How the SRA’s proposed reforms aim to prevent law firm failures and protect clients from poor trading results or cashflow

The Solicitors Regulation Authority (SRA) has recently launched a consultation with the aim of better protecting consumers, or clients, of law firms.

The consultation, triggered by the collapse of Axiom Ince, is wide ranging looking at both the SRA’s compensation fund and how similar collapses of law firms might be prevented.

In doing so, it asks for responses addressing three separate areas of risk:

• Managing the risks associated with the failure of firms resulting from poor trading results or cashflow.
• Managing the risks involved in mergers and acquisitions.
• Ways to ensure the protection of client money.

We have a strong and growing practice of solicitor firms across London and the South East and has contributed to that consultation.

Over three articles, we will touch on each of these areas of risk and what reform might look like.

Managing the risks associated with the failure of firms resulting from poor trading results or cashflow

The SRA is proposing to bring together risk factors and ‘red flags’ identified from previous interventions. We would suggest that a ‘traffic light’ system could be a useful step towards increasing financial risk management.

Unless a law firm is under serious review, the SRA currently receive minimal ongoing financial information in respect of the law firms under their governance. Whilst corporate law firms file accounts with Companies House, these are submitted well after the year end and, if no audit is required, very little information is provided within the filleted accounts. Unincorporated law firms will only share their detailed financial information with HMRC.

At present, the SRA does not have the access to this information, nor the resource or capabilities to appropriately assess it. We would suggest that the SRA could therefore liaise more closely with regulatory bodies such as HMRC, to obtain information where payments such as VAT or PAYE are in arrears, as these scenarios could indicate early signs of cashflow problems. They could also seek information on firms’ outstanding loans and overdrafts periodically. This information could be pooled to create a risk profile, or risk flags, which can then be used as part of a traffic light, risk-rating system.

This ‘traffic light’ system could then be used to help determine the information required to be provided to the SRA, and the regularity that this is provided. For instance, a firm may be determined to be high risk and, accordingly, be required to provide quarterly management data, inclusive of outstanding liabilities, to the SRA. This would tie in with the Making Tax Digital legislation due to be introduced in the coming years, which will require firms to provide timely management information to HMRC. This will better enable the SRA to assess the relevant risk factors on a more timely basis and take positive steps to mitigate the risk to consumers.

If you would like to discuss how these changes might impact your firm, or need advice on improving your financial risk management, please get in touch.