Warning notice

Improper use of a client account as a banking facility

 

Issued on 18 December 2014

This notice is relevant to all regulated persons holding client monies, and must be read in conjunction with our four case studies on improper use of client account as a banking facility, also published on 18 December 2014.

The Solicitors Disciplinary Tribunal and the courts have sanctioned solicitors for many years for processing funds through client account for purposes unconnected with legal advice.

Since 1998, guidance note (ix) to Rule 15 of the Solicitors Accounts Rules 1998 has warned solicitors of the need to exercise caution if asked to provide banking facilities through a client account and in 2004 the note was amended to state expressly that solicitors "should not provide banking facilities through a client account". In 2011, the guidance note was elevated to an Accounts Rule (Rule 14.5 of the SRA Accounts Rules 2011).

We have seen an increase in reports to us that client bank accounts are being used improperly as a banking facility, with its attendant risks of involvement in financial crime and the evasion of insolvency processes.

This guidance sets out a summary of the current position and some key issues that you should be aware of. We have also set out some case studies to assist you in complying with your obligations.

Whilst this guidance does not form part of the SRA Handbook, we may have regard to it when exercising its regulatory functions.

Our rules/principles/outcomes

Rule 14.5 of the SRA Accounts Rules 2011 provides as follows:

 

You must not provide banking facilities through a client account. Payments into, and transfers or withdrawals from, a client account must be in respect of instructions relating to an underlying transaction (and the funds arising therefrom) or to a service forming part of your normal regulated activities."

Guidance note (v) to Rule 14.5 states that:

 

Rule 14.5 reflects decisions of the Solicitors Disciplinary Tribunal that it is not a proper part of a solicitor's everyday business or practice to operate a banking facility for third parties, whether they are clients of the firm or not. It should be noted that any exemption under the Financial Services and Markets Act 2000 is likely to be lost if a deposit is taken in circumstances which do not form part of your practice. It should also be borne in mind that there are criminal sanctions against assisting money launderers."

The Principles

A breach of Rule 14.5 is a serious matter. In addition, allowing your firm's bank account to be used improperly may also involve a breach of the SRA Principles including:

  • Principle 1: upholding the rule of law and the proper administration of justice;
  • Principle 3: not allowing your independence to be compromised;
  • Principle 6: behaving in a way that maintains the trust the public places in you and the provision of legal services; and
  • Principle 8: running your business or carrying out your role in the business effectively and in accordance with proper governance and sound financial and risk management principles.

Outcome 7.5 of the SRA Code of Conduct 2011 also states that you must "comply with legislation applicable to your business, including anti-money laundering..."

Where clients ask you to process funds through your client account, you need to balance the client's best interests against the other Principles and your legal obligations. You should bear in mind note 2.2 to the Principles, which states that, where two or more Principles come into conflict, the Principle which takes precedence is the one which best serves the public interest in the particular circumstances, especially the public interest in the proper administration of justice and note 2.4 which states that compliance with the Principles is subject to any overriding legal obligations.

The Court of Appeal in The Attorney General for Zambia v Meer Care & Desai and others [2008] EWCA Civ 1007 noted in paragraph 234:

 

…it is plain that he was providing the service of a bank account, albeit only in credit… with almost none of the payments through the client account being related to any legal work done by the firm. It is equally plain that this was not a proper thing for a firm of solicitors to do."

Recent High Court judgments

In the past two years, two High Court judgments have upheld the principles underlying Rule 14.5:

Premji Naram Patel v SRA [2012] EWHC 3373 (Admin)

Mr Patel was a sole practitioner who acted for a company importing high value motor vehicles from Europe at a reduced price, to be sold in the UK for a substantial profit. Two significant investors were unwilling to pay funds directly to the company's owner because of past business failures. Instead investors paid money into the client account operated by Mr Patel. Mr Patel then transferred the relevant funds to the vehicle manufacturers directly.

We alleged that Mr Patel "permitted his bank account to be utilised by a client and/or third parties to receive and pay monies where there were no underlying legal transactions".

The Tribunal imposed a fine of £7,500.

Mr Patel appealed to the High Court. He argued that the second sentence of Rule 14.5 had to be read disjunctively: payments into and out of a client account have to relate to either (a) an underlying transaction or (b) a service forming part of the solicitor's normal regulated activities. He submitted that solicitors must not permit their client account to be used as a banking facility but will not be in breach of the rule if its use occurs as a consequence of a client's instructions in relation to an underlying transaction, albeit not a legal transaction.

