SRA: Reports says it should be more proactive
The review of the Solicitors Regulation Authority’s (SRA) handling of Axiom Ince shows it missed an opportunity to uncover the fraud a year before it eventually shut the firm down.
The report by Northern Ireland law firm Carson McDowell also revealed that Axiom had been on the verge of acquiring an unnamed “large medical negligence firm” when the fraud was finally discovered.
But poor communication fron the SRA meant that £36m was released from client account over the weeks that followed until the SRA shut down the firm, meaning there will be more calls on its compensation fund.
The SRA believes the fraud had been going on since 2019 and the report said that, during its investigation, the regulator was provided with forged documents purporting to be from the State Bank of India (SBI) about client money held by the firm.
Among the recommendations for reform are to reintroduce the requirement that all law firms submit an accountant’s report each year – we have detailed the recommendations separately.
The Legal Services Board issued a press release in advance of publishing the review – in which it announced its intention to take enforcement action against the SRA – but we have now read the full 75-page report.
It recorded that the SRA was called into Axiom Ince in October 2022 after the firm self-reported concerns about the conduct of a former employee. SRA policy is that its forensic investigation officers (FIOs) should routinely check a firm’s compliance with the accounts rules, even if the investigation is unrelated to them.
However, Carson McDowell found, the SRA “did not carry out an effective inspection of Axiom’s client account… and did not have in place an adequate procedure to confirm client account balances directly with a firm’s bank.
“It therefore missed an opportunity at that stage to identify the alleged wrongdoing at the firm.”
Axiom Ince provided a detailed list of client accounts and balances but the FIO did not obtain written confirmation from the various banks to confirm the balances, as required by the SRA’s procedure at the time.
It later emerged that 12 SBI statements given to the FIO were falsified. The procedures have been tightened up in response to what happened.
The next failure, according to Carson McDowell, was the SRA’s approach to the risk of ‘accumulator’ (or consolidator) law firms.
Even though the issue had first been flagged internally as long ago as 2014, and despite the collapse of three such firms – Kingly in 2020, Pure Legal in 2021 and Metamorph in 2022 – it was only in January 2023 that a member of the SRA’s authorisations team produced a briefing note on them.
This showed that the two ways in which the risk of such firms was being managed was a ‘watchlist’ – which excluded Axiom as it did not meet the criteria the team was using – and a report discussed at monthly ‘operational risk’ meetings.
The report said the watchlist was “of very limited use” – even if Axiom had been on it, it would have made no difference – while the data shared about Axiom at the meetings did not indicate any action was needed.
Axiom was discussed because of complaints the SRA had received about it, rather than because it was an accumulator, and it was judged a ‘medium’ risk, although there was no explanation as to how this rating was reached.
The report added: “It does not appear that the SRA gave any consideration for the unusual structure of the firm, in that [group chief executive Pragnesh Modhwadia] had a 100% shareholding in the firm and also held all of the compliance roles.” This was “unusual” for a firm of this size.
It later became “abundantly clear” that, outside of Mr Modhwadia, “there was little understanding of the working of the business” among the other directors – for example, the managing partner “indicated that she had no engagement with the firm’s banks”.
The takeovers of Ince Gordon Dadds (IGD) in April 2023 and then Plexus Legal in July exposed shortcomings in SRA processes, Carson McDowell continued.
In November 2022, the SRA received “credible information” which raised concern as whether IGD was fit and proper to hold client money. A forensic investigation showed that the firm had “significant financial stability issues”.
There were weekly and then daily meetings between the SRA and IGD as the firm prepared for a pre-pack sale, with Axiom emerging as the frontrunner to buy it.
“The SRA did not have any procedure in place to assess the risks of the acquisition of law firms in cases where a firm is being acquired by another firm or body which is already authorised… It appears that, in accordance with its procedure, the SRA gave limited consideration as to whether this proposed transaction was appropriate.”
The SRA did not carry out any wider risk assessment despite IGD being much larger than Axiom and in financial difficulties, as well as operating in an area of law, shipping, that Axiom did not.
There was no evidence that the SRA considered the risks associated with Axiom being an accumulator firm either.
“If the SRA had carried out due diligence, including a review of Axiom’s accounts, this could have assisted in revealing the alleged misappropriation of funds from the client account.”
