Posted by Legal Futures Editor Neil Rose
What is the best way to keep client money safe?
I have joked for many years that you could halve the size (and therefore cost) of the Solicitors Regulation Authority (SRA) overnight by banning both client account and sole practitioners.
Well, the SRA’s consumer protection review means that these notions, if not exactly on the table, are no longer as off it as they obviously were.
I would be very surprised if they came about but the reality is that these are both big drags on the profession. I tend not to say this in the vicinity of sole practitioners.
This is not, of course, to demean them professionally; rather, it is a recognition that the nature of client protection arrangements mean that they are a major cause of payouts from the SRA Compensation Fund.
Where partnerships are involved in acts of default, their indemnity insurers pay out if there is an innocent partner – hence why the insurer of London law firm Jirehouse has been battling (unsuccessfully) through the courts to establish that Stephen Jones’s partner condoned his fraudulent actions.
But with sole practitioners, the cost of fraud and default lands squarely on the fund.
Compliance is a headache for all law firms but even more so for sole practitioners, with no one to share the load.
Hence this question in the SRA review: “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?”
The appeal of solo practice is waning. SRA figures show that the number of sole practitioners has fallen from 3,252 in May 2013 to 1,539 in April 2024 – this perhaps reflects too the growth of fee-share law firms, where solicitors can essentially operate as sole practitioners but delegate the back-office operations, including compliance, to a central hub.
Holding client money is the bigger regulatory issue – from anti-money laundering (AML) to the intricacies of the accounts rules, countless solicitors trip over it year after year.
According to the SRA’s newly published year three evaluation of the Standards & Regulations (STaRs), the two areas of the rules that solicitors find the most challenging are those relating to AML and the prohibition on using client account as a banking facility.
So the question, which we will be asking in our free webinar next week, run in association with the SRA, is whether solicitors should continue to hold client money.
The consumer protection review discussion paper says: “We will explore with other regulators, escrow account providers and insurers different approaches to managing the risks of holding client money. This could include alternative approaches to holding client money, or certain categories of 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.”
It explains: “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.”
The review, of course, was in part triggered by the Axiom Ince scandal, and the disappearance of £66m from its client account (plus the rising number of interventions carried out by the SRA).
Eye-catching as that figure is, we frequently run stories of missing money; in just the last few weeks, there was the ex-City solicitor jailed for 15 years for his role in investment frauds, which also saw his firm fined a record £500,000 for allowing its client account to be used as a banking facility; and the probate manager jailed for four years after taking £634,000 from estates while working at two law firms.
Let’s also not forget the senior partner jailed for four years after stealing nearly £2m from clients as he struggled to meet the demands of scammers who told him he had won a Spanish postcode lottery.
It’s not just misusing money. Conveyancers are under constant pressure to watch out for a range of frauds seeking to intercept money, while earlier this year the SRA fined a law firm that held nearly £600,000 in hundreds of residual client balances dating back almost 29 years.
And then there’s the ‘everyday’ misconduct – as a random example, the solicitor fined for allowing improper transfers from client to office account – and the now regular drumbeat of fines for firms that have failed to comply with their AML obligations.
All of these examples are from just this year.
So, why bother holding client money? Many would say it is the mark of their professional standing, that they are trusted advisers, and that it is a service clients value. For many, it is also a question of control and a fear of losing it.
The STaRs evaluation report noted: “Some solicitors reported that their firms continued to operate client accounts, even if no longer required in order to provide reassurance for clients as to the security of their money and also to facilitate monitoring of the firm’s own finances.”
But we cannot ignore also that holding client money has been a money spinner over the years, at least until the recent time of low interest rates. Thanks to Liz Truss’s mini-Budget, those times are back.
In January, listed law firm Knights said a sharp increase in profits was helped by the £3.8m received in client money interest, while the Law Society’s recent financial benchmarking survey said that total net interest income across the 147 firms surveyed, more than two-thirds of which had turnovers of under £10m, rose from £2.6m in 2022 to £27.5m in 2023.
There has long been a question about whether solicitors should profit from client money in this way – along with alarm that, for some firms, it was what kept them afloat – and so it is no surprise that the Ministry of Justice is investigating whether this cash should instead go to good causes, as I revealed last week.
At the same time, not holding client money should lead to a reduction in professional indemnity insurance premiums, although whether that would make up for the loss of interest income is a moot point. For some, not carrying the risk (particularly those firms with large sums going through their client accounts) may be enough.
The alternatives to client account is a more practical question. Both the SRA and the Council for Licensed Conveyancers have been pushing third-party managed accounts (TPMAs) but take-up remains very low, according to the STaRs evaluation.
“Of the COLP/COFA responding to the survey whose firms handled client money and were not able to rely on the exemption not to have to operate a client account, only two firms (1%) operated a TPMA. Of these, one operated the TPMA as an alternative to the client account, whilst the other operated it in conjunction with the client account.
“Another two COLP/COFA (1%) reported that their firms would like to but had not found a suitable provider.
“In the interviews, one solicitor whose firm used a TPMA reported that the main benefits were ease of compliance with rule 3.3 (prohibiting the use of a client account to provide banking facilities to clients or third parties) and easier administration of multiple payments to multiple shareholders at the completion of a deal.”
The lack of enthusiasm is no huge surprise – getting the legal profession to change a deeply entrenched practice is always going to be a huge slog, and it may well be that the SRA will need to take firmer steps if it believes TPMAs to be a better solution.
Perhaps a more dramatic intervention will come from the Bank of England’s synchronisation project, which could have a huge effect on conveyancing, the area of practice where a lot of these issues crystallise.
According to a note published by the Conveyancing Association, “the concept is that instead of thousands of transactions going back and forth between multiple parties, a third-party synchronisation operator will work out what the net movement of money is and move the net amount themselves from one account to another”.
For example, say on one day the Halifax is sending 500 conveyancing transactions totalling £20m to the Nationwide, which is sending 400 transactions worth £15m the other way. This would be replaced by one transaction transferring £5m from the Halifax to the Nationwide.
It comes off the back of Project Meridian, which looked at how financial technology could deliver innovations in the real-time gross settlement (RTGS) systems by linking banks, conveyancers and HM Land Registry.
In a speech last month, Sarah Breeden, deputy governor of the Bank of England, explained how it “explored how such synchronisation might work in practice to enhance housing purchases.
“Movement of funds in RTGS could automatically take place at the same time as the change in home ownership is recorded on a digitised title deed, meaning less need for costly and risky chains of intermediaries.”
No wonder Coadjute, one of the proptech companies involved in Project Meridian, recently received £10m in funding, including from three major lenders.
The Conveyancing Association says: “As you will no longer hold your client’s money, you will lose the majority of the interest you currently make on your client account. Rightly or wrongly most conveyancing firms rely on the interest their accounts generate and often this has enabled them to keep fees low – therefore effectively it has subsidised legal fees.”
There are a lot of practical issues that need resolving if this is to work in the context of conveyancing (it is initially focused more on goods and services), and there are other initiatives out there, such as UK Finance’s Regulated Liability Network.
The basic point is that you would think, in the digital world, that we could make the holding and transfer of client money safer. Ultimately, this is not about solicitors – it is about the people whose money it is.
It may be that, eventually, the question of client account is taken out of the profession’s hands by the finance industry. But this will take time. In the meantime, the many questions raised above remain. Join us next week as we try and find a way forward.
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