The Court rejected that argument and upheld the fine imposed by the SDT commenting that "movements on client account must be in respect of instructions relating to an underlying transaction which is part of the accepted professional services of solicitors".

Fuglers & Ors v SRA [2014] EWHC 179 (Admin) (QB)

Fuglers LLP acted for a Football Club. The Club's bank account was withdrawn after a winding-up petition was brought by HM Revenue & Customs (HMRC). The Club was insolvent.

Over a period of 4 months, approximately £10 million of the Club's money passed through Fuglers' client account.

The SDT fined Fuglers £50,000 and its two managers £5,000 and £20,000.

They appealed against the amount of the fines that were imposed. The High Court dismissed the appeal and confirmed the seriousness of the misconduct that had been found by the SDT.

At paragraphs 39 - 43, the Judge sets out three reasons why client accounts must not be used as banking facilities for clients:

  • Objectionable in itself

     

    The first strand is that it is objectionable in itself for a solicitor to be carrying out or facilitating banking activities because he is to that extent not acting as a solicitor. If a solicitor is providing banking activities which are not linked to an underlying transaction, he is engaged in carrying out or facilitating day to day commercial trading in the same way as a banker. This is objectionable because solicitors are qualified and regulated in relation to their activities as solicitors, and are held out by the profession as being regulated in relation to such activities. They are not qualified to act as bankers and are not regulated as bankers. If a solicitor could operate a banking facility for clients which was divorced from any legal work being undertaken for them, he would in effect be trading on the trust and reputation which he acquired through his status as a solicitor in circumstances where such trust would not be justified by the regulatory regimen."
  • Risk of Money laundering

     

    The second strand is that allowing a client account to be used as a banking facility, unrelated to any underlying transaction which the solicitor is carrying out, carries with it the obvious risk that the account may be used unscrupulously by the client for money laundering. This was the danger referred to in paragraph 58 of the Tribunal decision in Wood and Burdett (8699/2002) which is referred to in note (ix) itself. That this was one of the dangers at which the rule was aimed is reinforced by the express mention in note (ix) of the criminal sanctions attaching to money laundering."
  • Insolvency or risk of insolvency

     

    The third strand arises in the particular context of insolvency or risk of insolvency. In such context, to allow a client account to be used as a banking facility is objectionable for several reasons. In the first place, it allows the client to achieve that which the client will normally be unable to achieve from any bank. It is the common practice of banks, as happened with the Club's bank in this case, to withdraw facilities upon notification that there has been a winding up petition. The solicitor is therefore giving the client a commercial service which would otherwise be unavailable to it through the device of using a solicitor as if he were a bank. Secondly there is the risk of disaffection and opprobrium which is involved in favouring one creditor over another. This exists in the absence of any risk of insolvency, but becomes more acute in the event of insolvency or potential insolvency. This arises irrespective of whether dispositions would or would not be subject to invalidity by the operation of section 127. A third reason is the risk of section 127 (of the Insolvency Act 1986) applying so as to require creditors to reimburse payments from the client account in a subsequent liquidation. A solicitor who knowingly makes or facilitates such payments may be subject to a personal liability, quite apart from the liability of the payee to reimburse the amount transferred."

Risks

You should therefore be aware that:

  • Providing banking facilities through a client account is objectionable in itself

    For the avoidance of any doubt, our view is that you should only receive funds into client account in relation to an underlying transaction that you or your firm is advising on. It is not sufficient that there is an underlying transaction if you are not providing legal advice to one of the parties.

  • There must be a reasonable connection between the underlying legal transaction and the payments

    Whether there is a reasonable connection is likely to depend on the facts of each case but where the legal services are purely advisory, it will clearly be more difficult to show a reasonable connection. The fact that you have a retainer with a client does not give you licence to process funds freely through client account on the client's behalf. Throughout a retainer, you should question why you are being asked to receive funds and for what purpose. You should only hold funds where necessary for the purpose of carrying out your client's instructions in connection with an underlying legal transaction or a service forming part of your normal regulated activities. You should always ask why the client cannot make the payment him or herself. The client's convenience is not the paramount concern and, if the client does not have a bank account in the UK, this considerably increases the risks. You should be prepared to justify any decision to hold or move client money to us where necessary.

