Consultations

Overview

• 1.

  The SRA is applying to become a Licensing Authority for alternative business structures (ABS) under the Legal Services Act 2007 (LSA). The assumption under the LSA is that existing Authorised Regulators will apply to become licensing authorities as this will bring both experience and efficiency to the regulation of ABS.

• 2.

  The principle that the SRA has adopted, after consultation, to the development of the regulatory framework for ABS is that consumers of legal services, whether from traditional firms or ABS, should enjoy the same levels of service and regulation. Therefore regulation and regulatory process should be as consistent as possible within the statutory scheme.

• 3.

  The advantage of this approach is that new organisations and their clients can benefit from access to an experienced regulator at little additional cost, and current providers who may change structure and become an ABS have continuity of regulation. It also allows for efficiency, keeping costs down for the regulated community and so consumers.

• 4.

  The starting assumptions for development of a fee structure for ABS therefore are firstly that the ongoing cost of regulation of an ABS will be broadly the same as the cost of regulation of an equivalent traditional firm, and secondly that the same general principles can underpin the fee structure for both.

• 5.

  This paper also proposes that contributions by ABS firms to a single Compensation Fund should be calculated on the same basis as for traditional firms.

• 6.

  The introduction of firm based regulation for traditional firms in 2009 led to the adoption of a new fee structure for such firms in 2010, after extensive consultation. That fee structure was developed with ABS in mind. The general principles adopted were as follows and the SRA believes that these principles should also apply to the fee structure for ABS:

  The fee structure should:

  • Be fair to fee payers
  • Be efficient and economical to administer
  • Ensure a predictable income to meet the costs of regulation
  • Be stable - charges should not vary considerably year on year
  • Be as simple as possible – to enable the regulated community to predict likely fees
  • Be based on data that can be verified
  • Ensure that – wherever possible – costs of particular processes that are not of general application should be borne by those making such applications on, as far as possible, a cost recovery basis
  • Take some account of ability to pay, in particular, in relation to small and new businesses – fees should not be a deterrent to new entrants.

Impact

• 7.

  The changes to the fee structure for recognised bodies in 2010 were intended to improve fairness and transparency in support of the SRA's aim of promoting equality and diversity. The benefits of the new system will apply to ABS firms. We do not believe at this stage that the application of the fee structure to ABS will have any different impact on individual solicitors working in ABS, or on ABS firms, than on recognised bodies. The firm fee, being based on turnover, supports the principle that the fee structure takes ability to pay into account. It also promotes the regulatory objective relating to access to justice. At this stage we have very little data on what kind of firms will become ABS but do believe as a result of some surveys that the model might be attractive to a number of small firms. The significant reduction in the practising certificate fee should result in a positive impact for some groups.

Regulatory Fees

Application fees

• 8.

  The principle of fairness links to the principle of ensuring that the costs of particular processes that are not of general application are borne by those making such application on a cost recovery basis.

• 9.

  This means, in relation to ABS that application processes that are ABS specific, such as the initial authorisation process, should be fully borne by the ABS community.

• 10.

  We propose to apply this principle and have included in the SRA's Application to become a Licensing Authority details of how the application fee will be set. Other ABS specific processes will also be subject to application fees which will be set on a cost recovery basis.

Periodic fee - allocation between individuals and firms

• 11.

  The key change to the fee structure introduced in 2010 was that the general cost of regulation, instead of being allocated only to regulated individuals, was allocated to both individuals and firms.

• 12.

  The process adopted is that the total annual funding requirement is first split between the amount to be contributed by individuals and by firms, and for 2010, 40% was allocated to individuals and 60% to firms. The same split has been proposed for 2011.

• 13.

  The amount to be allocated to individuals is then borne equally by all regulated individuals (with a discount for maternity leave). This paper does not include any proposals for ABS related change in relation to the individual fee structure. Regulated individuals will pay the same individual fee whether they work in a private practice firm, in house, or in an ABS.

• 14.

  The amount to be paid by firms is then allocated to firms on the basis of a formula based on banded turnover. This was on the basis that size of business is a reasonable proxy for the benefit of regulation, and a recognition that a periodic charge to firms cannot reflect the amount of work a regulator may actually have spent on its regulation. Any system of individualised fees would not be simple or efficient to administer. Paragraphs 19–25 below explain in more detail how we propose to apply this to Multi Disciplinary ABS who also provide services that will not be regulated by the SRA. In summary they will pay on the basis of turnover arising from SRA "regulated activities".

• 15.

  The ongoing development of risk based regulation may in future have an impact on the fee structure for firms. However at present the SRA does not have sufficient data to adapt the fee structure to take risk into account and will have to learn from its experience of outcomes-focused regulation (OFR). Our starting point however is that regulatory risk does not depend on structure and we do not believe that ABS are necessarily more risky than traditional firms. We therefore believe that broadly it will cost the same to regulate an ABS firm as a traditional firm. Any significant different costs will be charged through application fees (see above).

