News

The legal landscape is changing—and, with it, so is the SRA. We are transforming our approach to regulation for the benefit of clients and the public. We recognise that significant reform of our approach is necessary if we are to be a regulator fit for the liberalised legal landscape starting in October 2011.

6 October 2011 will be a historic day for legal services in England and Wales. Two major changes will arrive—changes which will have a major effect on every law firm, every lawyer and on the legal services market as a whole.

• First, it will be the day when outcomes-focused regulation (OFR) is introduced. OFR amounts to a shift in emphasis from prescriptive, rigid rules to flexible, outcomes-focused requirements. We believe that the way the legal services market is evolving demands that regulation should focus more on the quality of clients' experience—and less on prescribing the approach that firms should take. That means our regulatory approach will be more effective, proportionate and targeted, so we can consistently regulate a greater range of legal service providers with a targeted, risk-based approach. It will enable firms to be far more flexible in how they meet their regulatory obligations—as well as making them feel they can be more open with the SRA.
• Second, alongside the introduction of OFR will be the implementation of the framework for licensing alternative business structures (ABSs)—and, possibly, even the first ABS itself. The arrival of ABSs will help to foster a more flexible and innovative market for legal services—having a major impact on consumers' experiences of legal services—stimulating competition and encouraging innovation.

Our overall objective in preparing for 6 October—and in developing the new regulatory framework—has been to put public protection at the heart of our outcomes-focused approach.

The foundation stones of our new approach are as follows:

• the SRA's new Handbook—this will bring together all the SRA's regulatory requirements into a single, coherent structure that underpins the regulation of solicitors, law firms and alternative business structures;
• a new set of core principles that define the fundamental ethical and professional standards that we expect of all firms and individuals when providing legal services;
• a new Code of Conduct that replaces much of the detail and prescription of the current rule book—the Code sets out the key principles and outcomes that must be achieved, that is, the standards of service that all legal service providers will need to deliver to benefit the public and consumers.

The 10 core principles embody the key requirements on firms and individuals. They apply to all the individuals and firms we regulate—whether traditional firms, in-house practitioners or ABSs. The principles preserve all that is best about the solicitors' profession. They relate to proper independence from improper influence, the centrality of the rule of law, putting clients' interests first, being scrupulously honest and protecting clients' money.

They are the principles against which all actions will be judged—and are just as relevant for the OFR generation as they have been, in other manifestations, for other generations.

The Code is crucial to our implementation of OFR. Its development has been driven by the need to have a regulatory system capable of being applied to and applied by both traditional law firms and ABSs.

The Code brings together the principles and outcomes. The outcomes set out what firms and individuals are expected to achieve to comply with the principles. Finally, it contains indicative behaviours—which do the job of supporting the outcomes. They set out the sort of behaviour that would—or would not—achieve the outcome and, so, compliance with the principles.

On 21 October, we published our second and final consultation on the Handbook, including the Code. If you haven't looked at it, do. And please make sure you respond. The consultation closes on 13 January 2011.

Alongside—indeed, integral to—all of this work are our continuing preparations for the introduction and regulation of ABSs.

Before I turn to what these preparations entail, let us just remind ourselves of a few ABS facts. So, what are alternative business structures?

The definition of an ABS is broad. To put it as concisely as I can, it is a new type of law firm. It will enable lawyers and non-lawyers to share the management and control of a business which provides reserved legal services, and other services, to the public. It will allow external investment and ownership of law firms.

What will an ABS look like? What will emerge? You will see from this list that the permeations are numerous and diverse. I will summarise them, under three broad types of model:

• The first model would be firms that are in essence like traditional law firms or legal disciplinary practices (LDPs), but with the involvement of one or more non-lawyer manager, without external ownership, and providing solicitor type services only.
• The second model would include complete or partial external ownership with the legal services being operated through a separate entity. For example, if a high street store—the much used “Co-op law” analogy—were to set up a legal services division, it may set up a separate subsidiary, distinct from the rest of its activities, so that only the entity providing reserved legal activities will be regulated as an ABS.
• The third model would involve combinations of different services within one entity—this is the multidisciplinary practice (MDP) model.

