Risk-based regulation

Introduction

The public has a right to expect us to focus our resources on the solicitors and firms that are most likely to harm their interests as consumers of legal services, and to act promptly and effectively when risks are identified.

Solicitors are entitled to expect their regulator to operate in a proportionate manner, concentrating upon the issues that matter most and not wasting money on work that is inconsequential. Good solicitors appreciate that effective regulation helps to safeguard public confidence in their profession and in the administration of justice.

These complementary expectations are recognised in our strategy, which commits us to "adopt a risk-based approach to regulation". Here, we outline the method we use to assess risk in individual cases.

We accumulate a huge amount of information about solicitors in our daily work. It comes from a wide range of sources, including our own dealings with firms themselves, clients, media review and from other solicitors.

For some years, we have been assessing this intelligence to decide when to mount investigations and the priority that should be attached to each, and which firms should receive advisory visits.

Recently, we have been refining how we classify risk and use the information we receive more consistently, so we can focus our resources more efficiently. This refinement is a continuing process: we learn as we go along. Inevitably, because of the diversity of solicitors' work, it is a complex process. Throughout assessment of risk and deployment of resources, we will be objective, fair and non-discriminatory. Our adherence to process and aims can and will be audited.

By being open about our methods, we wish to encourage ethical behaviour by the profession.

Risk assessment

Allegations of misconduct received by the SRA are now assessed in one unit by applying a consistent classification and scoring mechanism in order to

• understand the relative seriousness of each allegation in terms of direct impact on the public,
• understand the credibility of the evidence and likelihood of the alleged misconduct being repeated,
• clearly and unambiguously express that understanding in a manner that is understood and accepted by our different units,
• help prioritise the regulatory response, ensuring that it is proportionate to the risk,
• provide a common way of describing what we do. This will improve reporting and communications across the SRA and to the profession and other stakeholders.

Process outline

In essence, the process consists of

• an initial assessment of the adequacy of the evidence received and/or its source,
• the scoring of incoming information against over 200 types of risk, assessing the objective risk to the public and the subjective behaviour of the solicitor, leading to an overall regulatory risk score (based on regulatory history and other relevant risk indicators) which reflects impact and probability of the alleged misconduct,
• a recording mechanism allowing analysis of results,
• a set of rules which determine what response to the risk, if any, is required, (These rules will reflect the current "risk tolerance" of the SRA Board.)
• a designation and allocation system to ensure the right resource and priorities are applied.

Process – step by step

The assessment assigns a risk scoring category to an allegation or an issue that is received by the SRA as an item of information or intelligence. These categories are organised by reference to the Code of Conduct, and each category carries with it a score from 1 to 10. The scores indicate the relative seriousness with which the participating units view the category, 1 being the lowest.

Objective impact scores are given values from 2 to 10 and are designed to be considered from one or several standpoints, depending on which is most relevant at the time:

• the extent of the impact and who it may have affected or be affecting, e.g. an isolated incident, or part of a systematic pattern,
• the number of people affected,
• the financial implications.

A subjective test is applied in an attempt to ascertain the intent of those who may have breached the rules. This can be difficult and may be classed as "unknown", given the limited information to hand. However, the subjective categories range from "inadvertent" to "deliberate/dishonest", with the subjective impact scores weighted accordingly, again on a range of 2 to 10.

The product of category score x objective score x subjective score is the risk score.

At this point, regulatory history and other background information is considered (see table of regulatory history scores). This may increase the total risk rating score—for example, if there are a number of related and recent matters. The final risk score is then used to categorise the allegation or information into bands of "low", "medium" or "high" risk. Subsequent operational action, whether on-site investigation or desk-based casework, can then be prioritised accordingly.

The risk assessment process is shown below in simple visual terms.

Figure – Risk assessment process for individual cases

This is the framework which the SRA is using so that staff can apply a consistent, proportionate and transparent approach as they identify and react to risk. Current scoring categories are given in the tables below. We will be continually refining them in the light of experience.

However, it is only a framework. There will be circumstances in which a different approach will be necessary. Two examples of such situations follow:

• The risk is immediate and obvious, and we need to bypass the formal process.
• The risk assessed by highly experienced staff is strongly at variance with the risk score. This might be due to particular circumstances relating to the information received, or imperfections in the scoring mechanism itself. In those exceptional cases, experience and judgement will override the risk score. This will be clearly recorded so that lessons can be learned.

Risk assessments will not be disclosed in individual cases. There are a number of reasons for this: it may be necessary to protect the source of information; the assessment will usually be carried out before an investigation starts, and we know that different concerns often arise once we begin investigating; and the risk assessment is irrelevant to any formal decision as to whether or not a solicitor has been guilty of misconduct.

