In the soup

Historically, the largest law firms have had a patchy relationship with the profession’s regulators. Can the Solicitors Regulation Authority build bridges?

Martin Baker, head of risk and compliance at Taylor Wessing, is sitting in a boardroom in front of a mountain of documents. He has only just read through the first few pages of the Solicitors Regulation Authority’s (SRA) second consultation paper on its proposed new code of conduct. With a worried look on his face, he mentions that, in order to bring his firm’s current risk and compliance handbook up to date, he may as well start implementing the changes now before they come into force next October.

The task he faces is not unique to his firm. In the next year, legal practices across the UK, from the Magic Circle to the high-street solicitor, will have to amend risk and compliance policies so they can meet the new requirements proposed by the legal watchdog.

Moving away from its current ‘box-ticking’ approach to regulating the UK legal sector, the SRA’s grand thinking is to overhaul the rules by introducing an outcomes-focused approach to governance. Cue the traditional sniping from the City.

‘No one knows how the new regulatory regime, along with multi-disciplinary practices and ABS, is going to pan out.’
Nick Eastwell, SRA

‘There is a huge difference between a sophisticated corporate client seeking representation on a commercial deal and an individual seeking legal advice in relation to a domestic matter,’ says Jonathan Westwell, general counsel and head of risk and compliance at Baker & McKenzie in London. ‘The SRA’s approach seems to have been to focus on the protection of the latter, not the needs of the former.’

And yet the profession’s regulator has a high level of City representation in its ranks. Charles Plant, a former senior litigator at Herbert Smith, has been chairman since January 2010. The regulator’s board is populated with current and former City partners such as Martin Coleman, head of the competition practice at Norton Rose, and Mark Humphries, formerly a litigation partner at Linklaters.

In October, Nick Eastwell, a one-time candidate for Linklaters managing partner, was brought on board to act as a conduit with practices in the Square Mile.

But the changes to the regulatory framework have resurrected unrest among the largest commercial firms, which say there has been little consultation and dialogue with the SRA. They complain that the new regulation and the constant alteration of the rules is eating up too much time and money.

Same face, more changes

Last March, just two months after Plant became chairman, the SRA launched its ‘Freedom in Practice: Better Outcomes for Consumers’ campaign. Faced with an evolving market, and with alternative business structures (ABS) due to be introduced in 2011, the regulator sought to open a dialogue with UK legal practices over the changing regulatory landscape. The campaign resulted in the regulator publishing the first of two consultation papers one month later, outlining its intended new set of proposals due to be introduced in October 2011.

Loosely based on the model used by the Financial Services Authority, the SRA is moving away from taking a reactive approach to governing the legal sector. Writing in Legal Business in May (see LB204, page 22), Plant said that the new governance stepped away from the ‘prescriptive rigid rules’ currently facing law firms and said the new approach, entitled ‘outcomes-focused regulation’ (OFR), would give the profession more flexibility. Its goal is to place the onus on legal practices, which will have to demonstrate ‘that [they are] acting in a principled manner and achieving the desired outcomes for clients’.

‘This is very much a new type of supervision,’ insists David Whitney, a relationship manager at the SRA. ‘It’s risk focused and pro-active. We’re looking to have a good relationship with firms unless they are unable or unwilling to engage constructively with us.’

Through OFR, the SRA wants to concentrate resources on dealing with the firms that pose serious risks and at the same time encourage those firms to assess the risks themselves. ‘It may be that some firms are relatively well run, but that the potential impact of a risk crystallising is huge,’ explains Whitney. ‘For example, if a large firm has financial difficulties, then that would potentially have very serious ramifications for its clients and the public.’

‘This is a new type of supervision. It’s risk focused and pro-active. We’re looking to have a good relationship with firms.’
David Whitney, SRA

It’s fair to say that many of the proposed changes are met with support in the City. ‘We’re more relaxed about the proposed regulations,’ says Stephen Parish, chairman of Norton Rose. ‘We already have strong internal procedures in place – it’s what we’ve been doing for many years. For us, we believe overall this is going in the right direction.’

‘Many of the proposals can be regarded as best practice and ought to be embraced,’ Baker comments. ‘If the SRA can persuade firms that risk management is an essential management tool and not just a regulatory burden, it will achieve more than it would ever have believed possible.’

