Deals: Questions over notification requirement
The Law Society has spoken out against the Solicitors Regulation Authority (SRA) having a broad power to require law firms to notify it about particular events.
The society said it was also against the use of fixed financial penalties to police the new system.
However, it recognised that there may be a case for “enhanced notification or approval requirements in relation to certain clearly defined high-risk events” such as significant mergers and acquisitions (M&As) or “rapid expansion”.
Currently, firms are obliged to notify the SRA of material changes to information they have previously provided. But it does not specify in detail what changes should be notified and a consultation issued in June proposed a rule to require firms to notify events that the SRA prescribed from time to time.
The first two would be notification of M&A after signing heads of terms and beginning to hold client money.
While supporting the SRA’s “overarching objective of improving its ability to identify and act on risks at an earlier stage”, the Law Society response said the prescribed events rule represented “a wide enabling power with limited safeguards”.
The move raised issues of legal certainty and predictability for law firms and “the potential for regulatory creep” over time.
“Indeed, the SRA is already seeking to add a third notifiable event – relating to third-party litigation funding – before submissions to this consultation establishing a notifications regime have even closed.”
The society was not opposed to notification requirements in principle, but the SRA should first make better use of the substantial information it already collected from firms, and then conduct evidence-backed consultations before imposing future notification requirements.
Otherwise, there was a danger of reporting obligations expanding “incrementally over time – whether through the prescribed events framework generally, or through the addition of further
information requirements – without the same level of consultation, evidential testing and impact assessment that would accompany primary rule changes”.
Meanwhile, the introduction of fixed penalties “may function as a blunt instrument that does not meaningfully distinguish between low-risk administrative failings and more serious compliance issues”.
As the SRA had acknowledged, financial penalties were “likely to have a greater relative effect on smaller firms, which may have fewer administrative resources and less capacity to absorb additional regulatory costs”.
The society supported “the inclusion of M&As as a notifiable event in principle, reflecting their potential to signal increased risk”, but did not agree that the heads of terms stage was “necessarily the most appropriate or proportionate trigger”.
Instead, there should be a “more flexible, risk-based approach” to defining when notification should happen.
Similarly, the society did not support an additional notification requirement at least 30 days prior to an M&A deal completing.
“Different and more flexible arrangements” were needed for “fast-moving transactions”, which could include post-event notification.
“Poorly designed notification triggers or timeframes risk creating unintended behavioural and market effects, such as encouraging firms to delay, restructure or alter the timing of transactions or business decisions solely to manage regulatory obligations.”
The society agreed that a law firm beginning to hold client money represented a “material change in its risk profile”, and the SRA should be made aware of those changes in “a more timely and explicit” way.
However, its support was “conditional on a number of important safeguards and clarifications, which are necessary to ensure that the burden on firms remains proportionate and that the regime operates effectively in practice”.
These included avoiding duplication with the current obligation to report material changes, and proportionality, particularly since the SRA’s own data had identified that firms beginning to hold client money for the first time were predominantly small.
The response agreed that firms should notify the SRA within 28 days of holding client money, so long as there was clarity when the obligation was triggered, flexibility in exceptional circumstances, proportionality and alignment with existing reporting processes.
Mark Evans, president of the Law Society, added: “We support the SRA’s aim of identifying risks earlier and strengthening consumer protection.
“The SRA, however, already receives significant amounts of information from firms, and should ensure it makes full use of existing data without any overlap before introducing additional reporting obligations.”
Leave a Comment