It is this third model that poses a few regulatory challenges: challenges, but not additional risks, in that it would not be appropriate to apply rules solely relevant to legal work to a completely different service.

For example, where an ABS provides a regulated non-legal service—an obvious example being accountancy—alongside a legal service, there is the very real potential for overlapping regulation, and more worryingly the risk of regulation falling between the gaps. In turn, this may lead to perceptions of inconsistency in regulatory requirements or, worse, different standards of consumer protection. This may especially be the case where the requirements on the entity are set by one professional regulator but requirements on individual professionals are set by others.

Our priority is to ensure that MDP ABSs are regulated in the most effective manner, avoiding, so far as is possible, regulatory duplication and gaps. We have undertaken a considerable amount of work on MDP ABSs with other regulators and professional bodies, and are making good progress.

Our work is focused on

• understanding how the SRA's jurisdiction in relation to MDP ABSs impacts on our Handbook of regulatory requirements;
• assessing the risks associated with MDPs—for example, some respondents were particularly concerned about the possibility of an MDP using confidential and sensitive client information to cross-sell other services, that it be ring-fenced from other forms of client money;
• deciding whether it is necessary to have specific rules/modified rules governing MDP ABSs;
• considering how we will share relevant information with other regulators and professional bodies, where we jointly regulate an entity providing a diverse range of professional services—the framework memorandum of understanding which is being developed with other regulators and professional bodies, will address the need to share information about firms and individuals where it is in the public interest to do so;
• identifying areas of regulatory overlap where more than one regulator regulates a firm—the framework will address how we as regulators can work together to ensure the efficient supervision and investigation of firms and individuals;
• discussing areas for potential harmonisation of regulatory regimes, for example, in relation to client money—the working group of regulators and professional bodies has agreed that we will seek to harmonise regulation to ease the regulatory burden on MDPs; and
• assessing the potential impact of MDP ABSs on the SRA's compensation fund—again, we have sought to ensure that the Compensation Fund Rules only cover those aspects of an MDP's activities that fall within our jurisdiction.

Our working group involving other regulators and professional bodies will continue to tease out and resolve some difficult issues in relation to MDP ABSs, both in the run up to 6 October 2011 and beyond. These discussions will be reflected in the framework memorandum of understanding that we plan to publish in December 2010.

But, I digress. We cannot, nor should not try to second guess what the market will want. It will be for the market decide on the ABS model it wants and then, hopefully, for consumers to benefit.

The SRA will be applying to the Legal Services Board to be designated as the first, if not—at least, initially—the only licensing authority for ABS. This means that, by 6 October 2011, we will be able to license and regulate these new business structures.

We do not think that it is the case that the ABS regime needs to start from a blank piece of paper in relation to the key consumer protections delivered by the current regulatory framework. The regulatory objectives themselves support the maintenance, through the ABS regime, of not only protecting and promoting the public interest but also protecting and promoting the interests of consumers, as well as encouraging a strong, diverse and effective legal profession and promoting and maintaining adherence to the professional principles.

In our view, the principal risks to consumers from ABSs are not intrinsically different from the risks from traditional law firms. Risks such as a failure to put the interests of consumers first, conflicts of interest, dishonesty, and incompetence will be risk in any type of entity, irrespective of the label we choose to give it.

We know that entry requirements will play a part in reducing these risks, but what we also know is that a mixture of a commitment to high standards in legal services providers, intelligent supervision by the regulator, prompt effective intervention and sanctions, where required, and consumer education are fundamental requirements.

The other key principle we propose is that the public are entitled to the same ethical standards and minimum standards of service from all providers of legal services.

After all, it is surely common sense that a consumer buying a conveyancing service from a high street store should receive the same ethical standards, consumer and financial protections and minimum service levels as they would if using a conveyancing service from a traditional solicitors' firm?

As I recall, there has been very little criticism of the consumer protections provided by the existing regulatory frameworks, and we see no public policy wish now to reduce or remove the consumer protections provided.

