Closed Consultation

Introduction

• 1.

  This consultation paper seeks views on two issues that relate to the SRA's treatment of Authorised Professional Firms (APFs).

• 2.

  These issues are described in more detail below. They relate to inconsistencies in the regulation of APFs arising from the introduction of alternative business structures (ABSs).

• 3.

  The consultation sets out the following:

  • a)

    the background and a summary of the issues,

  • b)

    a discussion of the various options,

  • c)

    an initial analysis of the potential impact of possible changes.

  The SRA seeks views on the options and the potential impact of the changes.

Background

• 4.

  Under the Financial Services and Markets Act 2000 (FSMA) no one in the United Kingdom can carry on financial services activities (known as regulated activities) unless they are authorised by the FSA or they are exempt.

• 5.

  The majority of law firms are able to rely on an exemption in Part XX of FSMA. These are described as exempt professional firms and are able to carry on those activities known as exempt regulated activities. Exempt professional firms are not regulated by the FSA. They comply with the SRA Financial Services (Scope) Rules 2001 in the Specialist Services section of the SRA Handbook.

• 6.

  A small number of law firms—currently 64—provide mainstream financial services to their clients. These law firms are known as authorised professional firms (APFs). APFs are authorised by the FSA to conduct these activities but they are partially regulated in the conduct of the activities by the SRA.

• 7.

  Because they are dually regulated, these APFs are entitled to some carve-outs from compliance with the FSA Handbook of rules and regulations. Significant aspects of this carve-out include:

  • a)

    compensation arrangements—APFs do not contribute to the Financial Services Compensation Scheme and comply with the SRA Compensation Fund Rules;

  • b)

    rules on holding client money—APFs are exempt from many of the FSA's Client Assets Rules and comply instead with the SRA Accounts Rules 2011;

  • c)

    professional indemnity insurance—APFs are required to have in place indemnity which complies with the SRA Indemnity Insurance Rules (SIIR).

• 8.

  In common with the majority of law firms APFs can also conduct incidental financial services. These are known as exempt regulated activities when undertaken by law firms which are not APFs. When APFs undertake such activities they are described as "Non-mainstream Regulated Activities" (NMRA). When APFs carry out such activities they are required to comply with the SRA Financial Services (Conduct of Business) Rules 2001, in the same way as exempt professional firms, plus a limited number of FSA regulations which are only relevant to authorised firms when they carry out NMRA.

• 9.

  The purpose of this consultation is to seek views of the future treatment of APFs. The issues that have triggered the need for this review are described below, as are three options that the SRA has identified as possible solutions. The SRA invites comments on these issues and the options.

Issues

• 10.

  Two issues have led to the publication of this consultation:

  • the position in respect of SRA-authorised alternative business structures,
  • the position of other APFs regulated by the SRA.
• 11.

  The SRA is a licensing authority for alternative business structures (ABSs). The SRA believes that the scope of its regulation of ABSs should extend only to reserved and non-reserved legal activities and any other activities that are subject to conditions imposed on the ABS licence. The SRA does not intend to licence activities that are not legal services. This position has been made clear since at least 2009. Its basis for this decision reflects its commitment to regulating in the public interest. The SRA does not believe that authorising an entity to provide services in respect of which it has little experience or expertise is in the public interest.

• 12.

  This means that the SRA will not be authorising the mainstream regulated activities of ABSs ("ABS APFs"). These activities will be regulated by the FSA, and such ABSs will need to comply with the FSA Handbook. The SRA will have no oversight role of such activities which will be separate from the SRA-authorised business.

• 13.

  A consequence of this is that ABS APFs will not have the benefit of the carve-out from the FSA Handbook requirements which are currently enjoyed by other APFs regulated by the SRA. The SRA believes that it is not appropriate for one regulator's requirements and protections to cover the risks presented by another regulator's area of coverage.

• 14.

  However, the SRA has been concerned that this would lead to a gap in regulatory protection for customers of such businesses. It has therefore been in discussion with the FSA. The FSA has altered its own regulatory requirements to ensure that the ABS APFs must comply with all pertinent requirements of the FSA Handbook and will not be entitled to rely on the carve-outs granted to other APFs as described in paragraph 7. The FSA's requirements are stated in their policy document PS 11/17 published on their website.

• 15.

  This decision means that there is currently regulatory inconsistency between ABS APFs and other law firms that are SRA-authorised APFs. This is because the latter continue to have the benefit of the carve-outs from the FSA Handbook as they are regulated by the SRA and subject to compliance with the SRA Handbook regulatory requirements.

• 16.

  Although this is a small percentage of the regulated community, this carve-out and the different treatment of ABS APFs and other APFs is inconsistent with SRA strategy that there should be a common approach in regulatory arrangements for all entities authorised and regulated by the SRA.

• 17.

  The SRA also believes that such carve-outs are no longer appropriate in any event. It has the potential to create the position where the SRA Compensation Fund is exposed to risks which are not derived from reserved legal activities or non-reserved legal activities and puts the SRA in a position where it is extending compensatory protection to activities which it does not authorise. The Law Society negotiated this concession in 2001, prior to the establishment of the SRA or the introduction of the Legal Services Act 2007. As such, the SRA does not believe this is now an appropriate or sustainable position to choose to maintain.

