Sum of all Fears – Risk Management Survey Part 2

Despite the perceived threats brought about by regulatory changes and law firm collapses in 2010, our survey shows that the real risks are more prosaic.

What are the biggest underlying causes of professional malpractice claims generally?*

This section analyses the key risks identified by the firms surveyed for this, our fourth annual risk management survey. As the tables on these pages show, we have made slight amendments to our questions on risk profiles this year. Instead of asking teams to simply identify the key potential risk to their firms, we have asked them to first assess the likely impact of a potential situation occurring at their firms, and then asked them to think about the actual likelihood of these situations occurring. We also asked respondents to assess the potential of a variety of professional negligence situations occurring at their firms.

‘I’ve heard there are some firms in care, but it’s a cycle, things have got very tight, banks have got tougher as they did 20 years ago.’
Bill Richards, LG

The most notable trend is the sizeable gap between perceived impact of an event against the likelihood of that event actually occurring. Nowhere is this gulf more evident than in a scenario where a firm’s liabilities exceed its resources, such as facing a professional negligence claim in excess of its policy limits. While it is obvious that risk teams understand that the impact of such an event on a firm would be huge (scoring 4.1 out of 5 in terms of impact) it was also considered the least likely event to occur (see table, ‘Legal risk profile 2’, page 60).

‘None of the results surprise me,’ says Sandra Neilson-Moore at Marsh. ‘For example, liabilities exceeding resources would have the greatest negative impact on a firm, but is deemed to have the lowest probability of occurring. Such a situation is historically extremely rare, but when it happens, usually completely destroys the firm. Errors made by fee-earners are shown to have the most potential to occur, but would not be on the scale from an impact point of view.’

Conflicting issues

It follows then that the most serious risk concerns for law firms are those where the aggregate score for impact of an event and the potential for it occurring are high. Taking both factors into consideration, it comes perhaps as no surprise that the biggest risks, when both impact and potential are taken into account, are disaster/business continuity failure, IT security, and serious legal or commercial conflicts of interest.

Conflicts of interest remain a perennial headache for risk teams and have featured large in discussions again this year. This was particularly noticeable when several departing partners from the Belgium operation of US firm Howrey pointed to the strict rules over client conflicts in the US as a major factor in their departures.

From a regulatory perspective, conflict of interest rules have formed the basis of many top firms’ concerns over the Solicitors Regulation Authority’s move to outcomes-focused regulation. Many argue that changing the rules on managing conflicts of interest could cause insurmountable problems. In a letter to Margaret Hope of the professional ethics unit of the SRA in August 2010, David McIntosh, chair of the City of London Law Society, which represents 13,000 solicitors at the largest international law firms said that the CLLS felt it was not the time for wholesale changes to the conflict rules. The current rules, he said, were introduced only four years ago following six years of review and debate and replaced a regime that was confusing and unclear. ‘Solicitors are naturally nervous about conflict rules because they are aware that if they misapply them, there are not only regulatory risks, but also serious exposure under the common law,’ he wrote. ‘They therefore like clarity and certainty in this important area of regulation.’ The tenet of the CLLS’s advice to the SRA was clear: the conflict rules should remain as they are, unchanged as part of an annex to the revised Code of Conduct.

However, regardless of whether the rules are changed as part of a move to outcomes-focused regulation, the threat of conflicts remains one of the most significant risk issues facing firms. ‘One of the big problems for firms is commercial conflict of interest, where there is no conflict under our conduct rules but the firm needs to take a view on whether it should act for a particular client in a particular matter,’ says Bill Richards, head of risk and compliance at LG. ‘That is still a significant risk headache for all commercial law firms,’ he adds.

The Halliwells effect

Despite the demise of Halliwells dominating the headlines in 2010, the fact that one of the UK’s 50 largest firms is no more has done little to raise genuine concerns among the legal elite. The circumstances are considered far too specific.

Bankruptcy and the risk of credit or other financial problems received a relatively low risk score, with most generally feeling it was unlikely to happen. Although this risk was perceived as diminishing in last year’s report, largely because panic had subsided since the collapse of Lehman Brothers and the recovery of the banks, this result suggests that any fears stirred up within the industry are minimal. Speculation on the ‘Halliwells effect’, where banks are perceived to have taken a less forgiving stance with law firms has been overplayed. Certainly the general consensus among those interviewed is that law firms are far too risk averse to allow a situation similar to the one that caused Halliwells’ demise to occur again. While the story may endure as a modern fable on law firm mismanagement, no-one expects it to happen again soon.

