Reinventing the wheel

With the SRA on the verge of overhauling the regulatory system yet again, our third annual Legal Business/Marsh risk management round table looked at how ever-moving goalposts will affect successful risk management in the new decade

At the top of a rain-lashed Gherkin on a chilly February night, yet another review of thelegal profession’s regulatory system was discussed, as industry experts came together for dinner to debate some of the most important issues facing law firm managers as we enter a new decade.

A key message to emerge from the third annual Legal Business/Marsh risk management round table is that the proposed shake-up of the regulatory approach used by the Solicitors Regulatory Authority (SRA) could still fail to deal with fundamental concerns about how the profession is governed.

The discussion opened with some disbelief around the table that the SRA was looking to revamp its regulatory stance yet again. In January, the SRA launched a new consultation, ‘Achieving the right outcomes’, and is seeking views on its intention to move towards ‘outcomes-focused regulation’ in 2011. The new approach will concentrate on the high-level principles governing practice and the quality of outcomes for clients, rather than tick-box compliance with rules. The launch is intended to coincide with the SRA’s new powers as regulator of firms operating through alternative business structures (ABS), which come into being next year.

One of the most significant proposed changes is a planned overhaul of the Solicitors’ Code of Conduct to reflect the new approach, designed to give flexibility by avoiding unnecessarily prescriptive rules on process, while giving clear guidance on what firms must achieve for their clients. In the main, those sat around the table are either ambivalent about or irritated bythis news.

Professor Stephen Mayson, a strategy consultant to many top law firms and director of the Legal Services Policy Institute at the College of Law, says that reaction among law firms so far is one of trepidation. Lawyers like rules, he says, so a shift to an outcomes-based approach means that their reaction will be tentative. This new approach means reliance on an ethical mindset more than compliance, and this worries some firms, he argues. Firms believe that there might be more risk in outcomes-focused regulation, as they might have no idea what the rules are any more.

However, Mayson questions whether firms really have anything to fear, as this could all just be a smoke and mirrors exercise.

‘I remain to be convinced whether it amounts to a real change from the SRA and whether law firms really have to worry about it in the short term, as the whole territory looks broadly the same,’ he argues.

By contrast, Linklaters’ head of law and compliance Michael Walkington believes any intention to move away from a dogmatic approach should be welcomed.

‘I view it positively as a move away from a prescriptive, box-ticking exercise,’ he says. ‘Yes, the timing is odd, just two and a half years since the last code came in, and the schedule is aggressive because it needs to fit in with the ABS timetable. But I think we can view the changes positively, as people should be able to decide what is most appropriate for the type of transaction or matters that they get involved in, or the type of client they act for.’

But getting to grips with this new approach is going to fall largely on risk teams, who will have to challenge themselves to rethink in some areas, says Emma Dowden, director of best practice and operations at Burges Salmon. ‘I think the outcomes-based approach will create problems for risk teams, specifically if the standards are open to wide interpretation. Risk teams will be put under enormous pressure – lawyers like clear rules,’ she says. ‘In addition to this, I know a lot of my counterparts are concerned about becoming the “risk police”, whereas now they are regarded as helpful and supportive, and people come and talk to them.’ In the context of authorised internal regulation, there could be reticence to share and discuss issues.

Dowden also feels the SRA is putting undue pressure on itself to meet an aggressive timetable. ‘The SRA is really challenging itself,’ she says. ‘When you think of all the things it has to do in terms of setting itself up as an oversight regulator for ABS, delivering the new Code for next year will be very tight.’

‘The idea that you can regulate a sole practitioner from Middle Wallop the same way that you regulate Clifford Chance is just absurd.’
Sandra Neilson-Moore, Marsh

Referring to separate recommendations made by Lord Hunt and Nick Smedley on the future of legal services in 2009, Dowden adds: ‘How will the Smedley and Hunt reform proposals be implemented in terms of monitoring and enforcement regimes, especially for large firms? How will they deliver all this?’

Bird & Bird’s general counsel and risk management partner Roger Butterworth feels that upsetting the status quo is unnecessary just now.