Next steps

• 18.

  The SRA has identified three options for the future treatment of APFs:

  • Option 1: to bring ABS APFs into the regulatory model which currently applies to traditional APFs,
  • Option 2: to extend the current ABS approach to all APFs,
  • Option 3: SRA regulation of non-mainstream activities, no SRA regulation of mainstream financial activities, across all firms.

Option 1 – to bring ABS APFs into the regulatory model which currently applies to traditional APFs

• 19.

  Under this option, in a reversal of current SRA policy, the SRA licence for an ABS would enable the ABS to carry on regulated financial activities.

• 20.

  The advantages of this option include:

  • a)

    no changes in regulation for existing traditional law firm APFs,

  • b)

    all APFs, including ABS APFs, will enjoy carve-outs from FSA Handbook.

• 21.

  The disadvantages of this option include:

  • a)

    the regulatory coverage of the SRA will extend to an area of work in which it has little experience or expertise.

  • b)

    this option places the Compensation Fund at higher risk as it will cover the regulated financial activities of ABS APFs.

Option 2 – to extend the current ABS approach to all APFs

• 22.

  Under this option the SRA’s licence of ABSs would not include any right to conduct financial activities under SRA regulation. The SRA would also switch off its rules and regulations in respect of other APFs.

• 23.

  No APF will have the benefit of carve-outs from the FSA Handbook in respect of compensation arrangements, accounts rules and professional indemnity insurance.

• 24.

  All APFs would need to comply with FSA requirements in all respects including those activities which would have been designated non-mainstream activities under any previous SRA regulation.

• 25.

  APFs would need to consider whether they needed to apply to the FSA for a variation of their existing FSA permissions.

• 26.

  The advantages of this option include:

  • a)

    the regulatory coverage of the SRA will be limited to legal activities,

  • b)

    this option limits risk to Compensation Fund as it will cover only legal activities.

• 27.

  The disadvantages of this option include:

  • a)

    no APF will benefit from carve-out from the FSA handbook

  • b)

    difference between APFs and other firms in the regulation of those activities which are designated non-mainstream financial activities under SRA regulation.

Option 3 – SRA regulation of non-mainstream activities, no SRA regulation of mainstream financial activities, across all firms

• 28.

  This option would distinguish mainstream and non-mainstream financial activities.

• 29.

  All APFs would be authorised by the SRA to provide NMRA in compliance with the SRA Financial Services (Conduct of Business) Rules 2001, in the same way as exempt professional firms (plus limited FSA regulations which are only relevant to authorised firms when they carry out NMRA).

• 30.

  The mainstream financial activities of all APFs would be fully regulated by the FSA.

• 31.

  The advantages of this option include:

  • a)

    it enables the SRA to have a common regulatory approach towards all types of law firms which it authorises and regulates,

  • b)

    it does not overly complicate the regulatory approach,

  • c)

    it removes the risks to the Compensation Fund which have been identified by the SRA,

  • d)

    it is a more proportionate response to risk: higher risk mainstream financial services will be ring-fenced, but APFs will be able to conduct less risky non-mainstream activities under SRA regulation in compliance with the SRA Handbook.

• 32.

  The disadvantages of this option include:

  • a)

    SRA will regulate the non-mainstream financial activities of APFs,

  • b)

    no APF will be benefit from carve-out from the FSA handbook.

Risks

• 33.

  The risk identified by the SRA is that allowing SRA-authorised APFs to provide regulated activities as part of the licensing conditions will expose the SRA Compensation Fund to disproportionate claims etc.

• 34.

  It is hard to quantify the level of risk. Because of the type of regulated activities undertaken by FSA authorised providers, combined with the unknown element of new ABSs and the fact that ABS regulation is in its early stages of development, the SRA considers that it is not in the public interest to submit the Compensation Fund to such potential exposure without a greater understanding of this market.

Cost-benefit analysis

• 35.

  An independent report has been prepared by external consultants and is annexed to this consultation.

Initial equality impact assessment

• 36.

  The proposals need to be considered in terms of impact. There are 64 non-ABS law firms that will be affected by the SRA's proposals regardless of which of the options is adopted.

• 37.

  One of the most immediate effects will be seen in respect of those APFs that are legal disciplinary partnerships (LDPs). In future each LDP will need to be licensed as an ABS. The implications of this change for LDPs will depend on the regulatory option adopted by SRA following this consultation. The SRA's records show that a small number of the 64 APFs are in this category. The SRA first notified these firms of the issues in April 2011 and kept them informed of the FSA position in SRA Handbook consultation papers. Transitional provisions in the Legal Services Act mean that LDPs do not have to be licensed until the end of a transitional period—no earlier than April 2013..

• 38.

  An EIA will be undertaken as part of this process and will be published. An initial assessment of these firms shows that the majority of the firms are medium to large in terms of composition. Smaller firms in the group are niche practices by the very nature of the mainstream financial services that they offer their clients. The SRA does not consider that there is a disproportionate adverse equality impact on the 64 firms that are currently APFs.

• 39.

  In terms of consumers of services offered by APFs, the initial conclusion is that there will not be an adverse impact of any equality group because of the changes.

Consultation questions