Misleading funders, inflating work-in-progress valuations and shortages in client account are among the common features of financially unstable firms that are currently under investigation by the Solicitors Regulation Authority (SRA), it has emerged.
More generally key features of those firms which have so far failed include sheer naïvity, an over-dominant partner and the lack of a good finance director.
But the SRA claims to have saved “millions of pounds” of costs by working towards an orderly wind-down of the likes of Halliwells and Cobbetts, rather than intervening in them.
The SRA’s regulatory risk committee will today consider a paper looking at whether the regulator needs any further powers to deal with financial stability among law firms.
It said there are a number of firms currently under investigation with a view to enforcement action. “Allegations vary but may well include misleading of funders, poor financial and risk management overall, inflating work-in-progress valuations, misleading the SRA and, indeed, breach of the SRA Accounts Rules 2011 sometimes leading to shortages. In one case, the (partly disputed) shortage was over £500,000.
Among the most striking features of the SRA’s experience to date, it said, were that “some substantial law firms very naïve in their financial management”, well-run firms tend to have a high-quality finance director, and that troubled practices simply failed to accept their situation or engage with the SRA.
“One individual is often the main problem – over dominant senior partners or sometimes chief executives cause both strategic failure by the firm but also a refusal to accept how serious the situation in the firm has become. This can also arise because of an ineffective financial director,” it said.
“Firms which have recognised this and dealt with the problem have sometimes recovered quickly, probably because they gain the confidence of their funders.”
It also warned that “the temptation to be economical with the truth with funders is a very serious risk for firms” in financial problems.
The paper defended the need for interventions, despite their cost, and said that “superficially attractive ideas for alternatives to intervention are often unfeasible largely because they would not necessarily cost less and would sometimes cost more”.
It continued: “It should be borne in mind that Parliament has provided the intervention process and indeed when there has been contact with other regulators to compare their powers, they have sometimes commented that intervention is the strongest and simplest remedy to take control of a firm that is in default or represents a high risk.”
The paper, authored by legal director David Middleton, said the main alternative to intervention currently employed is “constructive engagement” by the SRA’s supervision function and relationship managers.
“Millions of pounds have been saved by that engagement, leading to orderly wind-downs (such as Halliwells, Dewey LeBoeuf, Cobbetts, Challinors and others).”
The regulator is, however, to make an application to court to determine how long it must keep the files of intervened firms, with the cost of collecting, archiving and ultimately destroying closed client files one of the major drivers of intervention costs.
The paper indicated that the SRA’s current powers are largely sufficient to deal with financial stability issues. Most of the steps that are needed – for example, requiring firms to take independent advice on solvency is “the most effective method of causing firms to understand their true position” – can be achieved by agreement or by conditions on authorisation or practising certificates.