But it is here that the problems between the regulator and regulated begin to surface. The majority of large commercial practices say that they already have risk and compliance measures that suit their business in place and that the lack of detail from the SRA makes the new regulations appear opaque, creating a bigger job for in-house compliance heads. It is estimated that the biggest firms will have to spend over £1m to update current manuals, train staff and add new personnel.

‘The lack of clarity is a problem because the SRA won’t issue guidance,’ remarks one City partner. ‘If they had issued guidance then we’d know what we have to do rather than spending time trying to work out how we’ll have to adapt. It’s an added headache.’

It is unclear how the SRA defines risk or what will be used to gauge whether a firm is in a vulnerable position – the SRA says it has yet to work that out. The City of London Law Society (CLLS), which represents a small but very influential chunk of the profession in England and Wales, has taken an increasingly prominent role in advocating for the largest commercial practices to be regulated by a separate list of rules.

‘There is a huge difference between a corporate client and an individual seeking legal advice on a domestic matter.’
Jonathan Westwell, Baker & McKenzie

Going back to the days of the Law Society, the profession’s regulator has enjoyed a sometimes rocky relationship with the largest London practices. Even though the SRA has ramped up its efforts within the last six months to better communicate with this slice of the legal market, tensions continue to exist.

‘There was a sense that no-one knew our business,’ comments one senior Magic Circle partner. ‘There was anger that the SRA was applying rules in a regulated way and enforcement activity was over the top. There was also a growing sense that huge firms were paying the price, while in the past we’d had very little regulation.’

The report last March on the regulation of corporate legal work, by former Ministry of Justice senior civil servant Nick Smedley, was highly critical of the existing regulation of large commercial firms. It recommended an overhaul of the current regulatory structure to suit the largest firms.

Smedley noted that a breakdown in trust between the sector and the SRA was one of the many underlying issues. ‘The gap between the regulator’s skill set and the work of the corporate sector is too wide to enable the SRA to act with confidence and competence,’ read the report. ‘The system does not address the true risks adequately, while perhaps trying to address all sorts of non-risks, by focusing on minor, routine matters.’

City firms were angered by the ‘box-ticking’ regulations imposed on them that they said didn’t take into consideration the sheer size and nature of their businesses and criticised the lack of dialogue with the SRA. ‘I think there was a communication delay,’ comments one City managing partner. ‘The SRA was really taken aback by the level of frustration felt by City firms.’

Bridging the gaping divide

Following Smedley’s report, the SRA pledged to become more City focused in its approach. Plant was hired as chairman and then, in October 2010, ex-Linklaters partner Nick Eastwell was added as chief adviser on the Square Mile, liaising with any firm that has a London presence. It is a sign that the watchdog is moving in a direction that many have welcomed.

‘The SRA has the important task of making contact with the City firms and this is a new initiative. Nick Eastwell should improve further communication,’ says Nicole Bigby at Berwin Leighton Paisner.

Eastwell, a Linklaters partner for 20 years, is expected to bridge the gap between the UK’s largest firms and the SRA. His role, which is a non-executive position, begins this month and will see him initially dedicate only three full days a month to the job on top of attending ad hoc functions and meetings. He will also maintain his post as a consultant at Linklaters’ Central and Eastern Europe spin-off Kinstellar.

‘The SRA understands the need to take a closer look at how City firms advise clients and how those firms structure their own businesses,’ Eastwell comments. ‘My role is going to involve a lot of interaction between the SRA and City law firms and I hope to be able to meet regularly with senior partners and risk and compliance heads at the major firms.’

He insists that the task facing him is not an onerous one. At three days a month it certainly shouldn’t be, but Eastwell is confident that his understanding of big City businesses will help the SRA to analyse the forthcoming introduction of ABS. But not all in the market are clear on his remit. ‘Maybe someone like Nick Eastwell will make a difference, and I think it’s a good appointment, but what is he going to do on a daily basis?’ questions one managing partner.

‘If they had issued guidance then we’d know what we have to do rather than spending time trying to work out how we’ll have to adapt. It’s an added headache.’
A partner at a City firm

‘At this stage, no one knows how the new regulatory regime, along with the potential for multi-disciplinary practices and ABS, is going to pan out,’ Eastwell outlines. ‘I am confident that the SRA and the City law firms can and will work together to come up with grown-up solutions to any problems that might arise.’

