Regulatory risks - hot topics

Since the introduction of the Solicitors’ Code of Conduct (Code) and the Solicitors Regulation Authority (SRA), the profession has seen a remarkable change in approach to regulation and risk. The SRA is wielding its regulatory stick and its powers are increasing. During these difficult times, it is all too easy to put compliance issues on a back burner. The SRA’s message is very clear – don’t!

So, what are the ‘hot topics’ and main regulatory risks currently affecting the profession? It seems to me that they can be categorised under the following headings:

Code breaches;
Solicitors’ Accounts Rules;
Anti-money laundering;
Mortgage/property fraud; and,
Economic downturn

The Code

The main areas of risk from a compliance perspective are in rules 2, 5, 6, 7 and 9 of the Code.

Client relations (rule 2) is the rule that will generate the most complaints by clients and thus can put a firm within the regulator’s radar. Not properly scoping the retainer at the outset in the rule 2 letter can lead to complaints and potential negligence claims that the firm failed to comply with a client’s instructions. A failure to provide the best information possible about the overall likely cost of a matter risks further complaints. The Practice Standards Unit (PSU) of the SRA in carrying out a monitoring visit will look very carefully at a firm’s rule 2 letter to ensure that all the information required to be included is present. It will also review a firm’s complaints-handling procedure to ensure that complaints have been promptly and fairly handled.

One of the main costs issues that has recently led to disciplinary action is in relation to telegraphic transfer fees and the ‘secret profit’. Remember – any admin fee charged to the client over and above the fee paid to the bank is not a disbursement, but a profit cost. The Law Society Practice Note issued in July 2008 clarified the position, or so we thought...

In recent discussions with the SRA, I discovered that the SRA’s approach in fact differs from the Law Society Practice Note, with the SRA now saying that the whole charge is a profit cost. Regrettably, and most unhelpfully, the SRA has not deemed it necessary to issue any further guidance.

The SRA has also been keen to investigate discounts and rebates on search fees. These are not commissions, and so the benefit of the rebate must be passed on to the client. Again, a failure to do so is likely to result in a finding that the firm has made a secret profit, and could result in substantial payments having to be returned to clients.

Rule 5 is the business management rule, providing 12 areas of practice for which firms must make arrangements for ‘effective management’. Firms need to ensure that they have proper systems for supervision, file audit, appraisals, giving of undertakings, and so on, in place.

Make sure also that you have an equality and diversity policy (rules 5 and 6) and that it covers not only staff but dealings with agents, experts and counsel. Unfortunately, the SRA has so far refused to issue any standard wording for such a policy, arguing that it needs to be bespoke to the firm’s needs.

Rule 7 is the publicity rule. Breaches have led to a number of firms being disciplined, particularly in relation to conveyancing websites for providing misleading or inaccurate information about the charges for such work.

Last, but by no means least – rule 9 on referral arrangements. The controversy surrounding the miner’s compensation claims has been well publicised, and some serious and hugely damaging sanctions have been imposed, particularly where there have been breaches of the core duties under rule 1 (to be independent and to act in the best interests of the client, for instance) as well as breaches of the rule 9 requirements. Firms are now also being investigated for accepting business from a claims-management company that has made misleading statements about consumer credit agreements to the effect that debts can be written off because the agreements are unenforceable. If those firms have not acted in their clients’ best interests, they too could find themselves at the wrong end of disciplinary proceedings.

Solicitors’ Accounts Rules

Key areas that the PSU look out for on a visit include aged client-account balances and use of suspense accounts, rule 19 transfer of costs, and the new rules 15(3) and (4) and amended rule 22 relating to retained balances, reporting to clients (at least) annually on funds being retained, and the records and checks made before paying small left over balances to charity.

Anti-money laundering

Applying customer due diligence at the outset of the business relationship and ongoing monitoring is critical. The Law Society has published a practice note and the SRA will take it into account when checking that a firm’s policies, procedures and training of staff are compliant.

Property fraud

With the property crash, mortgage fraud has reared its ugly head once again. For those involved in conveyancing, the regulatory risk cannot be underestimated. The SRA has recently issued a warning card on property fraud identifying warning signs, and it has given a clear message that it will not tolerate property fraud. Common examples are: failures by solicitors to comply with the Council of Mortgage Lenders guidelines; ID theft of proprietors, prospective purchasers and vendors; and, acting, often at the last minute, where the sole instruction is to receive fraudulently obtained mortgage monies and send on to a bogus bank account.

Other investment frauds are also emerging – if the transaction seems fanciful or absurd, or the returns seem ridiculously high, then they probably are! Don’t allow the firm to be used as a vehicle for theft or money laundering.

Economic downturn

The collapse of the housing market and the recession has seen a dramatic fall in transactional work, which inevitably impacts on a firm’s cashflow. This had led to a number of regulatory risks emerging including:

The temptation to enter into an agreement with an introducer of new work with whom you would not normally get involved;
Making a secret profit;
Turning a blind eye to a potential conflict of interest;
Cutting back on staff, meaning those remaining may be overworked and so creating additional risk;
Improper funding of a firm’s overdraft by transferring money from client account – the SRA are alert to this and, during investigations, they will ask probing questions about a firm’s overdraft limit and look for evidence of it being exceeded;
Sweeping up of small balances without adopting the correct procedure;
Employee theft; and,
Non-payment of professional disbursements.

We are approaching what could be, for many firms, a difficult renewal period. Being able to evidence an effective compliance regime will assist in persuading insurers that you are a good risk to cover. Keeping up-to-date with changes to the rules isn’t easy, particularly if the partner responsible has a fee-earning role as well. Use the track changes facility on the SRA website to make sure nothing is missed.

We are hearing more reference from the SRA to ‘light touch’ regulation for those firms who can show that they are taking compliance seriously, allowing the SRA to focus more on those firms who can’t, or won’t, tackle risk themselves. A good idea, but I’m afraid I remain somewhat sceptical about whether this will be implemented in practice. The introduction of ‘firm-based regulation’ will impose even greater burdens on managers of firms who will be held responsible for systemic failures within the firm. It won’t take much for the SRA to find systemic failures in most situations where there has been a breach by an individual within the firm. This makes it even more important for proper systems of supervision, file audit and staff training to be in place and to ensure that there is evidence of them working in practice. More assistance from the SRA would also be appreciated. To command respect, the SRA will need to be more willing to provide clearer guidance, reliable advice and a consistent approach by its caseworkers to the regulatory issues being investigated.

In summary

One thing is certain – keeping the regulator from your door is essential to preserving your reputation. The damage that a published regulatory sanction can have on a firm or individual can be disastrous. Don’t wait for the nightmare scenario – compliance management isn’t a luxury anymore, it’s a necessity.

Michelle Garlick is a partner in the professional risk team at Weightmans LLP. She can be contacted at michelle.garlick@weightmans.com