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Solicitors accounts rules: Consultation in full swing

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23rd Jun 2016
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In June 2016, the Solicitors Regulation Authority (SRA) issued a consultation Looking to the Future: SRA Accounts Rules Overview. This consultation represents the third (and final) phase of the SRA’s review of the Accounts Rules.

Phase one made minor changes to the format of the annual accountant’s report and introduced exemptions for certain firms from the need to obtain a report. In addition, there is no longer a requirement for unqualified reports to be sent to the SRA.

Phase two was implemented in November 2015 and encouraged reporting accountants to apply an ‘outcomes-based’ approach to assessing compliance with the rules, with a greater focus on risks to client money.

Phase two also increased the exemption from the obligation to obtain a report to firms which have an average client balance of no more than £10,000 and a maximum balance of no more than £250,000 over the accounting period.

Phase three, which is the subject of the latest consultation, focuses more widely on the existing Accounts Rules and makes proposals for broader change. The SRA have acknowledged that the existing Accounts Rules have not changed for several years; are prescriptive and restrictive; and focus on ensuring that all law firms handle money in the same way.

The SRA have concluded that, in their present state, the Accounts Rules would not pass any assessment against the better regulation principles.

Clearly understanding the Accounts Rules themselves has been a particular challenge for solicitors and in the majority of cases, Accountant’s Reports are often qualified – some with minor breaches, but others with more serious breaches, such as a failure to maintain adequate accounting records and a repeated failure account for client money correctly.

The SRA have said that whilst the mitigation of misuse of client money has, and always will be, a priority for the SRA; the inherent complexity of the existing Accounts Rules makes it much harder for new entrants to the legal profession to understand what is required of them as well as making it difficult for consumers to understand what to expect when a firm handles their money.

The SRA undertook a sample of 9,000 firms which held client money in the period from June 2012 to December 2013. Of these 9,000 firms, 50% received a qualified report, but only 179 of the firms were referred to consideration for further regulatory action. This has led to the SRA concluding that their Accounts Rules are too complicated and are not focussed on the key risks to client money.

Simplification of the Accounts Rules

The SRA propose to simplify the Accounts Rules by placing a focus on key principles and requirements for keeping client money safe, including:

  • keeping client money separate from firm money;
  • ensuring client money is returned promptly at the end of a matter;
  • using client money only for its intended purpose; and
  • proportionate requirements for firms to obtain an annual accountant’s report.

The SRA view this simplification as an opportunity to allow law firms greater flexibility to manage their business and this should, in turn, allow the Accounts Rules to be easier to understand, hence reducing compliance costs.

The proposals remove unnecessary prescription from the Rules and reduce the length and complexity. The proposed Accounts Rules are significantly reduced in volume from 32 pages down to six. The key changes include:

  • Removing current references to the rules only applying to practices in England and Wales as well as references to Exempt European Practices. This is being proposed due to the proposal to allow solicitors to practice in firms that are not regulated by SRA.
  • Removing references in Rule 1 to the SRA Principles therefore removing the potential for confusion about the scope of the COFA’s responsibility extending to compliance with conduct requirements.
  • Key principles for when withdrawals from the client account can be made which will be based around the purpose for which client money is being held as well as a much simpler requirement that other withdrawals can be made in circumstances prescribed by SRA.
  • Removing the requirement for a written policy on the payment of interest as this will be reflected in provisions in the Code of Conduct of Solicitors (standard 8.8).
  • Removal of references to those taking appointments such as Court of Protection Deputies and as Trustees of an Occupational Pension Scheme. The Draft Accounts Rules confirm that monies held by these appointees will be client money and hence the Accounts Rules will apply in full (including the requirements to pay interest), subject to any conflicting obligations to comply with relevant statutory schemes.
  • Removal of references to circumstances where the solicitor may take insolvency appointments. Where the solicitor takes an insolvency appointment in a bankruptcy matter or company liquidation, then they are required to pay all money they receive into the Insolvency Services Account (ISA) kept by the Secretary of State. Voluntary liquidators may deposit funds into the ISA.

The changes include removal of the prescriptive time limits for which money should be moved from one account to another (such as the 14-day window from moving costs from the client account to office account).

New definition of ‘client money’ and ‘client liability’

The SRA have said that while the proposed simplification of the Accounts Rules will remove much of the prescription within the Accounts Rules, it does not address the core issue of what money should be protected by the Accounts Rules.

The SRA are therefore going to review the definition of ‘client money’ and are proposing a change to the definition in an attempt to strike a balance between consumer protection and regulatory burden.

Draft Rule 2.1 says:

Client money” is money held or received by you:

  1. relating to legal services delivered by you to a client, excluding payments for your fees and payments to third parties for which you are liable;
  2. on behalf of a third party in relation to legal services delivered by you (such as money held as agent, stakeholder or held to the sender’s order);
  3. as a trustee or as the holder of a specified office or appointment such as a donee of a power of attorney, Court of Protection deputy or trustee of an occupational pension scheme.’

