Proposed amendments to the Solicitors Regulatory Authority (SRA) accounts rules
Since the transition to the 2019 Standards and Regulations (regarding SRA regulated firms receiving or dealing with money belonging to clients including trust money or money held on behalf of third parties), there has been a certain amount of ambiguity surrounding a couple of the key changes. Whilst further guidance has been issued by the SRA in the subsequent years in an effort to clarify their intentions, the SRA have recently released a consultation proposing amendments to the rules.
Below is our response to the consultation:
“From a commercial perspective, many firms may wish to invoice in advance of incurring costs on behalf of a client. This may be in order to assist with working capital requirements and/or to avoid the risk of incurring any bad debts.
It is especially important in times of financial uncertainty for firms to consider their debtor days and to appropriately manage their work in progress to cover any ongoing liabilities, whether those be salaries, Professional Indemnity Insurance (PII) or general overheads. Therefore, the temptation may be there to invoice for work not yet undertaken, and then to transfer to the business account.
However, the first of the suggested amendments seeks to reinforce the initial intention that costs must be incurred before they can be transferred to the business account. At present, the rules do not explicitly prohibit a firm raising a fee and transferring costs ahead of the work having been undertaken. The consultation therefore seeks to clarify that client money can only be transferred once costs have been incurred, in order to preserve the protection provided by client funds being held in a ring-fenced account.
The previous guidance did give some flexibility to firms but emphasises the importance of clients understanding how their money is being treated, and the risks involved. The intention was never for these funds to be used to support ongoing working capital requirements.
From a practical standpoint, it is perfectly legitimate for a firm to raise invoices in advance of work being undertaken, and for the funds paid by the client to be kept in the separate ring-fenced client account until the point at which the costs are incurred.
There are a couple of points to consider here. Firstly, we need to consider how these costs are monitored and recorded:
- Will the funds be transferred to the business account on a time costs basis or percentage completion basis?
- How will this be recorded on the system in order for it to be checked by the accounts team and/or the COFA of the firm?
These will need to be considered by the managers of the firm as new systems may need to be introduced by the firm to ensure ongoing compliance. Separately, firms will also need to consider the VAT point of sale as this will have an impact on cashflow.
The first amendment does help to clarify the intention of the rule, and it would not change the approach for the majority of the clients we act for. However, it does emphasise the importance of managing working capital and updating systems and procedural notes when it comes to billing, especially when billing in advance of the work having been undertaken.”
“The initial introduction of the 2019 Rules and the apparent need to provide a bill or other written notification of costs before reimbursing the business account has led to both confusion and consternation among solicitors. There was concern among the profession that this would create additional levels of administrative burden, particularly where costs are being transferred for generic disbursements (for instance, in relation to those commonly found among conveyancing matters).
We have always advised our clients that this was not the intention of the rules, and if transfers are being made for expected disbursements, as covered within the engagement terms, there was no need to send clients separate written notification. This is being confirmed as part of the consultation, which will support the approach which many firms have taken since the introduction of the 2019 Rules.”
Clients’ own accounts
“The 2019 Rules recognised the risks involved in operating clients own accounts. If firms make erroneous payments out to third parties on behalf of clients (potentially as a result of fraud) and are unable to recover the funds, the firm is likely to have to make good these funds, and this is likely to be below the excess on any PII cover. There has also been the risk of fee earners misappropriating funds, and then teeming and lading with other clients’ own accounts in order to conceal this.
Therefore, the intention of the 2019 rules was broadly welcomed across the profession in order to mitigate these risks. However, practically speaking, these appeared to create a further administrative burden which was hugely challenging to meet, with having to reconcile these accounts every 5 weeks, in line with the general client accounts. This proved to be impossible for a number of accounts where statements are not sent through regularly, and the sheer volume of transactions going through these accounts would have taken significant time to post into separate ledgers. There was further guidance issued by the SRA which took into account the difficulty that firms were facing in complying with the rules, but this consultation proposes going further to make life a little easier for these firms.
There were a number of comments from clients about how their legal bookkeeping software was not able to deal with client’s own accounts, and this situation has not been dealt with to date by the majority of software providers. Therefore, if firms have been recording the transactions initiated by the firm, this has had to have been done separately, most commonly on Excel. This may have been possible for firms dealing with only a handful of client’s own accounts, but it would prove a lot more difficult for firms dealing with dozens of them, with the additional resource required in the accounts department proving prohibitive.
Whilst many firms will welcome the proposed amendments as it does loosen the requirements somewhat, the fundamental difficulties remain, in separately recording all of the transactions carried out by the firm.
Given the general move away from a prescriptive set of rules, there has been greater ability for firms to consider more flexibly their systems and procedures and justify why these still offer sufficient protection to client funds, even when they may not be able to meet each and every aspect of the rules.
Accordingly, we have previously advised our clients to assess the risks in dealing with these accounts and to update their systems and controls to reflect and justify their approach.
There is an inherently greater risk when dealing with clients’ own accounts which are not regularly reported to a third party. Deputyship accounts must be periodically submitted to the Court, together with a detailed income and expenditure, so naturally there is a reduced risk for these types of accounts. For any accounts where this is not the case, it is imperative that these accounts are regularly reviewed by someone with a good understanding of these type of accounts, who will be able to identify any anomalous payments.
The central register of clients’ own accounts should continue to be seen as a non-negotiable aspect of the Rules as it is a fundamental control. This should be regularly reviewed in order to assess the level of risk of the accounts held and ensuring that the systems and procedures in place are appropriate.
The key question is whether the proposed amendment to this specific rule is addressing the core risks involved. The need for regular reconciliations appears to duplicate the requirements already in place for Deputyship accounts.
It will be challenging for a member of staff outside of the Deputyship/POA teams to identify any anomalous payments or receipts without having a detailed understanding of that particular matter. It would be highly challenging for the COFA or a member of the accounts team to identify an erroneous transaction in a large firm where there are hundreds of clients’ own accounts in operation.
There also remains a reliance on the fee earners involved to inform the central finance team of any clients’ own accounts they may be initiating transactions for. If this is not noted, it will be very difficult for the central accounts team, the SRA or Reporting Accountants to identify these accounts, opening up the possibility of funds being misappropriated.
Please be on the lookout for further information once the consultation closes, as all fee earners within your law firm should be made aware of the changes, and amendments made to any written systems and procedures.”
If you require any further information and advice regarding the topics discussed in this article, please get in touch.
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