What is a material compliance failure?

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25 July 2013


Posted by Allison Wooddisse, head of practice compliance at Legal Futures Associate LexisNexis

There is a lot of disagreement over what is a material breach and what isn’t

Let’s assume you already know you have to report material compliance failures to the Solicitors Regulation Authority (SRA) as soon as reasonably practicable.

That begs the BIG question: what does a material compliance failure really look like.

What does the SRA say?

In the brave new world of outcomes-focused regulation, there’s no definition of material compliance failure and the SRA isn’t forthcoming with any real guidance or examples. Instead, you’re expected to work it out for yourself, taking into account all relevant factors, including:

  • detriment or risk of detriment to clients;
  • scale of the issue;
  • overall impact on the firm, its clients and third parties; and
  • extent of any risk of loss of confidence in your firm or the wider legal market

Remember too that a compliance failure can be material either taken on its own, or as part of a pattern of compliance failures.

What do practitioners think?

The table below gives examples of common compliance failures. We’ve canvassed practitioner opinion (at a series of workshop in spring/summer 2013) on whether each failure in the table:

  • is material
  • is non-material
  • could be either (material or non-material), taking into account the all relevant factors listed above.

You won’t be surprised to see that practitioners don’t always agree with each other and we don’t always agree with them…

 

Scenario

Practitioner opinion

Why is this a compliance

failure?

Source of    requirement

1

E-mail sent to a random third party in error, disclosing confidential client information.

Over two-thirds of practitioners considered this to be a material compliance failure

You must keep the affairs of clients confidential unless disclosure is required or permitted by law, or the client consents.If the e-mail contains personal data, this would also be a data protection breach 

SRA Code of Conduct 2011, O(4.1)Data Protection Act (DPA) 1998, Sch 1 Pt I

2

E-mail to another solicitor sent in error, which solicitor deleted.

Almost two-thirds of practitioners considered this to be a non-material compliance failure.Generally, practitioners felt that, as the e-mail had been sent to a heavily regulated person (another solicitor), the detriment to the client may turn out to be less than for an e-mail erroneously sent to a random third party 

If the e-mail contains confidential client information, this is a breach of the duty to keep the affairs of clients confidential unless disclosure is required or permitted by law, or the client consents. If the e-mail contains personal data, it is also a data protection breach

SRA Code of Conduct 2011, O(4.1)DPA 1998, Sch 1 Pt I

3

Loss of laptop containing client data

Nearly three-quarters of practitioners considered this to be a material compliance failure, although this appeared to be on the assumption that client data could be readily accessed on the laptop. Those who considered this to be a non-material failure (nearly a quarter) did so on the basis that the laptop/data was robustly encrypted and therefore could not be accessed

You must keep the affairs of clients confidential unless disclosure is required or permitted by law, or the client consents.Assuming the laptop contains personal data, it could also be a data protection breach (subject to comments already made re encryption)

SRA Code of Conduct 2011, O(4.1)DPA 1998, Sch1 Pt1

4

One-off failure to notify a client of a referral fee.

Over three-quarters of practitioners considered this to be a non-material compliance failure

Clients must be informed of:(i) any financial or other interest an introducer has in referring them to you(ii) any fee-sharing arrangement that is relevant to their matter.

The information you give clients should be clear and given in writing, and/or in a form appropriate to the client’s needs

 

SRA Code of Conduct 2011, O(9.4)-O(9.5), IB(9.5)SRA Code of Conduct 2011, IB(9.5)-IB(9.6)

5

Repeated failure to notify client of a referral fee

This was universally considered this to be a material compliance failure

Pattern amounting to material compliance failure

SRA Code of Conduct 2011, O(9.4)-O(9.5), IB(9.5)SRA Code of Conduct 2011, IB(9.5)-IB(9.6)

6

Paying client money to an incorrect third party

Well over three-quarters of practitioners considered this to be a material compliance failure

You must protect client money and assets.Client money may only be withdrawn from a client account for one of the reasons stated in SRA Accounts Rules 2011, r.20.1

SRA Principle 10SRA Accounts Rules 2011, r.20.1

7

Knowingly acting in a solicitor/own client conflict situation

This was universally considered this to be a material compliance failure

You can never act if there is an actual or significant risk of an own interest conflict. There are no exceptions

SRA Code of Conduct 2011, O(3.4)