From time to time, the framework may also be adjusted to reflect thematic concerns of the SRA Board or other stakeholders. It will also need to take account of the SRA's overall tolerance of risk.

Finally, the initial assessment of incoming information, important though it is to ensure we are consistent and proportionate, is only one element in the overall risk-based approach across the SRA. Systemic risk is assessed on the basis of information about particular problems—such as the prevalence of mortgage fraud—or market conditions.

Table 1 – Risk scoring category examples

For a comprehensive table of risk scoring categories, please email report@sra.org.uk.

Table 2 – Objective impact scores

Table 3 – Subjective impact scores

Table 4 – Regulatory history scores

Identified compliance risks

Solicitors are crucial to our efforts to identify and minimise risks to the interests of clients, to maintain professional standards and to safeguard confidence in the profession. We concentrate on the issues likely to pose the greatest risks: solicitors and those responsible for firms' regulatory compliance are often the first to identify them. The purpose of this report is to help you to be alert to issues that might cause problems, by describing the most significant regulatory risks we have encountered in the recent past.

Many of the risks, particularly misuse of client money and probate fraud, are longstanding. Nevertheless, the loss, upset and damage to public confidence in solicitors when things go wrong can be substantial.

We know that the vast majority of solicitors act honestly and responsibly. Although this paper identifies various risks, it is not evidence that overall standards in the profession are either poor or deteriorating. Indeed, the SRA is encouraged by the numbers of solicitors who strive to observe high ethical standards and to provide their clients with an excellent service.

Our concern is to drive out the small minority who are dishonest or incompetent and generally to raise standards.

We investigate firms primarily on the basis of intelligence and are developing a targeted investigative strategy. The risks are grouped under these headings:

• Financial issues
• Legal competence
• Efficiency, management and administrative competence

Examples are given to aid understanding of the risks and the steps necessary to minimise them.

We plan to revise this report periodically and would be glad to receive suggestions for improvement.

Peter Williamson
Chair, Solicitors Regulation Authority

11 February 2008

Financial issues

Misuse of client money

In the context of a profession with over 110,000 practitioners, a tiny but persistent number of solicitors steal or misuse clients' money. This can cause serious problems for partners as well as to clients and the profession generally, because indemnity insurers may not provide cover, particularly if money has been transferred to office account and all partners have benefited through their drawings.

Some solicitors have misused client funds because they felt under pressure to meet billing or fee collection targets. Firms with strong target-driven cultures need to avoid putting too much pressure on their staff and their partners, which might also lead to pressure to overcharge.

Secret profits

Clients' money is also at risk from solicitors who take even small amounts of secret profit. When solicitors charge for "disbursements" they can recover only what they have paid out for the client. Some solicitors add a mark-up, but still describe the full figure as a disbursement.

This often happens with telegraphic transfer fees and searches in conveyancing transactions. There is no doubt that it is unacceptable to describe a charge as a disbursement when it is not and particularly when some of it is kept by the solicitor.

Another way of taking a secret profit is to charge clients for a disbursement paid to a company providing searches for conveyancing transactions, the solicitors receiving just under £20 from the firm for each search. The solicitors may argue that this is "commission" because small amounts of commission (less than £20) do not have to be paid to clients, but this is not a genuine commission arrangement and is an improper way for a solicitor to take clients' money indirectly.

Arrangements like this are seen in various contexts. The amounts can be bigger. In personal injury cases, clients sign standard terms which say that the solicitors can keep £200 commission from insurance companies. The clients are often not told that this money belongs to them and there is no reason why the solicitor should keep it.

The Fraud Act 2006 criminalises the taking of secret profits. A solicitor who "dishonestly fails to disclose to another person information which he is under a legal duty to disclose" with a view to making a gain will be guilty of fraud, because solicitors are required to tell clients about money they receive when acting for them.

Impropriety in dealing with probate

Theft and serious overcharging by solicitors acting in a representative capacity such as executor of an estate (but also under powers of attorney) continue to pose a high risk.

The numbers of reports to the SRA of possible irregularity in probate cases increased from 6 in 2004 to 31 in 2005, 52 in 2006 and 65 in 2007. This problem is particularly insidious because it can take place over many years without detection. Beneficiaries, especially charities, are unaware that their money has been stolen. Sometimes solicitors or their employees take a long-term view by drafting wills to enable them to steal money from estates in later years.