Therefore, in defining the regulatory regime for ABS, our objectives have been twofold:

• to achieve the same degree of consumer protection for clients of traditional law firms and ABSs; and
• to facilitate the movement between two statutory regimes, as we believe that some firms will switch status—and perhaps not infrequently.

Let me be clear—we will ensure that ABSs are subject to the same robust authorisation and standards-setting requirements, and regulatory sanctions, as traditional law firms. We will import the best of the traditional, high standards into the new world.

However, it would be wrong—in fact, absurd—to expect ABSs to comply with the same high standards, and be subject to the same regulatory sanctions, as traditional firms, but then to demand that, unlike traditional law firms, they have in some way to prove themselves to be necessary and legitimate before they can operate. Frankly, it is a non-starter.

The level playing field is just that—level. Traditional law firms have never had to justify their entrance into the market on economic grounds, nor had to assess the effects of their entrance upon their competitors. It would be illogical and impractical to expect ABSs to do so. It is not our responsibility as regulator to protect certain sectors of the profession from competition. Nor is it our job to second guess consumer preferences. Our job is to ensure that the right, robust safeguards are in place to protect clients and the public.

In other words, we want to seek, where possible, to achieve harmonisation of the regulatory requirements. This will ensure that clients of ABSs benefit from the same protections as those enjoyed by clients of traditional law firms.

We believe this is the right approach to take. Not only is it in the public interest generally—but it is specifically in consumers' interests that we achieve a common standard of consumer protection while simultaneously promoting a competitive legal services market. It will of course be necessary for us, other regulators, and the Legal Services Board to review the effects of the new regime upon access to justice, and to monitor the effectiveness of our new regulatory processes in delivering consumer protection. We shall do that—but looking at the whole sector, not just ABSs.

The harmonisation of the regulatory regimes is hampered somewhat by the legislative framework.

The Legal Services Act, far from producing a fully rationalised regulatory structure for legal services, in fact produces an unhealthy hotchpotch of arrangements, with potential dangers for consumer protection.

So, while the Legal Services Act sets out the statutory regime for regulating ABS, the Solicitors Act and Administration of Justice Act set out the regulatory powers in relation to solicitors and recognised bodies. Therefore, we are faced with two statutory regimes, neither of which is ideal.

We do not consider that it is in the public interest or the interests of the profession to operate under two different regimes. This would create confusion for consumers and for providers as to which set of rules apply and when. And that is to say nothing of the cost burden for both us and you in operating a dual system.

We have identified disparities between the two regimes, which could have the effect of creating different levels of consumer protection. For example, under the Legal Services Act, approved regulators do not have the power to recover costs of investigations from licensed bodies. Yet the SRA has the power to do just that from recognised bodies.

Our ability to charge for the costs of our investigations is an important tool. We believe that the costs of investigations should be borne, so far as practicable, by those found to have committed acts of misconduct. The current regime for recovery of costs is that charges should only be imposed where a finding has been made, and based upon bands of costs related to the number of hours spent. We believe that the SRA should have an equivalent power in respect of ABSs.

There are also significant differences between our regulatory powers under the Solicitors Act regime and those under the Legal Services Act regime. It is our firm view that all firms, irrespective of business model should be subject to the same procedures and the same sanctions. This was a view shared by many who responded to our first Handbook consultation.

This is the fairest approach—and the one that is genuinely in the public interest. Having two regimes could, indeed would, undoubtedly lead to a complex set of procedures: not to mention inefficiency, inconsistency and the potential for regulatory arbitrage. We must, therefore, subject firms and individuals to fair, consistent and proportionate disciplinary procedures and sanctions.

Fortunately, help is at hand through a statutory instrument known as a section 69 Order. This is the mechanism by which the Solicitors Act, Administration of Justice Act and Legal Services Act can be changed. The Legal Services Board (LSB) recently published their consultation on a draft section 69 order. We have worked constructively with the LSB on this. Throughout this, our objective has been to achieve a common standard of consumer protection through necessary harmonisation of our powers.

