Exclusive: SRA begins fundamental review of client protection

Bradley: We don’t have the answers

The Solicitors Regulation Authority (SRA) today starts a conversation about the future of client protection arrangements, the extreme end of which could see the end of firms holding client money and of the SRA Compensation Fund, Legal Futures can reveal.

The consumer protection review essentially aims to answer whether there is more the regulator can do to identify firms that might fail and how to protect consumers when they do.

It is starting with publication of a paper setting out its scope and a plan to engage with the profession, consumers and other stakeholders.

The kinds of changes it could make range from incremental improvements in the SRA’s processes to radical reform of the regulatory framework.

There are no proposals at the moment, only ‘prompts’ for discussion, although this process will lead to a consultation on reforms towards the end of the year. This could in turn lead to rule changes or even the need to amend primary legislation.

The SRA is also shortly to begin a thematic review of ‘accumulator’, or consolidator, firms and of acquisitions more generally.

SRA chair Anna Bradley said the current arrangements had served the public and professional “pretty well”.

She explained: “That isn’t to say there haven’t been market failures. It’s a fact that in any market there’ll be failures but there’s been a small number of instances where firms have failed and there’s been a safety net in place that has worked and consumers have been protected.”

Stressing that the review was not triggered solely by the collapse of Axiom Ince last year, she said that event reflected the “shifting risks in the sector” that saw the regulator close down 65 firms in the year to 31 October 2023, compared to 25 in the previous 12 months.

The paper says: “In considering changes to our approach, we will need to get the balance right. For instance, bolstering or even maintaining the current level of consumer protection might not be in the public interest if it is unsustainable. It could lead to large increases in prices or reduced choice for consumers, negatively impacting access to justice.

“We therefore need to look at the overall impact on consumers. We are particularly conscious of the pressures faced by small firms, including those providing services to vulnerable consumers.”

The review will look at how the SRA identifies sector risks and monitors firms, as well as its approval processes for firms, rules and controls around client money, and approach to firms’ structures and ownership models.

Among the issues up for discussion are closer supervision of higher-risk firms, such as more targeted inspections, including forensic checks of client accounts.

The SRA pledged to explore with other regulators, escrow account providers and insurers different approaches to managing the risks of holding client money. “We would need to consider whether there are certain circumstances when it is or isn’t prudent for firms to hold client money…

“There may be certain risks flags that mean we should have tighter restrictions and more controls on certain firms – or business models – holding client money. For instance, linked to the type of work a firm does or its client profile.”

Third-party managed accounts have not taken off, despite encouragement from the SRA and also the Council for Licensed Conveyancers.

SRA chief executive Paul Philip suggested that this could be because solicitors felt the trusted position of being able to hold client money was a core part of their identity.

The review will also assess corporate structures. The SRA asks: “Should we tighten our rules to mitigate the risk that a small number of people can control management decisions, particularly in relation to accounts, such as our rules around the need for a firm to have a designated compliance officer?

“This could include exploring a restriction on the managing partner also being a compliance officer to reduce the risk around potential conflicts.”

The regulator will look too at the sustainability of ownership models and whether some carry more inherent risk. “We could consider mandating greater transparency around ownership models and structures,” the paper said.

The SRA says there is no evidence that alternative business structures (ABSs) have proven any more risky than traditional firms – only 6% of the interventions carried out in the past decade have been ABSs. They make up approaching 11% of firms.

On the compensation fund, the SRA will look at whether to further limit who can make claims on the fund – such as helping only those who will suffer financial difficulties as a result of the loss – or what transactions are covered. Some schemes, it said, did not consider claims linked to investments.

The maximum payout, currently £2m, could be lowered, although average payouts are less than £40,000.

It could recalibrate the capping provision: “Our rules enable us to impose a discretionary £5m cap – no more or less – on claims to protect the solvency of the fund. We did not use this cap in the Axiom Ince case, as the scale of consumer loss if it were applied would be too large and lead to an unacceptable loss in public confidence in solicitors.

“We could change the rules around a cap to give ourselves more flexibility. And we could introduce aggregate limits for claims per person, per firm, per incident or connected incidents.”

The most radical option would be to phase out the fund and limit the safety net to insurance. Firms could choose to insure against fraud/dishonesty by their staff or other directors, while some regulators have insurance-based compensation arrangements instead of running a fund.

Ms Bradley said: “We want to have a rich and deep discussion – the truth is we don’t have the answers. We want to find out what other people think and work our way through options.”

Mr Philip said the SRA was already making changes to how it monitored risk: “Other changes will need more extensive engagement. There will likely be strong arguments for maintaining the current level of protections, but we need to be sure that is proportionate in the face of evidence of escalating risks.”

The SRA will be carrying out consumer research and holding a series of roundtables in March. There will also be a webinar on 19 February.

    Readers Comments

  • Angie says:

    Third party managed client accounts sounds highly risky to me. What a target for a fraudster. Lots of smaller firms holding funds and diversifying the challenge to a fraudster seems to be a much safer option.

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