• 16.

  We therefore propose that the normal annual periodic fee payable by ABS firms should be calculated on the same basis as that for traditional firms, based on banded turnover. Paragraphs 26 to 32 below deal with how this principle needs to be adapted for the calculation of the periodic fee payable on initial authorisation.

• 17.

  The SRA Authorisation Rules, which have been consulted on as part of the new Handbook, have been drafted on the basis that turnover will be the basis of charging the periodic fee.

• 18.

  A clear explanation of the new fee structure, as it applies now, with details of how the banded turnover table works can be found at www.sra.org.uk/fees.

• 19.

  The ABS framework permits MDPs, i.e. businesses that provide a range of different services which include regulated legal activities but may include other regulated or unregulated services.

• 20.

  An ABS MDP may provide non-legal services regulated by one or more other regulators. This is not new. For example, traditional solicitors' firms can provide mainstream financial services that are also regulated by the FSA. The LSB and SRA do not believe that MDPs necessarily present more risk, but the relationship between different regulatory regimes, and the need to minimise unnecessary duplication and cost, adds complexity. This has been addressed through the development of and MDP Framework which is subscribed to by a number of regulators.

• 21.

  It has been suggested that this complexity could lead to additional costs which should be reflected in differential fees to ensure that those ABS and traditional firms who are not MDPs do not subsidise those who are.

• 22.

  The SRA do not propose to make any differential in periodic fees for MDP ABS. There will be no data to support any such differential. At the moment we are developing a new supervisory regime which applies different supervision to firms with different risks. In time firms' fees may vary according to risk and level of supervision. While MDPs may fall into a category requiring a high level of supervision we doubt that would be the case for all MDP models, and it would not be fair to make any assumptions at this stage.

• 23.

  We also believe that much of the additional cost will arise during the authorisation process, and we have made provision for differential application fees which vary according to the complexity of the ABS applicant, and will reserve the right to make additional charges where necessary.

• 24.

  It will, however be necessary to clarify the definition of turnover for MDP ABS as they will be providing some services that are regulated by the SRA and some services that are either unregulated or are regulated by different regulators. The Handbook defines "regulated activities" (the activities regulated by the SRA ) as:

  • any reserved legal activity
  • any other legal activity; and
  • any other activity in respect of which a licensed body is regulated pursuant to Part 5 of the LSA
• 25.

  The SRA proposes that for MDPs the fees will be based on turnover arising from "regulated activities". This will mean that MDP ABS must have systems to enable them to account for the turnover from such legal activities separately from other turnover. Views are sought on whether this will cause any significant practical difficulties, and on issues that need to be clarified in guidance. The Handbook requires ABS firms to distinguish client money received from regulated activities from other "out of scope" client money and this will also require MDPs to distinguish fees from regulated activities, for example, when seeking payments on account.

How should the initial periodic fee for an ABS be calculated?

• 26.

  Charging on the basis of turnover for an existing ongoing firm is relatively straightforward. The process requires firms to notify the SRA of a turnover figure for a completed accounting year by 31 October each year. (The practising year runs from 1 November to 31 October each year) That turnover figure will then be used to calculate the periodic fee payable by the following 31 October. Using a historic turnover figure permits the SRA to base the calculation on verifiable final figures, not estimated ones. It also allows the SRA to give an indication of the fees that will be payable as soon as the likely annual funding requirement has been calculated, usually in April/May.

We propose that this process will apply in future years to ABS firms.

• 27.

  Such a formulation is not possible however for the initial periodic fee which will be payable on authorisation.

• 28.

  The SRA's new fee structure for traditional firms charges a brand new firm a fixed fee on initial recognition and a fee based on an estimated turnover for the first 12 months on first renewal (ie the following 1 November). The following year's fee will then be based on a turnover figure for a completed accounting year.

• 29.

  Many new recognised bodies are not brand new firms, they are new bodies emerging from a split or merger of other firms. Such firms will have paid the annual periodic fee for the year in which the change happens. No refund is given and so no additional periodic fee is charged when the split/merger happens during the currency of a practising year. The annual periodic fee already paid covers regulation for the rest of the practising year.

• 30.

  However the firms involved in a split/merger are required to provide a Notice of Succession to the SRA at the time of the split/merger allocating the participating firms' historic turnover figures to the continuing/new firm/s. That turnover figure will be used to calculate the periodic fee payable for the next practising year.

• 31.

