Living the Eye Life! – September 2024
Life is just about to get interesting. Not least because the USA is about to elect a new President and who knows what impact that will have on the rest of the world. But also because at the end of this month, the chancellor of our government will deliver her first ever Autumn budget. At which point, all businesses, including law firms, will get a much clearer understanding of what’s in store for us in 2025. Now I don’t want to sound too alarmist but, it looks pretty clear that we will see some tax increases in areas that may start influencing the way law firms see their own futures.
By which I mean how many firms will now start thinking more seriously about their exist strategy. In previous articles I have touched on the subject of succession and exit plans and what impact this could have on legal cashiers. My conclusion was that there can be as many upsides as downsides to firms merging. But what may have been missed amongst all the excitement of the Euros and the Olympics was the Warning Card issued by the SRA on this very subject.
Over the course of the summer, the SRA published a paper to help firms understand their obligations when selling, acquiring or merging and how to comply with them. The regulator recognises that such activity is a legitimate strategy for growth and business resilience, particularly following the Covid-19 pandemic and other global events. These events have naturally impacted upon firm’s profitability and financial stability and as a result, many firms face an uncertain future.
To meet these challenges, some firms are looking to merge with or acquire other firms. This may be to stay competitive in the legal marketplace by offering a more diverse range of services and remain financially robust to continue to trade through tough times. It maybe for a number of other reasons too. As I have always said, there can be many good reasons for mergers and acquisitions, and the good news is the SRA have stated that they do not seek to stand in the way of a healthy, competitive legal market.
But the fact is, over the past few years, the market has seen some firms making multiple acquisitions in a relatively short period of time, which has led to challenges in respect of business integration, organisational culture, and maintaining standards of service to increased client numbers. The regulator is keen to ensure managers of such firms, including the COFA, should always make sure that acquisitional growth does not lead to ineffective governance structures, systems or controls which could cause detriment to clients or undermine trust in the profession.
If you are the firm’s COFA, you will need to ensure that you are fully aware of how any potential acquisition process is developing. For starters, you will need to immediately undertake a systematic review of any acquired residual client account balances and make sure that they are dealt with in accordance with the SRA Accounts Rules and associated guidance. This will be of huge significance because during the acquisition process, the SRA will expect you to clear all of these balances and failure to do so could very quickly lead to action being taken against the firm and the possibility of fines being levied.
So the Warning Card is very much real and failure to have proper regard to the warning notice is likely to lead to disciplinary action. But this is not the only thing you need to be aware of. At the beginning of this year, the SRA also launched a consumer protection review, and this will invariably impact on the role of the COFA and those working in the finance department. This is gathering speed, and you can expect to see proposed changes to the way firm’s operate client accounts this side of Christmas.
For example, one of the things they are considering is restricting firms from holding client money. They have said that they intend to explore with other regulators, escrow account providers and insurers different approaches to managing the risks of holding client money. This could include alternative approaches to holding client money, or certain categories of client money. They will then consider whether there are certain circumstances when it is or isn’t prudent for firms to hold client money at all. For the avoidance of doubt, they are considering fundamentally changing the 2019 Accounts Rules. Well that will be a lot of fun!
As part of their review process, the SRA has also said they will be engaging with reporting accountants to see if they can identify any short-term improvements to the inspection process. This is sensible idea, but it will inevitably lead to increased costs for firms. And you can expect your reporting accountants to begin asking for addition information during their annual visits.
You need to ask yourself if you are happy with the way the finance department is operating. Four things you can focus on are, financial stability, COFA matter file review programme, your residual balances and you accounting policy document. If you don’t have a current written accounting policy document, how do you, or the regulator or your reporting accountant know you are following your own processes? And the only way you can do this is to carry out COFA matter file reviews, preferably independently, to satisfy yourself that your controls are working. Similarly, if you are not producing monthly management accounts including a cash flow forecast, how do you know you are financially stable?
So plenty of food for thought. I correctly predicted the result of the July general election in this column earlier this year. I’m not going to be so brave with the US presidential election. Believe it not there are some things I just don’t have a clue about. I think I’ll stick to compliance!
David Thorpe
Director – Financial Eye