8

Negligence, eg missed limitation date

Over half of practitioners considered this to be a material compliance failure, although a third thought materiality depended on the circumstances of the case, applying the SRA factors

You must provide a competent service to clients

SRA Code of Conduct 2011, O(1.5)SRA Code of Conduct 2011, Ch 7, O(7.8)

9

Payment into wrong client account, rectified late but still within a few days

Nearly two-thirds of practitioners considered this to be a non-material compliance failure. Nearly a third thought materiality depended on the circumstances of the case, applying the SRA factors. Generally, this was considered to be less serious than paying client money to an incorrect third party—the difference being that, where you pay money into the wrong client account, you still have control of it

You must protect client money and assets.Client money may only be withdrawn from a client account for one of the reasons stated in SRA Accounts Rules 2011, r.20.1

SRA Principle 10SRA Accounts Rules 2011, r.20.1

10

Upheld complaint of discrimination by member of staff

Over two-thirds of practitioners considered this to be a material compliance failure. The remainder generally felt that materiality depended on the circumstances of the case, applying the SRA factors

It is difficult to see how an upheld complaint of discrimination against the firm can be anything other than a material compliance failure. The Equality Act 2010 (EqA 2010) provides protection against discrimination relating to certain protected characteristics, eg age, sex, race, religion or belief.You must run your business in a way that encourages equality of opportunity and respect for diversityYou must not discriminate unlawfully, or victimise or harass anyone, in the course of your professional dealings

 

EqA 2010SRA Principle 9SRA Code of Conduct 2011, O(2.1)

11

Firm’s website hacked meaning client passwords no longer secure for client portal

Over three-quarters of practitioners considered to be a material compliance failure

Data protection breachBreach of the duty to keep the affairs of clients confidential unless disclosure is required or permitted by law, or the client consents 

DPA 1998, Sch 1 Pt ISRA Code of Conduct 2011, O(4.1)

12

Failing to account to a client for commission received as a result of their instructions

There was no majority opinion on this issue. Almost half of practitioners thought materiality depended on the circumstances of the case, applying the SRA factors. Over a third of practitioners considered this to be a material compliance failure, regardless of scale. A very small minority felt it was non-material

You must properly account to your client for any financial benefit you receive as a result of their instructions. Generally, you should deal with the financial benefit by:(i) passing it to the client; or(ii) offsetting it against your fees

You should only keep a financial benefit where:

(i) you can justify keeping it;

(ii) you have told the client the amount of the benefit (or an approximate amount); and

(iii) the client has consented to your keeping it

 

SRA Code of Conduct 2011, O(1.15)SRA Code of Conduct 2011, IB(1.20)

13

Inadequate client due diligence (CDD) applied on a commercial transaction file

Over half of practitioners thought materiality depended on the circumstances of the case, applying the SRA factors. Over a quarter of practitioners considered this to be a material compliance failure

You must comply with legislation applicable to your business, including anti-money laundering. You must have a procedure for conducting CDD on clients instructing you on matters falling within the scope of the Money Laundering Regulations 2007. This involves:(i) identifying your client (and, where necessary, the beneficial owner of your client);(ii) verifying their identity; and

(iii) obtaining information on the purpose and intended nature of the business relationship

 

SRA Code of Conduct 2011, O(7.5)SI 2007/2157, reg 20

14

Ignoring a client complaint

Almost two-thirds of practitioners considered this to be a material compliance failure, a third thought materiality depended on the circumstances of the case, applying the SRA factors

It is difficult to see how ignoring a client complaint can be anything other than a material compliance failure.You must deal with clients’ complaints promptly, fairly, openly and effectively. In the event that the client makes a complaint, they must be provided with all necessary information concerning the handling of their complaintYou must comply with the SRA’s rules on handling complaints

 

SRA Code of Conduct 2011, O(1.9)-(1.11), (1.14)SRA Code of Conduct 2011, IB(1.23)-(1.24)Legal Ombudsman, Scheme Rules

15

Breach of an undertaking

This was almost universally considered to be a material compliance failure

You must discharge an undertaking within an agreed timescale or within a reasonable timeThe court has jurisdiction is to enforce honourable conduct by court officers, ie solicitors 

SRA Code of Conduct 2011, O(11.2)John Fox (a firm) v Bannister King and Rigbeys (a firm) [1987] 1 All ER 737

