We have sent a letter to all FSA-authorised professional firms (APFs) to alert them to a client protection issue, should they decide to convert to an alternative business structure (ABS). The letter explains the issue and what APFs are expected to do in response.
After the introduction of ABS, if there are no changes to the Financial Services Authority (FSA)'s regime, firms will be able to conduct financial services in one of three ways:
under the exemption contained in Part XX of the Financial Services and Markets Act (FSMA) – in this case firms would be authorised by the SRA, subject to the SRA's Handbook, and not authorised by the FSA;
as an APF authorised by the SRA to provide legal services and by the FSA in respect of financial services activities, and subject to carve-outs from the FSA's regime under the FSA's rules;
as a firm authorised by both the FSA and SRA that does not fall within the definition of an APF.
Recognised bodies will be able to conduct financial services in ways (a) and (b); whereas, by virtue of their structure, ABSs will be able to do so in any of ways (a), (b) and (c).
The carve-outs from the FSA's regime for authorised professional firms cover such matters as: compensation arrangements (APFs do not contribute to the Financial Services Compensation Scheme); client money (APFs are exempt from many of the FSA's Client Assets Rules) and professional indemnity insurance.
Application of the SRA and FSA regimes to ABSs
Our regulatory jurisdiction in relation to ABS, under the Legal Services Act (LSA), extends to reserved legal activities, other legal activities and any activities which are subject to conditions imposed on the licence of the ABS.
What this means is that the SRA Accounts Rules, SRA Indemnity Insurance Rules and SRA Compensation Fund Rules will not apply to the financial services regulated activities of an FSA-authorised ABS, since the SRA will neither be authorising nor regulating these activities as they will not fall within our jurisdiction.
This clearly exposes clients of such firms to the risk that, as an example, they will be protected by neither the SRA's Compensation Fund nor the Financial Services Compensation Scheme in relation to such financial services regulated activities.
We have brought this matter to the attention of the FSA and are in urgent dialogue with them as to how clients can be properly protected in relation to those activities authorised by the FSA.
If you are intending to switch status and wish to apply for authorisation as an ABS, you will need to ensure that
- should you switch, you make your clients aware of the lack of protection from the SRA's Compensation Fund and professional indemnity insurance provisions; and
- you review your operations to take account of the application of our rules for ABSs. For example, you will need to segregate client money derived from your financial services activities from client money as defined in the SRA Accounts Rules.
If you apply to switch, we will be asking you questions about how you have addressed these issues.
Application of the SRA and FSA regimes to traditional law firms
As we explain in our policy statement in response to our October consultation paper, we also believe that the time is right to review the APF regime as a whole from the perspective of what might be a sensible approach to regulatory coverage, particularly bearing in mind the development of the financial services market over the last decade and the impending changes to the legal services market. We do not believe that it is appropriate for an important sub-set of the SRA's rules to continue to apply to APF recognised bodies and sole practitioners, when the activity is clearly authorised by the FSA. It means, for example, that the Compensation Fund is exposed to activity that the SRA does not authorise.
We are also in discussion with the FSA regarding this matter. Depending on the outcome of these discussions, we expect to undertake a further consultation in the near future.
More information from the FSA