Troubled law firms keep partners in the dark about financial problems and refuse to accept the reality of their situation, a new SRA report has found.

The report to the regulatory risk committee, based on evidence from firms that have gone out of business in recent months, found a common set of mistakes and failures.

Analysis of behaviour found some substantial firms were ‘very naïve’ in their financial management and the best-run firms tended to have a high-quality financial director or equivalent.

The committee will meet on Monday as it works out how the SRA can mitigate the risk from struggling firms and protect the public.

The supervision team found striking features of firms that have suffered financial difficulty. These included:

  • Holding client money in office accounts
  • Poor quality management and lack of an effective financial director
  • Refusal or inability to accept problems and failure to plan properly for addressing them
  • Over-dominant senior partners or sometimes chief executives
  • Temptation to be ‘economical’ with the truth with funders

The report noted the best-run firms are transparent, sharing financial information. In the best cases, the SRA found very little negativity or unwillingness to assist when it had asked for information on a firm’s finances.

In contract, some firms exhibited a culture of non-transparency that is causing them damage, either through partners being misled or the inadvertent misleading of clients.

The report added: ‘If partners are unaware of problems they cannot contribute to planning such as restructuring, disposal of non-performing departments, or the seeking of a new firm for viable departments to ensure clients’ interests are fully protected.’

The report made clear that the SRA must intervene where there is a risk to the public, even when the firm in question claims it is costing too much.

It said:  ‘A desperate financial position clearly gives rise to temptation and risk to client funds but also to public confidence in those providing legal services if they compromise their integrity.

‘Indeed, ultimately there may be cases where there is a risk that law firms are being placed sequentially into insolvency processes with serious impact on creditors. Such behaviour could lead to enforcement action.’

The report warned if a firm is not engaging properly, the SRA should consider withdrawal of approvals from managers, owners or compliance officers.

Where intervention can be avoided, the regulator should seek to oversee an orderly wind-down of the business, as happened with Halliwells, Dewey & LeBoeuf, Cobbetts and Challinors.

To save on the costs of intervention, the paper revealed the SRA will shortly apply to the courts regarding how long it must keep the files of intervened firms.

The collection, archiving and ultimate destruction of closed files is one of the biggest drivers of intervention costs, and the SRA’s current policy requires the retention of all closed files for at least seven years from the date of intervention.

The SRA proposes that it will destroy files that were closed in the regulated entity more than two years prior to the intervention and destroy other client files following two years after the intervention.