16

Falling behind with file audits

Almost all practitioners considered this to be a non-material compliance failure

There is no specific requirement to conduct file audits, but rather to have a system for supervising clients’ matters that includes regular checking of the quality of work by suitably competent and experienced people. Most practitioners would agree that persistent failure to supervise clients’ matters (evidenced by persistent failure to conduct file reviews) would be a material compliance failureIn a guidance note to the Authorisation Rules, the SRA suggests that your compliance plan includes arrangements for file reviews 

SRA Code of Conduct 2011, Ch 7, O(7.8)SRA Authorisation Rules 2011, Guidance note to r 8

17

Allowing a client to mislead the court

Almost all practitioners considered this to be a material compliance failure

You must not:– attempt to deceive or knowingly or recklessly mislead the court– be complicit in another person deceiving or misleading the court

– place yourself in contempt of court

You must refuse to continue acting for a client if you become aware they have committed perjury or misled the court, or attempted to mislead the court, in any material matter unless the client agrees to disclose the truth to the court

 

SRA Code of Conduct 2011, Ch 5

18

Failure to take account of a client’s vulnerability

Almost three-quarters of practitioners thought materiality depended on the circumstances of the case, applying the SRA factors. The remainder were evenly split between material and non-material compliance failure

Despite practitioners’ opinion, this may well be a material compliance failure, as the SRA imposes specific requirements on this issue. You must act in the best interests of each client. This involves having proper regard to your client’s mental capacity or other vulnerability, such as disability, incapacity or duress in taking instructions, and during the course of the matterIf your client is physically disabled you must make reasonable adjustments to ensure they are not placed at a substantial disadvantage compared to those who are not disabled. You must not pass on the cost of these adjustments to the client 

SRA Principles 2011, Principle 4SRA Code of Conduct 2011, IB(1.6)SRA Code of Conduct 2011, O(2.3)

19

Failure to comply with court directions

Over a third of practitioners considered this to be a material compliance failure. The remainder were fairly evenly split between non-material or materiality depended on the circumstances of the case, applying the SRA factors.It was felt that firms should take court directions more seriously than in the past, due to increased risk of strike out under the post-Jackson regime

You must comply with court orders which place obligations on you

SRA Code of Conduct 2011, O(5.6)

20

Accepting money on client account that does not relate to an underlying transaction

Over three-quarters of practitioners considered this to be a material compliance failure

You must not provide banking facilities through a client account. Payments into, and transfers or withdrawals from, a client account must be in respect of instructions relating to an underlying transaction (and the funds arising therefrom) or to a service forming part of your normal regulated activitiesThis reflects decisions of the Solicitors Disciplinary Tribunal that it is not a proper part of a solicitor’s everyday business or practice to operate a banking facility for third parties, whether they are clients of the firm or not. It should also be borne in mind that there are criminal sanctions against assisting money launderers 

SRA Accounts Rules 2011, r.14.5SRA Accounts Rules 2011, guidance note to r.14

21

Leaving a client cheque on a file

Just over half of practitioners thought materiality depended on the circumstances of the case, applying the SRA factors. The remainder considered it to be a non-material compliance failure.No respondents considered this to be a material compliance failure

Client money must without delay be paid into a client account – in normal circumstances, either on the day of receipt or on the next working day. Despite the view of practitioners, excessive delays relating to large amounts which cause client loss could constitute a material compliance failure

SRA Accounts Rules 2011, r.14.1

22

Failure to update a client on costs

Just over half of practitioners considered this to be non-material. Most of the remainder thought materiality depended on the circumstances of the case, applying the SRA factors – in particular the disparity between the costs charged to the client and what the client expected

You must provide the best possible information about the likely overall cost of the client’s matter at the outset and when appropriate as their matter progresses

SRA Code of Conduct 2011, O(1.13)

23

Commenting about a client on your private social media account

Almost all practitioners considered this to be a material compliance failure – it is not sufficient to rely on privacy settings on social media accounts and once a comment has been posted to a social media account, it cannot be considered private

You must keep the affairs of clients confidential unless disclosure is required or permitted by law, or the client consents.If the comment contains personal data, it would probably also be a data protection breach

SRA Code of Conduct 2011, O(4.1),DPA 1998, Sch 1 Pt I

24

Failing to manage client’s expectations

About three-quarters of practitioners thought materiality depended on the circumstances of the case, applying the SRA factors – in particular the disparity between the client’s expectations and the eventual outcome. Most of the remainder considered it to be non-material