We appreciate the positive dialogue that we have had with the LSB on the section 69 order and look forward to responding formally to the consultation.

I would like to highlight another issue now. This relates to an extremely important aspect of the SRA's consumer protections. I refer, of course, to the Compensation Fund.

The fund, as you will know, is part of a suite of public financial protections in respect of private practice. This is complemented by compulsory professional indemnity insurance, the intervention process and the ability to make awards in relation to legal service complaints, though that is now in the hands of the Legal Services Ombudsman.

Rightly, the Legal Services Act requires that the licensing rules of regulators must contain appropriate compensation arrangements. We believe it is important to have the same levels of client protection whatever the type of firm a client instructs. I do not think anyone would disagree with this.

Where there is not so much disagreement but a divergence of opinion is the issue of how best to achieve fair and consistent levels of consumer protection.

There are essentially two options. The first is for the operation of a combined compensation fund to cover both ABSs and traditional law firms. The second is for the establishment of a separate compensation fund for ABSs.

Our view is that the interests of consumers are best protected by a combined compensation fund. We have concluded that two separate funds would create confusion, be administratively burdensome and result in avoidable yet complex disputes about which fund pays out what losses and when.

It is then our intention to adopt the approach of applying the existing compensation fund for the broader purposes of ABSs. A note of caution though—we are currently carrying out a root-and-branch review of our indemnity and compensation arrangements, and the decision we have made in respect of the compensation fund is subject to the outcome of that review. We will be consulting on this in December this year.

Therefore, as a temporary measure, and one that we have agreed with the LSB, we have adopted an interim solution under which cover for both types of business model will be through the SRA's existing compensation fund. This arrangement will remain in place pending first the outcome of the review.

You may wonder at the wisdom of an interim solution. Quite simply we do not have the luxury of time to wait for the outcome of the review, and we cannot risk there being inappropriate or unsatisfactory arrangements in place.

There is, however, one further major area for discussion that remains outstanding: the definition of reserved legal services or, as I prefer to call it, the nonsense of reserved activities.

That nonsense—already evident in areas such as will writing—will potentially be made worse with the advent of alternative business structures.

At present, there are six ”reserved legal activities” set out under the Legal Services Act—that is, activities lawyers need to be authorised to undertake before being allowed to do so, for example, representing a client in court. The activity of will writing is not currently a reserved legal activity. We believe that consumer protections should extend to all ”solicitor activities” offered by ABSs, as they already do for traditional law firms, in order to

• provide consistent consumer protection in what may be a rapidly changing legal services market, and
• avoid consumer confusion over which legal services in this new market are regulated and which are not.

In our constructive discussions with the Legal Services Board, we have been pressing hard for rationalisation of the system, to ensure that the clients of legal firms, particularly vulnerable consumers, have the protection they deserve, whether they are obtaining services from a solicitor in the high street or from the new kinds of business structures likely to emerge in the autumn of next year.

We have been fierce in defending the approach that the SRA set out more than two years ago: namely, that protection for clients must apply across the sector. Any suggestion that the clients of ABSs should be offered a lower level of protection, or that ABSs should be given an unfair, commerical advantage on the basis of inferior consumer protection, is in our view wholly unacceptable.

Therefore, we intend to apply our existing Separate Business Rule to ABSs. This will have the effect that ABSs regulated by us, like traditional law firms, would not be able to undertake unreserved legal activities through an associated unregulated entity.

There is an alternative view that the need for a level, competitive playing field implies that solicitors should be able to offer non-reserved legal activities on the same basis as a firm that is not regulated at all. We consider that this argument underestimates the vulnerability of many consumers. Offering consumers the choice of cheaper unregulated services or more expensive regulated ones is only meaningful if consumers have the understanding to make a reasoned choice. We have recently carried out consumer research that shows that there is a high degree of confusion among consumers over the provision of legal services and a lack of understanding of which services are regulated and the consequences of receiving services from an unregulated provider.