Plexus too was in financial difficulties and in regular contact with the SRA but again the regulator did not consider the risks of the acquisition, despite the same risk factors, even though it was coming so soon after IGD – indeed, the FIO dealing with Plexus was apparently unaware of that deal.
These events demonstrated “the limitations in the SRA processes to join together information from within different teams to enable it to take a holistic view to risk”.
Carson McDowell said: “The SRA, across the organisation, had information which, if drawn together, should clearly have flagged a potential risk to clients and consumers.”
However, one member of the forensic investigation team had been concerned about the integration of Axiom Ince and IGD, and in May 2023 asked for a new file to be opened. This led to a “precautionary” visit to the firm, although not until late July.
At this meeting, Mr Modhwadia was challenged about the growth of the firm but “came across to SRA staff… as being well in control of the business and there was little to indicate that there was anything amiss with the operation of the firm”.
However, one FIO was “unsettled” by aspects of the firm following the interview and it was their “diligent investigative work” which unpicked the fraud.
This revealed that an SBI letter which had been provided by leading law firm Pinsent Masons on behalf of Axiom after the meeting to verify the firm’s accounts at SBI had been falsified.
While Axiom purported to hold £57m in client deposit accounts with SBI as of 30 June 2023, SBI said it held no client accounts for Axiom; rather, it had office accounts containing about £20m. This meant the £57m of client money was missing.
The report added: “It appeared that the firm had been in financial difficulties for some time, likely tracing back to early 2019.”
Further, while Mr Modhwadia said he had funded the various acquisitions with family money and Axiom’s total borrowing was £1.5m, including an office overdraft of £850,000, SBI confirmed that Axiom had borrowed £18m.
“On the basis of the SRA’s findings it appears that false statements and correspondence were used to misrepresent the position with Axiom’s bank and, in addition, aspects such as residual balances were utilised to mask the financial activities of the firm,” Carson McDowell said.
“It required the strong skill set of the FI team to uncover the firm’s true financial position and the extent of the alleged fraud.”
This led to a decision to intervene in the individual practices of Mr Modhwadia and two other directors, but not the whole firm, as it appeared the suspected breaches were not more widespread. The report said it was not clear the extent to which the difficulty of closing down a firm this size was a factor in the decision-making.
Carson McDowell accepted that it was a difficult decision – given the disruption shutting down the firm could cause clients – and said it was “reasonable” for the SRA to carry out a ‘partial’ intervention initially.
But this had a “greater degree of risk”, as the SRA could not be sure that nobody else was involved.
The report went on: “In order to protect client funds, it was vital for funds in the client account which had been ‘tainted’ by the alleged fraud to be ringfenced. The SRA’s investigations indicated that the last date of any alleged misappropriation of funds was 27 July 2023. Therefore, any money in the client account as at 27 July 2023 was ‘tainted’ and no further transactions should have been made into or out of the client account.”
The problem was that this did not happen, with the SRA itself admitting that its communication with the remaining Axiom directors was “less than clear”.
They thought it was business as usual and, as a result, the £44m of client money held at the point of the partial intervention was legitimately reduced to £8m by 3 October, when the SRA shut down the whole practice.
The other Axiom partners had told the SRA on 21 August that they were unable to open a new client account and the report said it should then have recognised the risk of payments being made out of the tainted client funds.
Carson McDowell said: “Some clients were able to complete their transactions using money in the client account but, due to the significant shortfall in the account, there were insufficient funds left for other clients of the firm.
“Some clients may have therefore recovered all the money they put into the Axiom client account, whereas other clients may not have received anything back out of Axiom’s client account and will instead have to seek to recover their funds either from the SRA Compensation Fund or from Axiom’s professional indemnity insurers.”
Corporate clients are not eligible to recover from the compensation fund – and more than a quarter of the payments made out of the client account during the time of the partial intervention were for corporate clients.
The report ended: “We have concluded that the SRA did not act adequately, effectively and efficiently, and nor did it take all the steps it could or should have taken and that the SRA’s actions and omissions in this matter necessitate change in its procedures to mitigate the possibility of a similar situation arising again…
“Our review has found that there are areas of the SRA’s regulatory regime which should and can be changed.
“Whilst recognising that the SRA has the benefit of many hard-working and knowledgeable employees across the organisation, we consider that the organisation as a whole could and should take a more proactive approach to the protection of the public interest and the identification of wider risks in the legal market.”
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