You should discuss whether the potential outcomes of the client’s matter are likely to justify the expense or risk involved. Clients must be in a position to make informed decisions about the services they need, how their matter will be handled and the options available to them

SRA Code of Conduct 2011, IB(1.13)SRA Code of Conduct 2011, O(1.12)

25

Delay on client’s matter

Well over three-quarters of practitioners thought materiality depended on the circumstances of the case, applying the SRA factors – in particular the extent of the delay

You must deliver services to clients in a timely manner

SRA Code of Conduct 2011, O(1.5)

26

Failure to pay interest

Nearly half of practitioners thought materiality depended on the circumstances of the case, applying the SRA factors. Almost a third thought it was a material compliance failure

You must pay interest when it is fair and reasonable to do so in all the circumstances. You must pay a fair and reasonable sum over the whole period that the money is held

SRA Accounts Rules (AR) 2011, r.22.1SRA AR 2011, r.23

27

Leaving a paper file in a café

All practitioners considered this to be a material compliance failure

You must keep the affairs of clients confidential unless disclosure is required or permitted by law, or the client consentsAssuming the file contains personal data, this would also be a data protection breach 

SRA Code of Conduct 2011, O(4.1)DPA 1998, Sch 1 Pt I

28

Residual balance remaining on client account for over six months

Over half of practitioners thought materiality depended on the circumstances of the case, applying the SRA factors. Nearly a third of practitioners thought it was a material compliance failure

You must promptly either:(i) return client money to the client or other person on whose behalf the money is held; or(ii) write to the client etc at the end of the matter telling them how much money you are retaining and why.

‘Promptly’ is not defined in SRA AR 2011 by reference to a specific time frame; it should be given its natural meaning in the particular circumstances. You should therefore consider the nature of the matter. In many cases the conclusion of the retainer is clear and you will return the funds in matter of days. In other cases the matter may be more protracted; if that is the case you must make the refund once you are aware there is no reason to retain the funds

SRA AR 2011, r.14.3SRA AR 2011, r.14.4SRA AR 2011, r.14, note (vi)

29

One-off failure to attach terms of business to client-care letter

Over three-quarters of practitioners considered this to be a non-material compliance failure, although most acknowledged that failure to provide terms of business could cause contractual difficulties, particularly in relation to recovery of costs

The SRA does not require you to have a client-care letter or terms of business document. Instead, it describes outcomes that you must achieve in relation to client care. Many of these outcomes require you to give information to the client, sometimes in writingThere are also information requirements in various regulations, eg Provision of Service Regulations 2009, SRA Indemnity Insurance Rules 2012, SRA Financial Services (Conduct of Business) Rules 2001, Legal Ombudsman Scheme Rules, Cancellation of Contracts Regulations 2008, SI 2008/1816 and Distance Selling Regulations 2000, SI 2000/2334

Information requirements scattered across SRA Code of Conduct 2011 and other regulations

 

What do we think?

Although some compliance failures are obviously material, many aren’t and will depend on all relevant factors, including those in the SRA’s list. If in doubt call the SRA’s ethics helpline or e-mail the SRA on report@sra.org.uk, which is the e-mail address for reporting material compliance failures.

One final word of warning: the SRA has never suggested that rectifying a material compliance failure downgrades it to non-material. In fact, the SRA says: “Although it will commonly be appropriate for the firm to take steps to remedy breaches immediately, this does not obviate the need for compliance officers to record the breach and make a report…where appropriate.”

I’m obliged to say that you shouldn’t rely on the above table as a definitive statement on whether certain scenarios are material; but hopefully, the information is a good starting point for your own assessment. Also, if you’d like to submit further examples (real or imagined) please e-mail pslpracticecompliance@lexisnexis.co.uk . If appropriate, we’ll add your example to our table in an entirely anonymised form.

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One Response to “What is a material compliance failure?”

  1. I have carried out breach webinars recently to over 300 firms and it is clear they need help with determining materiality and the need to identify issues that could impact on when to report to the SRA. Although the SRA has issued a small number of case studies so far, more would be welcome so there is a better understanding of where it expects firms to land!

  2. Brian Rogers on July 25th, 2013 at 10:29 am

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