‘It actually brings the rules into disrepute, because why comply with detail in the rulebook when everyone knows we’ll have a different one in two years’ time?’ he says. ‘There is an issue over quality when you’re changing so frequently. My own preference would be for the Code of Conduct to bed down and for the SRA to get its act together, and then we can move on.’

Alison Smith, head of professional indemnity at Eversheds, sees the positives of the new approach inthat both the SRA and the lawfirms it governs will be able to focus on requirements genuinely neededto protect clients. ‘What the SRA should be working on is serious misconduct,’ she says. ‘On that basis, the outcomes-based approach is very valuable in the flexibility it would give.’ However, she agrees that these aims could probably be achieved using the current system, without tearing up the rulebook.

Fit for purpose

This moved the debate on to whether the SRA is fit to regulate the profession in its current form, particularly in providing guidance on outcomes rather than slavishly applying rules. There is the suggestion that the SRA could beout of its depth in guiding firmson principles.

Although it is agreed that the outcomes-focused approach is a reaction to the financial crisis and how other sectors are governed, it is also an acknowledgement that the strict application of rules doesn’t work. This was shown in the high-profile investigations of law firms regarding miners’ compensation claims in 2009, where a lot of the debate centred on a strict interpretation of the rules.

‘I think we can view the changes positively, as people should be able to decide what is most appropriate.’
Michael Walkington, Linklaters

‘The SRA has recognised that the new approach is a significant change for it to ensure that it has the right skills,’ Smith says. ‘It is addressing that through the work it has done with City firmsto date. It would be useful to understandin more detail why a whole new set of regulations and a whole new approach is needed.’

Two-way split

All of which begs the question of whether the SRA is spreading itself too thin, and adds fuel to demands to split the profession’s oversight in two – one concerned with specific regulation of commercial law firms, and the other with consumer and high-street law firms. The argument follows that the SRA lacks the sophistication and understanding to properly regulate commercial law firms, particularly given the increased regulatory scrutiny that the financial services sector finds itself under from the Financial Services Authority and the attendant pressures that puts on commercial law firms.

‘There should be a consequence to behaviour that disregards risk, but I’m less convinced about a direct link between that and remuneration.’ Lord Goldsmith QC, Debevoise & Plimpton

Sandra Neilson-Moore, European practice leader for solicitors’ professional indemnity at Marsh, recounts her experience of working with US firms, saying that the level of detail the SRA goes into is not matched on the other side of the pond. ‘In the US, regulation does not drill down into the level of detail the SRA is doing in the UK, nor is there any attempt to regulate the high-street law firms in the same way as you would regulate White & Case, for example,’ she says. ‘It just doesn’t make any practical sense: the internal rules that the large firms follow are different, the way they operate is different, the kinds of clients they serve are different. The idea that you can regulate a sole practitioner from Middle Wallop the same way that you regulate Clifford Chance is just absurd, which I believe most commentators recognise.’

This is a longstanding and important issue, argues former Attorney General and now European chair of litigation at Debevoise & Plimpton Lord Goldsmith QC, recalling his time as a former chair of the Bar Council. ‘The number of times that Bar leaders from different countries have said to me: “I don’t understand why these commercial firms are not being regulated by your organisation, as you seem to have much more in common with what they are doing rather than the other firms being regulated by The Law Society,”’ he says.

‘Why comply with detail in the rulebook when everyone knows we’ll have a different one in two years’ time?’
Roger Butterworth, Bird & Bird

Walkington argues that commercial law firms are likely to be better equipped to deal with an outcomes-based regulatory system than the thousands of individual practitioners that also fall under the SRA’s remit. ‘I think it’s probably easier for larger firms to deal with the kind of self-regulation described,’ he says. ‘I’m not sure how it’s going to work for small firms, which may not have been able to make the same kind of investment in quasi self-regulation.’