The standard of at least some non-reserved activities conducted by unregulated entities is scandalously poor. We would not tolerate the standards of non-reserved activities carried out by solicitors sinking to that standard. One may hope that consumers' buying preferences would discriminate against poor providers and force them out of business, but consumers who buy will-writing services may not know that the advice given was poor until it is too late. We shall, therefore, continue to argue for regulatory protections that more closely match what consumers want. To put it another way, the regulatory regime needs to level the market upwards rather than downwards.

We welcome the LSB's commitment to examine this issue. For our part, we will continue to lobby hard for what we believe is not simply right, but imperative.

As I have already said, ABSs will enable lawyers and non-lawyers to share the management and control of a business that provides reserved and other legal services to the public.

The minimum requirements for an ABS are twofold. First, an ABS must have at least one lawyer “manager”. That is somebody who is either

• a solicitor with a practising certificate;
• a registered European lawyer;
• a lawyer of England and Wales, authorised by an approved regulator other than the SRA.

Secondly, it must have at least one non-lawyer manager or owner.

Any manager or any owner of an ABS or, indeed, any manager of a corporate entity that is a manager or owner of an ABS, will have to be approved as being suitable by the SRA. We will do this through the application of the Suitability Test—more on which, later.

An ABS must also have two statutory officers who are seen as a key bulwark against inappropriate interference from non-lawyer owners—a Compliance Officer for Legal Practice and a Compliance Officer for Finance and Administration.

You may remember that these roles are referred to as Head of Legal Practice (HOLP) and a Head of Finance and Administration (HOFA) in the Legal Services Act. The reason for the name change is simple—we have chosen to impose this requirement on all firms, whether ABS or traditional law firms. This is an integral part of our aim to provide equivalent consumer protections whatever type of firm a client uses. And, while we know that for some traditional firms the requirement to have a COLP and COFA will be contentious one, our decision is founded on sound principles.

Turning now to define the role of the COLP and the COFA:

• The Compliance Office for Legal Practice is responsible for ensuring compliance with the rules in general and any statutory obligations.
• The Compliance Office for Finance and Administration, meanwhile, is responsible for ensuring compliance with the SRA Accounts Rules—and is under an obligation to report breaches to the SRA.

They will have the obligation to ensure everyone in the firm, and the firm as a whole, complies with the regulatory requirements. They will be a fundamental part of the firm's governance and compliance arrangements. As such, firms will to need to provide them with access to all necessary systems and information to enable them to fulfil their roles. Let me make clear though that they are not a substitute for the managers' responsibility for the firm overall – the buck will still stop with them.

It is of course probable that, in many cases, the COLP and COFA will be one and the same individual. But, whether one or two people, they must be of sufficient seniority and in a position of sufficient responsibility. It is also equally clear that both will need to satisfy the Suitability Test—and will also be subject to continuing training.

We have developed the Suitability Test to be robust and effective. It is based on—and has modernised—the SRA's current character and suitability criteria. The test covers a range of factors such as

• criminal offences,
• non-disclosure of information,
• inappropriate behaviour,
• financial behaviour, and
• regulatory findings.

It will apply not only to students, trainees and those seeking admission to the profession but also, crucially, to a range of individuals and corporate bodies that need to satisfy the SRA of their suitability. For example:

• managers, that is, all partners in a partnership, members of an LLP and directors of a company and members of the governing body;
• owners of a firm who have or propose to acquire a material interest of 10 per cent or more, either on their own account or cumulatively,
• COLPs/COFAs.

Approval will be required at the stage of initial licensing and where there are changes in ongoing businesses.

The approval of the key players in an ABS is a major a step in assessing the fitness of a firm to be licensed. We want to ensure that we only license ABSs that are fit and appropriate to provide services to the public. Likewise, we want to ensure that those firms that are not fit to be licensed fall at the first hurdle.

One of the biggest challenges the regulatory regime for ABSs has to grapple with is the issue of external ownership—and all that that brings with it.

