Keeping the FSA at bay

A year after the Financial Services Authority sent tremors through the legal profession, law firms are still agonising over how to comply with the regulatory guidelines.

Should they join the watchdog's regime or operate outside it? Scott Neilson looks at the various tactics adopted by practices

N2 - otherwise known as the Financial Services and Markets Act 2000 (FSMA) - came into force on 1 December last year, gathering almost all of the UK's regulatory activity under the umbrella of the Financial Services Authority (FSA).

Among many other measures, the Act gave the FSA the power to impose criminal and civil sanctions on lawyers who, in the course of their work, 'impart financial advice' to their clients.

The problem was that no one actually seemed sure what this meant, explains John Morton, chief executive of Ashcourt Asset Management, a two-and-a-half-year-old hived-off company, which has the investment management business of five law firms under its wing.

Under the then-unclarified Act, such advice could have meant anything from offering main-stream wealth and asset manage-ment advice from a firm's private client department to arranging a meeting to discuss a deal and sending out a sale-and-purchase agreement, Mr Morton says.

This latter issue concerned secondary legislation called the Financial Promotions Order, which regulates inducements and invitations to enter financial agreements.

It caused real concern in the City, where there were fears that firms' everyday activities could be caught and led many to insert long disclaimers in their communications.

Law firms had three options to ensure that they would not incur the wrath of the FSA when the Act came into effect.

The first tactic, chosen by only 334 of the firms throughout England and Wales, was to sign up to the FSA's year-long 'grand-fathering' scheme into regulation.

This was mainly taken up by those which deal directly with financial services advice, but the worry over the Financial Promotions Order meant that major practices such as Wragge & Co, Pinsent Curtis Biddle and Addleshaw Booth & Co also signed up.

This move allowed them to continue business as usual but at the same time exempted them from FSA prosecution because they had come under the watchdog's regulatory umbrella.

The catch was that 'opting in' opened firms up to more stringent compliance checks and greater administration costs than under the old regime, which was supervised by the Law Society.

There was also an element of double regulation.

However, the impact of signing up to FSA regulation has been softened by the FSA's 12-month transitional arrangements, which came to an end late last month.

Roger Purcell, an accountant and compliance consultant who worked for the FSA for 14 years, points out that non-compliance could now prove 'extremely embarrassing' for some law firms.

The new regime is tougher.

Regulated firms are obliged to post official notices with the FSA; these range form an annual questionnaire to notices informing the regulator of changes in control of the firm.

Previously, penalties for late returns of such notices were rarely, if ever, imposed, he says.

But he adds: 'The FSA has made it clear that details of any penalties for late returns are to be made public.'

Mr Purcell adds: 'For many firms, the resulting publicity and embarrassment could be considerably more important than the financial penalty.

And there must be a temptation for the FSA to target one or two high-profile offenders with late returns, to set an example for others.

Firms should not expect a gentle reminder letter.'

His prediction lines up with warnings from the regulator's staff, one of whom recently commented that while the FSA had been 'under-zealous' in pursuing defaulters, 'the honeymoon period' would end soon.

Clifford Chance was another firm that chose to play it safe and opt in to the FSA's scheme, to the surprise of many commentators at the time.

A spokesman says it has no plans to opt out again and the firm's head of global asset management, Tim Herrington, says the firm is used to complying with 'thousands of rules and regulations around the world'.

'This is just an extra one, one that we can take in our stride,' Mr Herrington says.

'We always knew the impact would be slight, in terms of the number of areas within the firm that it would affect.'

However, not every firm has Clifford Chance's compliance resources at its disposal.

Others are struggling with the FSA's 9,000-page guidebook, says Ian Muirhead, director of the Solicitors for Independent Financial Advice (SIFA), a group of solicitors who specialise in providing clients with financial advice.

'The chickens are coming home to roost because the FSA is now issuing its fee bills, fees which are rather significant.

The FSA is coming in with hob-nailed boots, so a number of firms have thought twice about whether or not they'll be involved,' Mr Muirhead says.

And now the year-long transition period is at an end, the Gazette has learned from the FSA that 'around 60' of the firms that chose its financial regulation have since dropped out of the watchdog's scheme.

Many law firms only opted into the scheme 'as a precautionary measure,' explains Mr Muirhead.

'When these firms realised the consequences of opting in, in terms of the regulation, procedure, fees and all the rest of it, they decided that they could do without,' Mr Muirhead says.

However, it is worth remembering that the firms which opted in constituted only a fraction of the total number of practices in England and Wales.

By contrast, around 8,000 other firms decided to continue to offer their financial services outside the FSA's regulation, refusing to sign up to the insurance policy of FSA regulation and choosing instead to wait for guidance from the FSA and the government.

Their tactic was to 'tread carefully around the edges of the Act to avoid trouble', says Ruth Fox, head of Slaughter and May's financial regulations group.

And it was a gamble that paid off in April of this year when the FSA issued its long-awaited guidelines, thereby removing the ambiguity that had surrounded the Financial Promotions Order, Ms Fox says.

'The FSA has produced some extremely helpful guidelines.

We and other law firms have since been very much comforted by the approach that the regulator took in its guidance because it supported the view that we'd been taking, as to what the nature of a financial promotion was.

Other lawyers I've spoken to are also glad that we didn't step into the regulatory net,' she says.

But besides opting in and opting out, firms have adopted another tactic to deal with the Act.

Many practices have already hived off their financial services departments - ring-fencing their exposure to the FSA.

Firms in financial advice work split between those offering advice on products and those in investment management work.

As well as just hiving off on their own, some investment management firms have pooled their resources in groups such as Ashcourt, while some personal advisers have joined forces in Mr Muirhead's Solicitor Financial Centres, of which there are now seven.

The plan is to expand around the country with 50 predicted by 2005.

Another tweaking of the model emerged in May, when two leading south-west law firms - Michelmores and Foot Anstey Sargent - combined to launch iimia, an investment management business believed to be the first of its kind with membership of the Stock Exchange.

Firms using iimia's services have the chance to take equity in the company.

Ashcourt Asset Management is one of the larger examples of a ring-fenced operation.

Formed in May 2000 when Maidstone law firm Brachers and Salisbury firm Wilsons merged their wealth management practices, Ashcourt has since picked up the practices of City firm Lawrence Graham and south-coast practice Blake Lapthorn, while 34-partner Brighton-based DMH became the latest to join last month.

The company now has almost 250 million under management, small beer in the investment management business but a significant amount for the solicitors' sector.

Mr Morton labels the company's latest deal as 'evidence that the consolidation of the investment management function within the legal profession continues to gather pace'.

Mr Morton adds: 'As stock markets continue to fall and the burden of compliance continues to grow, law firms' partnerships will inevitably continue to question the viability of offering wealth management advice.

There are very clear economies of scale that will lead to further rationalisation and consolidation.'

Scott Neilson is a freelance journalist