Many have argued that The City of London Law Society (CLLS) would be the best outfit to regulate commercial law firms and the panel here is broadly in agreement (albeit because the CLLS would simply be an alternative to the SRA). As Butterworth points out: ‘The CLLS would do better because it would bring in new people; and, indeed, the SRA could do better than it does now if it were to bring in new people.’ Mayson contends that this shift in regulatory style goes some way to addressing the ideology of Lord Hunt in his recent review of legal services. ‘There is an interesting issue that Lord Hunt tried to bring up,’ he says. ‘It addresses the question of what it means to be a solicitor, whether you are in a high street or a global law firm. As far as I recall, he was not advocating the two-tier system; he wanted one system that applied to every firm or solicitor, and it would have to be applied differently to reflect different circumstances.’ He adds: ‘I think that some of what the SRA is doing is picking up on Lord Hunt’s view that maybe Rule 1 of the Code of Conduct should be the overarching principle, and then you fit the rest of it into a structure that gets you to that point, albeit by different routes for different reasons. But I don’t actually think that the SRA’s consultation paper gets to the point that Lord Hunt would have wanted it to get to.’

Financial incentives

The most important aspect of moving towards an outcomes-based regulatory approach will be self-regulation. But with more pressure being brought to bear on law firms to encourage all their fee-earners to embrace the spirit of self-governance, how do risk teams ensure everyone is on board? Is now the time for law firms to introduce financial incentives to reward good compliance behaviour?

Bird & Bird’s Butterworth feels that it is necessary to introduce an element of reward to risk. ‘You get what you pay for, so it should play a part. It’s a question of balance, but for a firm that is not pure lockstep, some assessment for how well partners deal with risk should be included.’

Jonathan Westwell, general counsel and partnership secretary at Baker & McKenzie’s London office, agrees in part. ‘I believe risk compliance is an important part of overall performance and not just at partner level,’ he says. ‘It starts as a trainee and continues throughout a lawyer’s career, whether it is good file management or client selection and intake procedures. If remuneration is linked to performance, then risk compliance is a component of the overall assessment, but I don’t think they should be linked in a mathematical way.’

‘If firms can’t manage the riskof “insourcing” because theydon’t understand it, the risk of outsourcing mustbe compounded.’
Professor Stephen Mayson, College of Law

This is why Neilson-Moore says that she is more in favour of the stick. She argues that perhaps lockstep points should be taken off a partner or things taken away from a fee-earner who is not handling risk appropriately. However, she says that the errant rainmaker will always be a thorny issue for firms and recognises thatwith people being driven by financial gainthere has to be some component of rewardfor good behaviour.

Westwell feels it boils down to the culture and leadership at his firm. He explains that the global professional responsibility and general counsel offices within the firm are strongly backed by management, and it is a part of the firm that all partners recognise and respond to. Therefore the risk management function has the ‘stick’, as well as being ingrained into the culture.

Neilson-Moore says her observation of the US market suggests that the UK type of compensation structure may be helpful to the risk culture of the firm. In the experience of both Neilson-Moore and Andrew Carpenter, senior vice-president of the FINPRO (financial and professional) practice at Marsh, the classic lockstep seems to be more conducive to a successful risk and claims management culture than eat-what-you-kill, which encourages silos and risk-taking as the focus swings too much in favour of the individual. It also means that a partner’s focus can be influenced too much by one client. By the time the firm identifies a problem, it is often too late.

‘If the standards are open to wide interpretation, risk teams will be put under enormous pressure – lawyers like clear rules.’ Emma Dowden, Burges Salmon

Butterworth also points out that another danger is that compliance becomes a box-ticking exercise and people are only adhering to it because such compliance is measured, even when the exercise is of no real benefit to the risk culture of the firm.

Mayson is concerned that talk of financial incentive turns what should be fundamentally an ethical issue into a transactional one. ‘The question for me is not “do we pay you less?” if there’s a transgression, but rather we ask the question “are you in the right place?”. That disconnects the remuneration from the behaviour.’

He adds: ‘I certainly think there should be a consequence to behaviour that disregards risk, but I’m less convinced about a direct link between that and remuneration.’