Persistently, there are cases of unfair advantage being taken of elderly clients. Danger signs to watch out for include:

• delay in finishing the administration of an estate;
• delay in paying beneficiaries, especially charities;
• apparently substantial overcharging, particularly if it is part of a pattern;
• a practitioner spending noticeably excessive time with an elderly client, particularly if the time is being billed.

Failure to take required steps to prevent money laundering

Many solicitors are still not doing enough to prevent money launderers from transferring the proceeds of crime anonymously through client accounts.

Whether principals realise it or not, client accounts are being abused—sometimes on a massive scale.

There have been several previous cases, with solicitors being imprisoned for up to seven years.

A solicitor should not allow his client account to be used where there is no underlying transaction, except where he is certain that he is holding and disbursing money on behalf of a client for a proper purpose. It is not a proper part of a solicitor's job to operate a banking facility for third parties, whether or not they are clients.

Legal competence

Failure to protect mortgage lender clients

Mortgage fraud is increasing. Reports of suspected mortgage fraud to the SRA Fraud Intelligence Unit rose from 85 in 2005 to 215 in 2006, 320 in 2007 and 350 in 2008. Some solicitors are failing to warn lenders about suspicious features of transactions.

In the early 1990s, the solicitors' profession was at the centre of the massive losses caused by mortgage fraud. This led to the highest-ever grants from the Compensation Fund: £29 million in one year. It is vital that this does not re-occur. The SRA is acutely aware of the threat of mortgage fraud and will continue to discipline solicitors who take improper risks. We may need to take particularly strong regulatory action as a warning to those who are tempted to get involved. We will continue to share information with lenders when it is right to do so.

The facilitation of mortgage frauds by solicitors can be due to incompetence rather than dishonesty. A conveyancing solicitor's obligations to a lender client are clearly set out in the Lenders' Handbook and in rule 3 of the Code of Conduct.

There are signs that the misleading of mortgage lenders is increasing again. Some solicitors are failing to tell lenders that

• the price paid is actually less than what has been reported,
• buyers are not providing the balance of the price from their own resources,
• the loan is for more than the price paid—and often the "profit" is paid to people with no apparent connection to the transaction,
• the property has been sold in the previous few months, usually for a much lower price than is now being paid.

The secret discounting of sale prices on new-build properties causes concern, particularly because the gross sale price before discount is then registered with HM Land Registry. This could skew national figures for property values. Such discounting appears to be becoming endemic.

The Council of Mortgage Lenders has warned: "[T]he valuation and price paid for new-build properties, especially flats, may not be transparent because of sales incentives offered by the developer. Typical examples are discounted purchase prices, cash backs pre- or post-completion, and marketing allowances. If the incentives are not clear and taken account of in the valuation, then the lender may not be lending on the true value of the property."

There is a danger of a spiralling effect. Inflated registered purchase prices may be relied upon to value other properties nearby. A big downturn in the property market, or any distortion of this nature, could make for a very hard landing.

Some say that the obtaining of mortgages by misleading a lender is really a commercial matter. We do not accept that, because the involvement of solicitors in misleading lenders is a serious risk to the public:

• If a solicitor's integrity is compromised by involvement in a dishonest, or even a dubious transaction, we must take action because solicitors must be entirely trustworthy;
• Claims by lenders against indemnity insurance or the Compensation Fund affect consumers because the costs are passed on by higher fees;
• Consumers can suffer directly from the improper obtaining of mortgages:
  • dubious brokers might charge them unnecessary fees;
  • they are unable to pay their mortgage which, usually because of the broker, has been obtained at too high a level for them;
  • sometimes they find that the property they have bought is in poor condition and worth less than they paid for it—particularly if the broker is associated with the seller;
  • they feel unable to take action to help themselves because they are warned that they are implicated in wrongdoing—often because the broker uses this as pressure upon them.

Poor conduct of personal injury or housing disrepair claims

Clients are at risk from a small hard core of practitioners incompetently trying to conduct personal injury or housing disrepair claims.

We see cases in which solicitors

• fail to identify the need to appoint a litigation friend;
• fail to update medical reports, despite recommendations to do so by experts;
• simply send medical reports and offers to settle to clients without offering any advice;
• settle cases prematurely, often without waiting for injuries to settle down;
• fail to comply with court orders, resulting in their clients' cases being struck out.

It is not in the best interests of clients to try to pursue unmeritorious claims. It causes inconvenience and exposes them to the risk of costs. It puts defendants, particularly in the public sector, to unnecessary expense. Public confidence in the profession and in the administration of justice is damaged.