‘I don’t think what happened to Halliwells has changed the risk profiles of firms.’
Sandra Neilson-Moore, Marsh

Beachcroft insurance partner Tony Cherry, who chairs the firm’s internal committee for governance and risk, says the effects of Halliwells’ demise on risk management are more mood-changing than tangible. ‘Nobody can really comment on the Halliwells case without knowing exactly what was happening on the inside but people would be lying if they said that it had no effect,’ he says. ‘Looking at it though, if you take a capital asset and strip away at it then you are going to have problems. Lawyers are generally prudent and if they are not then the bankers will be for them. As a consequence of Halliwells, people are a little more conservative than before.’

But one UK risk manager suggests that the most significant changes in the wake of Halliwells will be in attitude rather than direct action. ‘It hasn’t affected firms’ risk profiles but it has perhaps affected the awareness of the risk profile,’ he says.

LG’s Richards says he is old enough to remember the difficulties experienced by many firms in the early 1990s, which led to the demise of Turner Kenneth Brown in 1994, where vaulting ambition caused irrecoverable financial problems for the firm. He feels that this may be just a case of history repeating. ‘I’ve heard there are some firms in care,’ he says. ‘But it’s a cycle, things have got very tight, banks have got tougher as they did 20 years ago.’

Neilson-Moore sums up the situation thus: ‘General lessons that can be learned from Halliwells are: one, be careful how quickly you expand in boom times, as these may not last; and two, a solid partnership, with fair and transparent distribution to all stakeholders, is key to a firm’s cohesiveness and survival in troubled times. I don’t think what happened to Halliwells has changed the risk profiles of firms. However, I do think that it has changed the way firms look at acquisitions.’

Mounting pressure

Moving from the hypothetical to the tangible, according to data released by Reynolds Porter Chamberlain last summer, the number of professional negligence claims against solicitors in the High Court rose by more than two and a half times in 2009 compared with 2008. A total of 210 claims were begun in the High Court last year, a rise of 163% on the 2008 figure of 80 – itself a big increase on the mere 31 actions raised in 2007.

It’s clear that cases against solicitors are on the up and a glance at our survey findings shows a direct link between increasing client demand and the likelihood of mistakes occurring. Of all respondents 62% cite ‘pressure of work/pressure of deadlines’ as one of the biggest underlying causes of professional malpractice claims. Meanwhile, according to the firms themselves, the three most likely situations to occur giving rise to professional negligence claims are errors made on both routine and highly complex transactions, as well as pressure on fees and the need for ‘instant’ advice. This appears to be borne out when looking at some of the most recently publicised professional negligence cases against law firms.

Richards says analysis of the claims records of most firms would prove that the most significant volume of claims would come from ‘routine’ matters such as drafting errors and missed time limits with few claims ‘arising from getting the law wrong’.

It seems the new reality is that firms are being squeezed at both ends – their most significant financial burden is clients driving down fees. Dwindling finances means downward pressure on resources. Fewer resources mean that fault lines start to open up when clients demand more bang for fewer bucks.

However, Richards says he doesn’t subscribe to the view that because there is pressure on fees and because clients want things done more quickly that it is feeding through into more claims. ‘We all have to adapt to the situation where we’re in a commercial marketplace and clients have a lot of choice. I believe it’s wrong to attribute more claims to clients wanting things done more quickly. In my experience that’s not the case,’ he says.

It seems once gain that the lag between perception and reality over what poses a genuine risk threat to law firms remains very large indeed. Just look at the furore caused by the potential impact of the SRA’s revised Code of Conduct, and how likely law firms think errors caused as a result of the confusion would give rise to a professional negligence claim (see table, ‘Legal risk profile 3’, page 60).

‘Firms do not believe that confusion over OFR will “cause” claims,’ says Neilson-Moore. ‘The fear is that OFR will produce unfair results for a firm in the aftermath of a claim, when the firm’s actions are viewed with the potential for 20/20 hindsight, rather than in terms of whether the rules were followed or not. The impact of OFR is high, because it is a complete change to the way firms are regulated. This, coupled with a fear that it will be vague, difficult to implement or understand and potentially produce unfair results, is what is causing the furore.’ LB

mark.mcateer@legalease.co.uk