The proposed definition in Draft Rule 2.1 above dispenses with the current detailed descriptions in the Accounts Rules about different types of disbursements as well as the definition of office money and office account.

The Draft Rule 2.1 is aimed to be more principles-based and the consultation acknowledges that this revised definition will mean that a firm should decide how it manages its money having regard to other obligations in the Accounts Rules, any legal obligations and its assessment of its own financial stability.

Example

A law firm has two clients: Mr Smith and Mr Jones. Mr Smith makes a payment to the law firm for his fees in advance of the services being rendered. Mr Jones makes a payment in respect of agreed fees.

Under the current Accounts Rules, the money received from Mr Smith in respect of advance fees would be client money and hence paid into the client account. The money received from Mr Jones in respect of agreed fees would be treated as office money and paid into the office account.

Under the simplified rules, all payments for fees are treated in the same way and will be paid into the business account (the new description for the office account).

The treatment of fees paid in advance as office money will clearly have a cash flow advantage to the law firm and, of course, is not without risk (particularly if the law firm goes into administration).

The consultation suggests that the consumer may wish to consider paying for fees in advance on a credit card so as to take advantage of the protections available in consumer legislation if the supplier does not provide the agreed services in part or in full (so long as the services were bought for between £100 and £30,000).

Disbursements

Solicitors will often handle payments that relate to a client’s case on behalf of the client (such as payments to counsel, professional fees or Land Registry search fees) and such fees are referred to as ‘disbursements’ in the existing Accounts Rules, which are distinguished between professional disbursements and other disbursements.

Under the existing rules, monies received for unpaid professional disbursements are client money and must be held on client account until the disbursement is discharged.

The consultation proposes that where the law firm is responsible for discharging the disbursement, monies received from the client for such disbursements will not be client money and should be paid into the business account – in other words they will become a liability of the law firm.

Monies received in respect of disbursements for which the client is responsible for discharging (such as Stamp Duty Land Tax or Estate Agent’s fees in a conveyancing transaction) will continue to be client money and will be put into client account.

Use of a client account for other payments

Under the current Accounts Rules, only client money can be held in a client account. If a mixed receipt is received by the firm (i.e. it is comprised of both client and office money), the current rules say that the receipt may be paid into a client account in the first instance, with the office portion of the receipt being transferred out of client account into office account within 14 days of the date of receipt.

The SRA’s preliminary view is that they should retain this current approach. However, they are seeking views on whether or not client money (as redefined in Draft Rule 2.1) can continue to be paid into the client account, or whether there should be flexibility for clients to agree different arrangements.

The SRA would like to retain this current approach because they recognise that there is potential for funds belonging to the firm to be used improperly to conceal shortfalls in the client account, or where client money should have been paid into the client account. In addition, the SRA say that it would make it easier in the event of intervention of a firm because it would be easier to identify money which is generally client money (over which the SRA have statutory powers) and what money belongs to the firm.

Payments from the Legal Aid Agency (LAA)

The SRA are proposing to completely dispense with the Accounts Rules relating to payments from the LAA and the SRA are currently discussing whether they can safely dispense with the specific rules relating to payments from the LAA (currently contained in Rule 19).

Third party managed accounts

The SRA have proposed an alternative to the holding of client money through the introduction of clear and consistent safeguards around the use of third party managed accounts as a mechanism for managing payments and transactions.

Conclusion

The consultation is open for comment until 21 September 2016 and responses can only be sent in hard copy to:

Solicitors Regulation Authority

Regulation and Education – SRA Accounts Rules 2017

The Cube

199 Wharfside Street

Birmingham

B1 1RN

 

Assuming the consultation goes smoothly, the SRA expect to issue the SRA Accounts Rules 2017 around March or April 2017.

Replies (2)

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By Sheepy306
23rd Jun 2016 18:45

So a huge number of law firms have been facing increased cash flow problems due to a competitive market place, reductions in legal aid across all sectors, Jackson reforms, the huge power that insurance companies appear to have over the government in respect of RTA claims and costs, general increased fraud and mismanagement, and allowing unregulated external investors to own law firms. To deal with this increased public risk the SRA decide that they will allow law firms to treat payments on account and disbursements as office money, therefore putting all such money (and it IS client money) at risk instead of being safe in a client account, law firms are closing down all the time at present, they will naturally use these funds Ponzi style and the consumer will lose all their money, simply becoming an unsecured creditor. Presumably the SRA don't have any ethical issues with this?

And what business clients are seriously going to pay their legal fees in advance by credit card?

But don't worry, that office account is now called a business account, so that's good then.

Some of the other proposals are actually quite sensible.

Phase 2 has already reduced firms accountability and incentive to actually implement good internal controls and procedures. For what purpose? Purely to save the SRA's workload.

Good for law firms, bad for clients.

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Replying to Sheepy306:
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By Sheepy306
23rd Jun 2016 18:47

Oh, very good article and summary Steve.

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