Keeping control – managing the regulatory risks of outsourcing

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By Legal Futures

17 January 2011


In the first of a two-part article, Duncan Finlyson of Legal Futures Lawyers Defence Group investigates the reasons for law firms to outsource certain functions and the regulatory issues that they throw up

India: maintaining oversight and control is the main problem

They, whoever “they” are, are constantly telling us that as a profession, lawyers must all start to embrace new business models and practices if we are to survive the ABS revolution.

They, whoever they are, are probably right. However, and it is an important however, as lawyers we must approach any changes with a degree of circumspection and ensure that we are not moving forward in a way which places our clients, or own firms, at risk.

Nowhere is this more topical than in relation to the ever growing trend for firms to outsource.

The following article looks at some of the regulatory issues and risks which firms face when considering this.

The forms of outsourcing

Outsourcing is big business and over the past six or seven years has gained a rapidly growing prominence in the legal world.

Outsourcing can take many different forms, including:

  • Outsourcing office services such as word-processing and secretarial services;
  • Having elements of the legal work outsourced to lawyers outside of the firm, sometimes overseas where labour costs are lower;
  • Sharing serviced offices so that the firm does not have to worry about problems relating to premises, and
  • Cloud computing – where firms store their data off site, run computer programmes remotely and access files and records via the Internet.

In the US, where outsourcing has taken off far more than in the UK, many firms are having substantial parts of cases handled externally to the firm, including discovery, document review, due diligence, drafting, legal research, and paralegal support.

In one way, solicitors have outsourced aspects of their work for a considerable time – instructing counsel to draft pleadings or give an expert opinion. This, however, has never been viewed as a problem since barristers form another group of professionals with rules of ethics and conduct as strong as those affecting solicitors. The problems only start to arise when firms outsource matters to businesses which are not subject to strict rules of conduct, who are not tightly regulated or even who are in a foreign country and may not even be subject to the same rule of law as solicitors here.

Whilst many firms continue to be uncomfortable about outsourcing legal work to third-party providers, the reality of the situation is such that that a great deal of the work undertaken by law firms is relatively routine and does not need to be undertaken by highly qualified and costly solicitors and barristers. Overall costs, therefore, cam be reduced substantially if the more routine aspects of a case can be dealt with elsewhere.

The benefits of outsourcing

There can be no doubt that for many firms, the benefits of outsourcing are considerable. Law firms’ costs – particularly staff, premises and insurance – are constantly increasing, whilst at the same time the pressure upon firms to reduce fees, do more work for less money and limit disbursements places many firms between the proverbial rock and a hard place.

Added to this, many clients are seeking improvements in speed and efficiency from firms whilst at the same time requiring that firms increase their levels of accountability.

Understandably then, outsourcing, which allows many firms to both reduce cost and improve service, is becoming an increasingly attractive option.

Many of the providers of outsourced services are basing themselves overseas in economies where labour costs are lower, premises are cheaper and where the employment rules are less onerous and the benefits lower, or even non-existent. Even were the actual individual costs not lower, the ability of outsourced service providers to ensure that staff are more effectively utilised can in itself reduce costs. If a secretary or junior fee-earner is not employed fully, then the incremental cost of their time increases.

From a perspective of continuity of service, the use of external providers can ensure that peaks and troughs are ironed out and that there is always a sufficient resource to undertake the work which needs to be done. Moreover, it means that the firm can simply purchase that support which it needs at the time at which it needs it.

Furthermore, fixed costs can be reduced because the firm is not having to rent space to house workers or purchase equipment and technology for them to use. There are no pension contributions to be made. There is no sickness pay to be found. There are no redundancy payments if levels of work decrease. There are no recruitment fees to pay when work levels pick up.

If one looks more widely and considers issues such as cloud computing external IT services, the benefits become even more apparent. Not only can firms can reduce capital expenditure on expensive IT equipment and the cost of IT support departments, but also they can allow fee-earners the greater flexibility of being able to access data and programmes anywhere where they can gain access to the Internet.

It looks like a win all round. But is everything really that easy? Can the firm simply find the cheapest supplier of services and watch the overheads fall?

The simple answer to that question is “No”. There are risks associated with all forms of outsourcing and all firms would be well advised to review and address those risks before they even begin to think about the financial benefits.

The regulatory risks of outsourcing

So what are the risks associated with outsourcing and to what extent should firms be concerned about them?

There are at least 11 separate regulatory risks associated with outsourcing:

  • Data security – information being lost or corrupted;
  • Lack of confidentiality – information being disclosed to third parties or even the use of information to assist in crime;
  • Risk of conflict of interests – there are a limited number of outsourcing suppliers and therefore a real danger that outsources may become involved in both sides of the same matter. Firms wishing to outsource must therefore ensure that appropriate conflict checks are undertaken at the service provider and that where appropriate information barriers are put in place;
  • Loss of supervisory control – the outsourcing firm not knowing what the service provider is doing or how they are doing it;
  • Quality of service – the work undertaken by the service provider not being of a sufficiently high quality or of a variable quality;
  • Level of understanding and knowledge of the work being undertaken – service providers may not keep up to date with relevant developments or may miss cultural indicators that would have been picked up locally;
  • Availability and the reliability of ready access to information – the outsourcing firm not being able to gain access to information, data or files when required;
  • Consumer perception – whatever the safeguards that are put in place many consumers may have concerns about work being outsourced generally, may have objections to work being outsourced abroad (and thus depriving the home market of jobs) or may have concerns about the security of data outsourced abroad;
  • Contractual problems – breakdown in the contractual relationship during the work being undertaken and the ability of the outsourcing firm to recover papers and data or to be able to handle the work without the service provider’s assistance;
  • Problems with local staff – an increase in outsourcing could cause local staff to fear that their jobs are at risk. This could lead to low morale, unwillingness to work with the outsources or even straightforward sabotage of the outsourcing arrangements;
  • Regulatory problems – breach of rules in the jurisdictions of either the outsourcing firm or the service provider, irrespective of whether any of the foregoing risks exist. This could include, for example, reserved work being undertaken by unqualified staff where the regulator felt that inadequate supervision existed.

In April 2005, the Financial Services Authority produced a report on the risks associated with outsourcing to India. It concluded that “the main risk identified is the complexity of achieving suitable management oversight and control from a distance”.

Clearly the level of risk will depend upon the particular type of outsourcing. Thus a firm that outsources part of its secretarial function will have fewer concerns than a firm which uses an Indian-based company to undertake a part of the legal work. However, both would need to be conscious of the requirement for confidentiality and data security.

The Solicitors Regulation Authority, in its response to the Legal Services Board consultation Alternative business structures: approaches to licensing, was clear how it would regard outsourcing when stating that it would be allowed “subject to the regulated firm remaining at all times responsible for the activities of the outsourcer [service provider], which brings with it the necessity to monitor outsourced activities to ensure that the desired outcomes are being achieved.”

Tomorrow’s article will look at the issues that the Solicitors Code of Conduct throws up in relation to outsourcing.

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