Research: outcomes in SRA Handbook not linked to LSA’s regulatory objectives

The move by the Solicitors Regulation Authority (SRA) to embrace entity-based and outcomes-focused regulation (OFR) is hard to understand, major new research commissioned by the Legal Services Board and Law Society has claimed.

The research, conducted by the Regulatory Policy Institute (RPI), also warned that the level of checks imposed by the SRA on new entrants to the profession could be stifling innovation for no benefit.

The surprise results came from the RPI’s analysis of the economic barriers to entry, exit and merger in the solicitors’ market.

The authors said that as the project developed, they became “increasingly puzzled” as to how the current regulatory arrangements have developed.

“Regulation of the profession has traditionally been focused on the conduct of individual solicitors for fairly obvious reasons. The post-Legal Services Act arrangements have shifted the focus much more to business entities, and the rationale for that is less easy to understand.

“An obvious question is: why is the regulation of individual conduct not sufficient to achieve the desired policy purposes? We have found no convincing answer to that question.”

They said the Act did not mandate a shift to either entity or OFR. “These seem to be later, discretionary choices, and they have led to a heavy-handed regulatory structure for a profession subject to what continue to be potentially substantial sanctions for individual misconduct and negligence, operating in a market populated with a large number of suppliers, many of very small size, in an institutional framework that offers multiple additional consumer protections (general consumer law, the Compensation Fund, the Solicitors Indemnity Fund, the Solicitors Disciplinary Tribunal, the Legal Ombudsman and the existence of extensive professional indemnity insurance).”

The RPI said the principles and outcomes in the SRA Handbook are “not at all closely linked” to the Act’s regulatory objectives. As a result, regulation can become “ill targeted and disproportionate”.

Its report explained: “The LSA (and SRA) objectives refer to the protection and promotion of consumer interests, whereas the regulatory system seems to be focused on protection of consumers only against certain types of performance failures. This risk reduction is not necessarily in consumers’ interests, and does not necessarily promote their interests.

“It is, we conjecture, based on an economic error that higher quality of service is always in the consumer interest. Whilst that might be true if other things were held equal, what it misses is the link between quality and costs and prices/fees.”

The RPI recommended that outcomes-focused regulation itself be re-focused “to give a significant role to the concept of value-for-money, which encompasses not only the quality and integrity of the services provided to or (in the case of regulation) on behalf of consumers, but also what consumers have to pay for those services”.

This would not mean some form of price control, “but rather a recognition that, in assessing risks to consumers, regulation is not just about preventing things that might go wrong, it is also about not preventing things that might go right.

“That is, non-authorisation or over-regulation of innovative firms puts consumer welfare just at much at risk as authorisation of a firm that looks like a walking hazard to its future clients.”

The research questioned the number of checks – including assessing business plans – that the SRA undertakes before authorising new practices. “Entity regulation focused on financial and business matters substitutes a regulatory process for a competitive market process. It is the regulator who is responsible for weeding out risky business models. There is no evidence that a non-commercial bureaucracy will be more effective at this task than the process of competition itself.”

More importantly, the researchers said, this approach means that “the kinds of financial and business models that get the most regulatory attention, and hence that are the most likely to be hindered or prevented by that attention, are those that are the most innovative or experimental and that most deviate from familiar and standard models”.

This approach overlooks the benefit that new entrants potentially bring to consumers in terms of extra supply to the market (and hence lower prices) and additional innovation, the RPI said.

Instead it suggested a greater focus on clamping down on poor behaviour after the event, which acts as an incentive to deter it in the first place. A combination of the two could mean new entrants would have to apply for authorisation but it would be automatic unless the SRA found the information provided gave it reasonable grounds for suspecting that entry would give risk to immediate and material risks for clients.

The RPI also found unnecessary duplication, with professional indemnity insurers able much more quickly to determine the risk posed by practices than the SRA; this could mean that the sole trigger for SRA engagement with business models, structures and finances would be a failure to obtain insurance.

It also raised a more general issue of unnecessary duplication of effort which arises from the way that outcomes-focused regulation is applied to small practices.

“This requires each of a large number of small businesses to allocate resources to thinking through what compliance requires for them, in circumstances where the relevant objectives are broad, vague (what precisely is meant by the public interest?) and entangled…

“Practices have, in effect, to try to assess (and guess is probably a more accurate description in many cases) what view the SRA will take on the implications of a particular piece of commercial conduct for (the SRA’s) regulatory objectives, and in particular whether the conduct is compliant because the ‘outcomes’ help promote the objectives.”

This is especially difficult for small firms and so the usual solution in other sectors is to produce “simple, clear, prescriptive rules, thus avoiding the costly duplication (and risks and uncertainties) of asking large numbers of businesses to work it out for themselves”.

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