clients.

However, in a paper about future business that went before the last council meeting, the Society recognised that a situation where solicitors appear to profit from clients' money can lead to adverse publicity.

It is expected to consider over the next year whether to require the sums of interest earned to be put to another purpose, such as the financing of the Solicitors Compensation Fund - which compensates the victims of fraud - as happens in South Africa, where some interest is also put towards indemnity insurance.

In the Australian state of Queensland, interest is mainly put towards legal aid, with 13% directed towards the compensation fund.

There is also a suggestion that the money could be donated to charity.

In March, the US Supreme Court voted narrowly in support of IOLTA programmes (interest on lawyers' trust accounts), ruling that states may pool clients' escrow funds in bank accounts and give the interest to legal aid programmes, which happens in all 50 states.

In 2002, IOLTA programmes generated more than $200 million (125 million).

They were challenged on the grounds that the interest earned in the accounts belongs to the clients and cannot be taken by the state without just compensation.

In the case in question, the amount lost by the client was $4.96.

Ms Crawley foresees a 'big scrap' over the best way to spend the money raised by collecting such interest.

'The government may want the money for legal aid, the Law Society might want to finance the compensation fund, and pro bono groups will want funding,' she says.

As with the new accounts rule, there is a concern in some quarters that changing the rules on interest would be change for change's sake.

There is undoubted scepticism, not least because of the headaches and expense of administering such a scheme at a time of low interest rates.

'If the sums are so small and transient, I do not know how feasible it would be to pay them over to the body in question,' says David Wyld, chairman of the City of London Law Society.

'It seems like a plan that sounds good on paper but would not work.'

Mr Fox is equally dismissive.

'It is pointless,' he says.

'The balance is right where it is now.'

Client accounts may appear to be a prosaic aspect of the law firm, but they are beginning to raise passions.

Philip Hoult is a freelance journalist