  • Significant aggravating factors include the risks of insolvency and money laundering

    The seriousness of the breach will be aggravated by indications that the funds were paid into, or transferred out, of client account, to avoid responsibilities imposed by insolvency legislation or to perpetuate suspected financial crime or tax fraud. In the case of Simms SDT 8686/2002 the Tribunal noted at paragraph 76:

     

    A solicitor who involves himself in transactions which he knows or suspects or should have known or suspected could involve illegality or impropriety or who gives such transactions credibility cannot but appreciate that his behaviour will be perceived as affecting his integrity and trustworthiness and so affect the reputation of the Profession. The duties of a lawyer as an officer of The Supreme Court are not simply owed to the client but also involve the respect which the Profession owes to the law itself and to justice."

    You should be aware that criminals often target solicitors' client accounts to lend credibility to fraudulent schemes or to launder the proceeds of their criminal activity. You must not allow money to move through client account unless it is in connection with a genuine transaction about which you are providing legal services. You should ensure that you undertake proper due diligence before accepting any funds into client account and you should not act if you do not fully understand the transaction on which you are advising.

    Compliance with Rule 14.5 offers an important 'first line of defence' to clients who may seek to take advantage of your client account to launder money. It also helps you to secure professional independence from your client in compliance with Principle 3.

    You should make sure that you and all members of your firm are familiar with the warning notices and guidance we have issued in relation to high yield investment fraud and money laundering.

Other related issues/considerations

Use of escrow accounts

Firms may hold funds 'in escrow' or subject to professional undertakings in circumstances where they are advising a party to the underlying legal transaction; for example, funds for the purchase of an asset (e.g. an aircraft) might be held pending the completion of a purchase.

The decision of the SDT in Wilson-Smith (SDT 8772/2003) (para 60) was unequivocal that a solicitor should not act as 'escrow only' agent:

 

It can be described as nothing other than crass stupidity to accept a role as, for example, an "escrow agent" when the solicitor cannot know what that means as, indeed, that expression has no meaning in English law."

The use of escrow accounts is a serious risk if they do not have a reasonable connection to an underlying legal transaction (which you are advising on) or are not in association with the recognised "professional duties" of a solicitor. For the avoidance of doubt, if you are instructed only to advise on the terms of an escrow account in the absence of being instructed on an underlying legal transaction or the provision of other professional duties (such as probate services), this is likely to involve a breach of Rule 14.5.

In each case you must therefore carefully consider all of the relevant circumstances and the risks involved before you agree to hold funds in escrow. You should be prepared to justify your decision to us where necessary.

A possible alternative: If parties want funds to be held independently in escrow, they could appoint an independent trustee company or bank regulated by the FCA and authorised to provide banking and/or escrow services.

Private Client Services

Historically, some solicitors have agreed to receive and hold funds for clients to enable them to pay routine bills and invoices on their clients' behalf. This has been predominately for the clients' convenience as they may be based abroad or because they are incapacitated so that operating their own bank accounts is problematic.

In view of technological advancements, in particular the ease of internet and telephone banking, we consider that allowing client account to be used in this way is no longer appropriate. Clients can now operate their bank accounts from their own homes or indeed from anywhere in the world. Allowing clients to hold anonymously what might be significant funds in a client account gives rise to significant risks in relation to potential money laundering or other breaches of the law, such as exchange control consent regulation. The anonymity of client accounts is attractive to criminals.

In each case, you must therefore carefully consider all of the relevant circumstances and the risks involved before you agree to hold funds in this way. You should be prepared to justify your decision to us where necessary.

This guidance is not intended to affect your ability to make reasonable and proper payments on your client's instructions when related to an underlying legal transaction on which you have been instructed, for example, upon completion of a house purchase on your client's instructions under Accounts Rule 20.1(f). Once a transaction is complete, we would remind you that Rule 14.3 provides that client money must be returned to the client promptly, as soon as there is no longer any proper reason to retain those funds. If you retain funds in client account after completion of a transaction, the risk of a breach of Rule 14.5 increases. Risk factors of laundering in particular would involve the payment of substantial sums to others, including family members, or to corporate entities, particularly overseas, since there is no reason why the client could not receive the money into their own account and transfer it from there.

Enforcement Action

Failure to comply with this warning notice may lead to disciplinary action.

Further help

High-yield investment fraud: Warning notice
Issued on 10 September 2013

Money laundering and terrorist financing: Warning notice
Issued on 8 December 2014

Further assistance

If you require further assistance with understanding your obligations in relation to anything please contact the Professional Ethics Guidance Team.


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