SRA worried about firms over-reliant on client account interest

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Interest: Firms need to inform potential clients of their policy upfront

The Solicitors Regulation Authority (SRA) will ask next week whether it is ever right for solicitors to retain interest received on client account money, saying it is worried that some firms rely on it to stay solvent.

It comes as a new report showed that client account interest amounted to more than 10% of turnover for one in six of the law firms surveyed.

The question will form part of three consultations arising out of the consumer protection review, details of which were previewed at yesterday’s SRA compliance officers conference in Birmingham.

The consultations will be on the model of solicitors holding client money – with the long-term view of moving away from it if a suitable alternative is established – how the client money they are holding is protected, and delivering and paying for the Compensation Fund.

Speaking to the media, SRA chair Anna Bradley said the regulator was concerned about “creating incentives potentially to misuse client funds”.

She explained: “We’re worried about residual balances and the rate at which those are given back to clients. We’re worried that, for some people, the balances are being seen as a source of income in terms of interest.

“We’ve heard some quite worrying things from some firms about the fact that, if they didn’t have that source of cash, they would be in some difficulty. That’s obviously not what that cash is there for.”

One suggested change will be a specific time period in which residual balances have to be returned to clients, rather than the current requirement that it be done “promptly”.

Aileen Armstrong, the SRA’s executive director for strategy, innovation and external affairs, said the consultation would explore more broadly “the question of whether it’s ever right that any interest is retained”.

The annual law firm benchmarking survey conducted by accountants Crowe, published yesterday, recorded that the rise in interest rates generated interest on client accounts “at levels not seen for years”.

It found that 41% of the 56 City and regional firms polled received interest in excess of £1m, the highest being more than £7m, while for 17% of firms this was more than 10% of their turnover.

It asked: “With more than 78% of firms generating client account interest in excess of 1% of their turnover, which could be considered no longer incidental for VAT purposes, have firms considered the implications for the recovery of their VAT incurred on their costs under the partial exemption VAT rules?”

Earlier this year, the Law Society’s 2024 financial benchmarking survey revealed that total net interest income across 147 firms, more than two-thirds of which had turnovers of under £10m, rose from £2.6m in 2022 to £27.5m in 2023.

The amount of interest that should be paid to clients was raised at a conference session on the accounts rules.

Crowe partner Ross Prince said many firms had a de minimis of £50 to £100, adding that firms that paid their clients all the interest generated were “not as common as you would imagine”.

More frequent was applying the rate of interest on no-notice savings accounts of the firm’s own bank, or the average of a group of banks.

He suggested one approach could be to have different de minimis levels for different types of clients – while large companies were “probably not as excited by relatively small amounts of interest”, for vulnerable private clients they could be very important.

Sean Hankin, the SRA’s head of forensic investigation and intelligence, said it expected solicitors to be “upfront with your client at the start of your retainer – if [the interest policy] is important to the client, then they need to make an informed judgment as to whether to engage your firm”.

He stressed that it was not enough for firms to have a policy – they needed actually to apply it too and pay interest when it was due.

Mr Hankin noted as well that the government was interested in client account interest – earlier this year, Legal Futures revealed that the Ministry of Justice was formally looking at whether interest on some client accounts could be diverted to fund legal services for people unable to afford advice.

One of the protections for client money is the annual accountant’s report and next week’s consultation could signal a return to requiring information on all firms’ reports, rather than just those that are qualified.

This could be in the form of submitting the report to the SRA – a requirement dropped in 2015 – or an annual declaration, either by the reporting accountant or the law firm.

The consultation will also ask whether law firm managers who can make ‘unilateral’ decisions involving client money should not also be able to hold a compliance officer role – and how this could work for small firms.