  This treatment of setting periodic fees for new traditional firms cannot be directly applied to all new ABS firms but must be adapted to deal with the variety of different models that may arise. However there are some underlying principles that can be applied:

  • If no refunds are given (thus saving costly administration and giving better funding certainty) then credit must be given where essentially the same business has already paid an annual fee.
  • New firms that incorporate pre-existing ongoing legal activities, as opposed to brand new start ups, should pay an initial periodic fee that takes into account the size of the business.

• 32.

  Applying these principles to the most likely ABS models would result in the following:

  Traditional law firm/LDP converts to ABS during the practising year:

  • 32.1

    The periodic fee has already been paid for that practising year so the initial ABS periodic fee will be set at nil. Next periodic fee will be based on historic turnover already submitted to SRA (unless also impacted by Notice of Succession if split/merger also taken place).

    N.B. if the conversion to ABS takes place on 1 November the initial periodic fee will also be based on historic turnover.

  Previously unregulated legal business/or business previously regulated by another legal regulator becomes an ABS:

  • 32.2

    There appears to be a choice. Either the initial periodic fee is based on an historic turnover figure relating to its pre-existing legal business or on an estimated turnover figure for the first 12 months of operation as an ABS. Either figure can be verified during the authorisation process, as that will also form part of the risk assessment. The actual fee will be a pro rata figure depending on the date of the authorisation. The SRA proposal is that a more realistic figure may be the estimated turnover for the first 12 months given that most such businesses will be seeking to expand their legal offerings on authorisation. This would also harmonise the SRA system with that of the Council for Licensed Conveyancers (CLC) and remove any unintended incentive to choose one regulator over another.

Combinations of both scenarios above, e.g. new ABS comprises previously unregulated legal business and traditional law firm/LDP:

• 32.3

  The traditional law firm/LDP will have already paid fees for the rest of the practising year and so the initial periodic fee arguably should only be based on the estimated turnover for the first 12 months of the previously unregulated part of the business. That however may be a very artificial figure (and one which would not otherwise need to be calculated) as the objective of the new business will no doubt be to maximise the synergy of the combined businesses. We propose that a better way of calculating the initial periodic fee is to base it on the estimated turnover for the first 12 months of the combined business (a figure which will be necessary for a number of business reasons and the SRA's risk assessment) but give credit for the fees already paid by the traditional law firm/LDPs. This again would have to be subject to discussion and verification during the authorisation process. It would also be pro rata according to the date of authorisation.

Brand new ABS start up business:

• 32.4

  Applying the proposals in the models above, the logical thing is to base the initial periodic fee for a new start up business on the estimated turnover figure for the first 12 months of business (pro rata according to the date of authorisation). This figure will be sought along with details of the proposed business plan during the authorisation process.

• 32.5

  This however is different to the position for a brand new traditional firm. The consultation on the initial fee for new recognised bodies had proposed an initial fee based on estimated turnover, and that position was supported by some respondents. The decision to apply a fixed fee was driven in part by the operational process applying to the set up of new recognised bodies...a paper driven process with little scope for validation. The authorisation process for new ABS requires the submission of business plans and estimated turnover figures. Estimated turnover is clearly fairer as new ABS will vary in size and that scope for variation is perhaps more than with the start up of a new traditional firm.

• 32.6

  It is proposed that the fixed fee for brand new recognised bodies should remain for 2011/12, but when the authorisation process for new recognised bodies is brought more into line with that for ABS, as intended in 2012, then the fee structure will be harmonised.

Compensation Fund contributions

• 33.

  Changes to legislation have been made to permit the SRA to extend the operation of its existing Compensation Fund to ABS firms. This will save the significant start up costs of a new fund for ABS and recognises the reality that many traditional firms will become ABS firms and some ABS firms in future may transfer back. Having different Compensation Funds could operate against consumers' interests. The position will be reviewed in 2012.

• 34.

  The SRA Compensation Fund Rules, consulted on as part of the Handbook, have therefore been adapted to apply to ABS authorised firms.

• 35.

  It is proposed that the contributions payable by ABS firms should be on the same basis as traditional firms.

• 36.

  Each year the SRA sets the annual funding requirement to fund the anticipated cost of claims, the cost of handling claims and reserves required for the Fund. Both regulated individuals and firms which hold client money pay contributions. In 2010 the annual requirement was split approximately 50/50 between individuals and firms with each paying a fixed contribution. This was possible because the requirement that year was unusually low in order to reduce a build up of reserves. There will be a larger requirement for 2011, but it is still intended that roughly half of the requirement will be paid by regulated individuals, and the rest shared among all firms through a fixed contribution, possibly with a discount for very small firms who would otherwise face a significant rise in overall cost because of the rise in the Compensation Fund contribution.

• 37.

  This would mean that a new ABS would pay the fixed firm contribution on authorisation pro rata according to the date of authorisation.