Living the Eye Life! – March 2025
Earlier this year, Financial Eye were invited to attend various SRA Round table meetings including one specifically on the protection of client money. For those of you who may not be familiar with the background to the events leading up to these meetings, the SRA launched a consumer protection review in 2024. This was in response to the failures of several well-known law firms including Metamorph Law and Axiom Ince to name but two.
The SRA has obtained feedback from over 200 stakeholders and have conducted their own research in an attempt to prevent similar failures taking place in the future. It is not yet known when new rule changes will be implemented but you can be sure that they are coming.
It will come as no surprise that the biggest risk to consumers identified by the SRA the is the safeguarding of client money. The SRA are determined to understand what additional checks and balances can be introduced to safeguard client money. The consultation closed on the 21st February 2025 and we now await their findings.
Where else can the SRA proactively manage risk, from and beyond learnings from Axiom Ince? In my opinion rule changes are necessary in order to achieve greater protection. These changes will require the SRA to examine in greater detail how the firm is structured and what areas of law they practice in.
There will need to be a much greater focus on the management structure to ensure that not one single individual can have the power to manage all of the roles within a firm. This should not be too dissimilar to the roles that an FCA regulated entity has to put into place prior to and during authorisation.
So rather than just having COLP and COFA, the firm could have defined roles for the managing director, the finance director, the operations director, the IT director and the HR director. There would need to be exemptions for smaller firms that hold much smaller amounts of client money and who would not in themselves present a major risk to the compensation fund.
But what else the SRA could do to identify, assess and monitor potential risks when solicitors hold client money? They could begin by taking a greater interest in the bank statements that firms are asked to provide to the SRA during an investigation prior to intervention. Banks statements can be fraudulently amended. The only entity that can provide the SRA with an exact copy are the banks themselves. With at least 60 firms having been intervened in the past two years it is important that the regulator tightens up its own internal procedures when they become aware of a firm that is displaying signs of unusual behaviour.
Should the SRA be more prescriptive about firms notifying them outside of annual reporting? Well this could include notifying any changes to any role holders requiring pre-authorisation from the SRA. This may delay the process of appointing a new employee to a new key role, but it will allow the SRA to ask for additional information if necessary.
Much greater scrutiny should be given to firms acquiring other firms. The bigger the firm being acquired the greater the scrutiny. This could be linked to the turnover of the firm based on statutory accounts so that thresholds could be put in place. Acquisitions over a certain threshold would require a more vigorous approach and would require the provision of budgets and cashflow forecasts, integration plans, background checks on the management team of the acquired and acquiring firm and any other information that may be required to make an informed decision. This process may take between 6-9 months to gain regulatory approval, but it will go a long way to eliminating potential risks to client money.
After the event monitoring and supervision following an acquisition would also be required. The SRA would need to receive evidence that actual figures were broadly in line with the budgets they had been provide with and there was no obvious risk to financial stability. Who would pay for all this additional work that would need to be undertaken by the SRA? Well an application fee would go a long way to covering this and could of course be linked to some sort of sliding scale based on revenue.
You will not be surprised to learn that the SRA are also considering whether current safeguards need to be strengthened – both within firms and those provided externally. One area that they are taking a keen interest in are existing checks and balances in place when making payments from client account. No one individual should be allowed to set up payments and then make the payment. A “four eyes” policy should be in place during the payment process and fee earners should be approving all payment prior to release. Ideally, the managing partner should not play any part in the payment process. All of this would have to be properly documented in the firm’s Accounting Policy Document.
External safeguards are currently limited to the reporting accountants and the AR1. The current process for only having to submit qualified reports to the SRA already looks like a big mistake as it is so open to abuse by exactly the kind of firms that the regulator should be interested in. In the future you can expect that the reporting accountants’ regime will be much broader and will have to identify where client money is at risk. The SRA will also have to explore alternative arrangements that could provide appropriate safeguards for smaller firms.
So what does the bigger picture look like? Well the SRA will have to give some serous thought as to who is actually controlling the amount of client money any particular firm may hold?
Is it the firm itself, which means it is in effect self-insuring and will be of no help if it ends up in Administration? Is it the SRA, which will have to balance this against the value of the compensation fund it will need to maintain in order to pay out on future losses? Is it the PI insurers – who may inadvertently get dragged into a claim for compensation and who will undoubtedly deny it is covered under the current minimum terms. Or is it the bankers, who have a duty to protect money held in a designated client account? Good luck getting all of those interested parties to agree on anything!
David Thorpe
Director – Financial Eye