One firm of solicitors was referred to the Solicitors Disciplinary Tribunal (SDT) after a complaint from a local authority following the striking out of over 50 housing disrepair cases. The firm also faced wasted costs orders in these and other cases. In another SDT case, approximately 40 per cent of claims were found to have been cancelled by clients, often by telephone. It is worth remembering that the low claim success rate of The Accident Group—less than 30 per cent—was a key factor in its collapse with debts of more than £100 million.

Efficiency, management and administrative competence

Significant risk to clients is caused by inefficient management of solicitors' practices. We are concerned by failures to comply with basic regulatory requirements, to implement effective anti-money laundering procedures and to identify conflicts of interest.

Failure to comply with basic regulatory requirements

Some solicitors prioritise clients' cases so much that they overlook their own regulatory obligations and get into serious difficulty.

Poor regulatory compliance can affect clients. For example, clients whose solicitors act in litigation without a practising certificate cannot recover their costs from the other side.

Failure to supervise staff is a perennial problem for clients and partners. Not only can it give rise to an allegation of failure to supervise, but principals are themselves directly responsible for professional misconduct in their firm. At one extreme, a secretary noticed dormant balances in client account printouts and requisitioned cheques supposedly to pay counsel's fees. The money was in fact being stolen.

Employing a struck off solicitor without the permission of the SRA is a particularly serious regulatory breach. Struck off or suspended solicitors represent an obvious risk to the public.

There is a continual flow of cases in which practitioners fail to comply with several of their regulatory obligations. Solicitors, either through incompetence or desperation, fail to arrange indemnity insurance. Consequently, any claims they generate fall on the profession through increased premiums. Clients are also severely inconvenienced, because they cannot identify the solicitor's insurer when they need to make a claim. Similarly, some solicitors fail to renew their practising certificates but continue to see clients and conduct cases, without having paid their practising certificate fee or Compensation Fund contribution.

The SDT can take a strong line in such cases and suspend the solicitor until professional obligations have been complied with. In one case, the SDT suspended the solicitor for failing to pay an insurance deductible of £1,500. In another, the solicitor was suspended unless he complied with SRA adjudications within 28 days.

Solicitors who fail to supervise their practices properly are likely to face disciplinary action. The inconvenience and upset to clients can be enormous.

Anti-money laundering compliance

Compliance with the money laundering rules and regulations is not only a financial issue, but also one related to the way the firm is managed and administered.

Solicitors risk criminal prosecution and disciplinary action if their procedures are not fit for purpose. Systems must be robust and practitioners need to be vigilant.

Rule 5 of the Code of Conduct requires solicitors to "make arrangements for the effective management of the firm as whole, and in particular provide for compliance with the Money Laundering Regulations, where applicable".

But many do not comply. About 88 per cent of firms visited by the SRA Practice Standards Unit in 2005 carried out "relevant financial business" within the meaning of the Money Laundering Regulations 2003. However, only about 40 per cent had implemented systems to carry out consistent client identity checks on relevant matters. There was evidence of systematic breach of the regulations in about 11 per cent of firms and of occasional breach in a much higher number.

This is probably a managerial failure, but one which carries substantial risk of harm to the public and the profession.

Conflict of interest

Conflicts of interest can be insidious and invisible to clients. Solicitors who act for clients where there is a conflict breach their fundamental duty of undivided loyalty.

Some solicitors fail to see the obvious. One reason for this is evident from the following SDT findings:

Companies which offer to buy the homes of people who are in financial difficulty may direct distressed sellers towards a recommended solicitor. This raises serious questions about whether the sellers receive truly independent advice.

Even City firms can fail properly to identify conflicts. This was shown when the High Court granted an injunction preventing one from acting in a proposed takeover of Marks & Spencer. The responsible partner was fined £9,000 with £50,000 costs by the SDT in August 2007.

Solicitors' relationships with introducers can sometimes blind them to conflicts between their own and their clients' interests.

Clients can be at risk because firms often fail to ensure that their arrangements with introducers are properly documented and monitored. Many of the most serious problems with referral arrangements are caused by the introducer rather than the solicitor. Solicitors need to protect their clients competently by ensuring that the introducer is acting properly and lawfully. A starting point is to ensure that introducers are registered with the Claims Management Regulator.

Delay

Delay remains a common problem. It causes inconvenience, upset and sometimes loss to clients.

Serious delay on its own can lead to disciplinary action. It can also trigger panic and a slide into dishonesty. Personal injury solicitors who lie to their clients about the progress of their cases or worse, falsely say the case has been won and pay the "damages" from client account, will probably be struck off. Firms must create a culture in which fee earners can admit to mistakes so that loss, inconvenience and serious distress to clients and inexperienced practitioners can be minimised.

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