We've asked ourselves whether there is an inherent conflict of interest in, say, a bank or an insurance company owning a law firm. How comfortable would clients be buying legal services from firms owned by someone they knew may have an adverse interest? And what about the ABS owned 100 per cent by a claims management company? To what extent can we look to the activity of the proposed owner to decide if they are suitable?

ABSs need to have systems and controls in place to identify their own conflicts of interest, including those conflicts that can arise as a result of commercial relationships. As such, the employees, managers and the ABS—all of whom are subject to the Code and the Principles—would not be able act for the client in such a case.

For our part, we will carry out the appropriate checks on the suitability of a manager at the time of their application to be a manager of an ABS and will ensure that the manager continues to meet the criteria for approval.

We may refuse an application for authorisation as an ABS for a number of reasons, including

• that we are not satisfied that the managers/interest-holders are suitable as a group to operate or control a business providing regulated legal services,
• that the management or governance arrangements are inadequate to safeguard the regulatory objectives,
• that we do not believe that the ABS will comply with the regulatory arrangements.

We also have wide powers to require information in support of an application and may refuse an application if any such information is inaccurate or misleading or any material change has not been notified.

We will take into account relevant information regarding a manager, employee or "interest-holder". This will include information regarding any persons they are related to, affiliated with, or act together with, where the SRA has reason to believe that person may have an influence over the way in which they will exercise their role.

If there is a concern that 100 per cent ownership is too high, provided there is evidence for this, we could refuse the licence application. In doing so, we might of course go back to the applicant firm and explain that we might look at this differently were the ownership by the company to be limited to less than 100 per cent. We could also refuse approval of a 100 per cent owner on that basis. We might, in such a situation, indicate that the combination of the type of owner and the extent of ownership is the stumbling block, and that, if it is removed, authorisation may follow.

In addition, we can use our Authorisation Rules to impose licence conditions to restrict the firm or manager, employee or interest holder from acting in certain circumstances, and to manage the risks of any conflict of interest. We may chose to do this on application for a licence or at any other time. In the example of the claims management company I gave a moment ago, we could do this by limiting the firm's use of the claims management company owner's services in clients' matters. —or by imposing extra checks and balances due to the referral to the firm of clients from the claims management company owner.

We may revoke or suspend authorisation where it was granted on false or misleading information or the body has failed to provide information requested, the body is ineligible for authorisation, the managers and interest holders are no longer suitable as a group to operate or control the business or for any other reason in the public interest. This would allow us to respond to evidence of an unsuitable association.

Lawyers must always be perfectly clear that external investment must never be allowed to influence their professional judgement. The interests of clients, whoever they are, must always be above those of shareholders, owners and investors. If potential owners and investors struggle with this concept, then I would suggest they may be better off saving their money.

There are those who regard the introduction of ABSs as, at best, a challenge and, at worst, a threat. But I do hope the majority of our profession will welcome ABSs for the opportunities they offer. I would like to encourage you all to begin to consider how you will respond to the ABS challenges and opportunities. There is, after all, nothing wrong with being prepared! But, in doing so, I also sound a warning; this is not the green light to begin setting up ABSs left, right and centre. We are very clear about guarding against the establishment of pre-emptive ABSs until the consumer safeguards that the Act provides are in place—which will not occur until 6 October 2011. The Act rightly combines economic liberalisation with regulatory safeguards. I hope we are all agreed that innovation and competition should not be at the expense of professional standards—nor need they be.

To help you navigate the ABS minefield—and, in particular, the thorny issue of conditional contracts—we will soon be publishing further guidance on what is and is not allowed before 6 October 2011. It is our intention to have this guidance published by the end of the year. When it arrives, I would encourage you all to read it.

Our timetable is demanding; but we are firmly on course and have no intention of being diverted from our end goal. We know not everyone shares our drive. There are some who would rather drag their heels—thoroughly debating every nuance and teasing out every problem.

For our part, we will continue to engage in intensive work to ensure we are ready for the new regulatory regime. We are committed to ensuring the first ABS licences can come into effect on 6 October 2011—and that we are ready to regulate them.