Crucial in testing the water is a pilot programme, headed by Whitney, to test out how the new risk-based regulation will affect law firms across the board. A group of 15 law firms, from the large corporates to sole practitioners, have been signed up to the scheme, which will see the regulator send ‘relationship managers’ to sit down with the firm and act as its main point of contact.

The idea arose out of the Smedley report and initially saw the SRA turn to Clifford Chance, Herbert Smith, Freshfields Bruckhaus Deringer and Travers Smith to run a pre-pilot test. From there, the SRA identified the need to work one-on-one with firms on a regular basis to both identify risk-prone situations and avoid those scenarios.

The SRA has built a team of five relationship managers drawn from legal and financial backgrounds. Each firm in the programme will be visited by two of these managers on a regular basis, meaning the regulator will have to beef up this function to ensure things run smoothly.

Whitney gives the impression that much is riding on this one pilot. It is set to end next July, just three months before the implementation of the new regulatory regime.

The pilot is expected to tell the SRA how much it needs to boost resources – currently it employs 710 staff across its Leamington Spa, Redditch and London offices. It should also indicate whether OFR is suitable for all members of the legal sector and how to define ‘risk’ – all things the CLLS called for in its July response to the first consultation paper.

Whitney says that the SRA is pleased with the feedback it has received so far. In July, a number of firms expressed how sceptical they were about the new regulation and all of its components, but Whitney said that the SRA has taken on board what they’ve said by updating the second draft.

But the degree to which the SRA has taken onboard the City’s feedback arouses further criticism. ‘Its like they’ve said, “Thank you very much for your input” and have gone ahead with their original plan anyway,’ says one risk manager at a City firm.

Consumption habits

City firms feel that they are faced with a new set of regulatory burdens that don’t apply to their own business model and will be costly to change and update. Many feel that the language contained within OFR guidelines is geared towards the impending introduction of ABS because of the way the SRA refers to ‘the public’ and ‘the consumer’ in the consultation papers.

Norton Rose’s Parish says that most City firms don’t view their clients as consumers and maintains that it is another example of how the SRA has got it wrong. ‘We do think it would be helpful to have more one on one dialogue… our main concerns relate to the nature and approach of the consultation,’ he says.

One managing partner says it’s hard to see evidence that the SRA has listened to City firms during the consultation period. Another says, ‘OFR is supposed to protect the public, but for a large commercial firm, who is the public and who is the consumer? It’s very much geared towards legal practices not owned by solicitors and it is not suitable and applicable for commercial practices.’

Feelings run high, but many of the City’s managing partners are hesitant to put their frustrations on the record.

Plant says that all clients, including sophisticated corporates, should be considered as consumers of legal services. He highlights that the introduction of new regulation has been a hot topic for a number of months and that the regulator has held several road shows to talk about the changes. In other words, firms have had plenty of opportunity to voice their concerns.

‘If the SRA can persuade firms that risk management is an essential management tool, it will achieve more than it would have believed possible.’
Martin Baker, Taylor Wessing

There is also increasing concern mounting among London’s firms over the requirement for each firm to employ a compliance officer for legal practice and a compliance officer for finance and administration, who will act as internal whistleblowers if the firm has breached any of the rules.

One firm questions why it needs to establish additional compliance officers when the model works better for an ABS and not a commercial entity, while another suggests that it’s not within a law firm’s culture to have such a role. The SRA defends the move and says that experience shows ‘a clear need for specified individuals within firms to be responsible for implementing systems and control’.

‘We think it’s better to spot potential problems coming over the hill and to deal with them as soon as possible than to wait for them to occur and then deal with them reactively,’ says Whitney. He points to the collapse of Halliwells and suggestions that five of the UK’s top commercial firms are currently in intensive care with the banks as signs of the fragility in the market.

Firms now have until January 2011 to voice their concerns before the regulator publishes the final version of its written handbook four months later and implements OFR six months after that.

Eastwell’s appointment, along with the formation of a London-based group at the SRA, which will focus on dealing with large commercial firms, is certainly a step in the right direction but it’s hardly a wholesale change of course.

‘A one-size-fits-all approach cannot work,’ insists one partner at a City firm. ‘The SRA has to be clear that the processes in place will meet the needs of firms and that the regulations don’t dampen the entrepreneurial spirit of the partners at the firm. One has to be sure that the heavy hand of the regulator doesn’t prevent a forward-thinking ethos at the firm.’ LB