Lord Goldsmith QC argues that good risk management and remuneration have to be extrinsically linked, as culture will only get you so far in motivating individuals. No fee-earner will get a pay rise for turning away potential clients because of risk fears, he argues, to peals of laughter from around the table.

Distance control

The other hot topic that has dominated law firm discussions is that of legal process outsourcing (LPO). Last year saw a raft of leading commercial law firms sign up to deals with third parties to outsource some of their low-level work to cheaper jurisdictions, such as India or South Africa. Some firms were following in the footsteps of the legal department of mining giant Rio Tinto, which made savings of $14m in seven months from offshoring its legal work last year. As Neilson-Moore says, most of the pressure on law firms to outsource some of their work comes from clients who are refusing to pay London market rates for the more commoditised aspects of the service.

Walkington points out that law firms are in some way protected from the risks if the client is driving the move towards outsourced services and highlights some of the key concerns from a risk perspective. ‘Although a firm might feel that outsourcing companies can’t possibly provide the same quality of service, some clients clearly think they do,’ he says. ‘We as law firms have to accept that this is increasing and we have to get on board. It will be important to manage three primary risks associated with outsourcing: protection of confidential information; quality of service from the LPO provider; and the internal risk associated with your employees and how they view outsourcing.’

Baker & McKenzie has run itsown offshore captive operation in Manila for ten years, which beganby providing back office servicesand progressed to certain aspects of LPO work supporting areas such asIP, Westwell says.

‘If remuneration is linked to performance, then risk compliance is a component of the overall assessment.’
Jonathan Westwell, Baker & McKenzie

‘When you have something that is part of your own organisation it is easier to manage the risk initially I think, but you still have many of the same issues as you would if you went to a third party,’ he says. ‘You still have to do the diligence, you still have to make sure all the appropriate processes are in place. The fact that it is part of your organisation helps you culturally, and gives you greater control over the people and processes, but it doesn’t mean that you can’t manage those risks effectively with a third party.’

‘If the executive is saying that how risk is managed is one of the firm’s priorities, then it will happen. Annual objectives and a focused strategy will link to that goal.’
Alison Smith, Eversheds

Mayson finds the idea of LPO fascinating, but largely because, he contends, law firms in general haven’t got to the bottom of ‘legal process insourcing’ just yet. He says too much work has been done at a senior level and not driven down to a more cost-effective level, and also cites the failure of some partners who manage transactions to get their specialists – whether they are, say, tax lawyers or employment lawyers – involved soon enough. Clients faced with that failure of basic transaction management and cost-effective delivery of services can probably be excused for putting pressure on firms to get this done by using somebody else on a different cost base, he argues. ‘If you can’t manage the risk of “insourcing” because you don’t understand it, the risk of outsourcing must be compounded,’ he says.

Eversheds’ Smith counters that project management skills vary widely from one firm to another, and fee-earners recognise the risks of poor project management much better than they did before.

Again, the issue boils down to one of culture within specific firms: risks associated with outsourcing work, client delivery and project management are largely controlled by firm culture. All participants agree that creating a culture where risk is universally accepted is the way forward. However, such utopia may be difficult to attain when dealing with partnerships that ultimately are comprisedof individuals.

Smith is adamant that the key message has to come from the top: ‘It depends on what the executive is saying. If the executive is saying that how risk is managed is one of the firm’s priorities, then it will happen. Annual objectives and a focused strategy will link to that goal.’

‘This discussion illustrates that the greatest driver to risk is the desire to make money,’ says Lord Goldsmith QC. ‘Yes, factors such as management influence and the likelihood of damage to reputation are all disincentives to taking on risk. Topics we have discussed in terms of the regulatory environment and leadership at firms driving a risk cultureare important, but, ultimately, the greatest cause of risk to a law firm is the desire tomake money.’

And while not everyone around the table would necessarily agree wholeheartedly with the idea that culture plays second fiddle to personal gain, the stark reality of covering all eventualities is very high on the agenda, particularly with a new regulatory era around the corner. LB