Closed Consultation

Consultation discussion paper

The introduction of an eligibility criteria: Compensation Arrangements Review

Who should be eligible to benefit from the SRA' compensation fund?

Summary of our proposal

1. We have considered if our compensation arrangements should be open to all consumers, or whether we should, for example, mirror the arrangements adopted by the Legal Ombudsman and industry standards adopted by the Financial Conduct Authority in their management of the Financial Services Compensation Scheme who have restricted their protection to individuals and small entities. Given the differential capacities of consumers to protect themselves, we have concluded that we should make the change in order to focus the fund on those who require regulatory support.
2. In this Consultation Paper we propose that the SRA Compensation Fund Rules 2011 are amended to limit eligibility to claim on the Compensation Fund to:
   • individuals;
   • a micro-enterprise - this would be a business with a turnover not exceeding £2 million;
   • a charity with annual income less than £2 million; and
   • a trustee of a trust with a net asset value less than £2 million.
3. The chief impact of the misuse and misappropriation of client money is upon those clients whose money has been misused, although such activities can also harm public confidence in the legal market and solicitors. This can crystallise as an actual loss of money, requiring remedy from the Compensation Fund. Putting in place an eligibility criteria is a key step in ensuring that consumers of legal services are protected.
4. Mr Justice Lawrence Collins in the case of Re Ahmed & Co (a firm) and others [2006] EWHC 480 (Ch) commented that "...Applicants do not have a right to compensation which they are entitled to enforce; all they have is a right to seek a favourable exercise of discretion...".
5. The eligibility criteria will therefore provide a framework for how we will manage claims on the Fund and will inform good practice in the long term. The criteria will underpin our decisions and our process. We are keen to ensure that we get the eligibility criteria right both legally and to ensure that consumers continue to be protected.

Why does the SRA need to make compensation arrangements?

6. The SRA's Compensation Fund has been in existence for over seventy years providing cover for solicitors' mishandling of client money.
7. The Solicitors Act 1974 (SA 1974) and the Legal Services Act 2007 (LSA 2007) both set out provisions relating to compensation arrangements.
8. The SRA's policy recommendations must therefore be accompanied by an assessment of whether they fall within the provisions of the SA 1974 and are appropriate to satisfy the requirements set out in the LSA 2007. The challenge is to identify and implement compensation arrangements which have regard to our statutory obligations, regulatory objectives, and the principles of better regulation. We will conduct an impact analysis as part of reaching any final decision post consultation.
9. The background to the SRA's review is set out below and we have recently published key documents following research into our current arrangements, arrangements which exist in other jurisdictions and an analysis of firms generating claims. View the key documents.

Who should be able to claim on the fund?

10. At present there is no restriction on who can apply for and be paid a grant out of the Fund. Anyone can make an application free of charge. They do not have to be the clients of the closed firm. A claim can be made by an individual consumer, company, charity or other entity and irrespective of the wealth and means of the applicant.
11. The highest claims by value relate to monies which have been misappropriated in a conveyancing transaction or probate matter.
12. An applicant who can show that he or she has suffered loss as a result of failure to account for money is deemed to have suffered hardship if he or she is an individual whose dealings with the defaulting practitioner have been in a personal capacity. If the applicant's dealings with the defaulting practitioner have been in a business capacity then they must provide evidence to show that the body or individual has suffered or is likely to suffer hardship.
13. If the applicant has suffered loss because of the defaulting practitioner's dishonesty there is no 'hardship test ' to satisfy.
14. The SRA's Compensation Fund is generally a fund of last resort. The Fund provides a safety net for those affected by authorised individuals or firms who have misappropriated or failed to account for money in the course of practice. The Fund can also make grants in respect of the civil liability of the defaulting practitioner where the authorised individual/firm has failed to take out qualifying insurance.
15. There are clear advantages to clients and consumers in being able to claim from a compensation fund for financial loss arising from misuse or misappropriation of client money. However, entities regulated by the SRA serve a wide range of clients, from individual consumers to large financial institutions and government agencies. These consumers are not all empowered to the same extent in their choice of service provider. Nor do they possess the same amount of knowledge and confidence to engage with a firm to put things right if they are unhappy with an aspect of the service received. Some are more able to protect themselves than others, for example by insuring themselves against such losses, or demanding that solicitors take additional steps to protect client money, for example by holding it in an escrow account. Large commercial service users are better able to protect their interests and make a commercial decision on the use of legal services and the risks involved.

16. This issue is linked to the ethos of the SRA's compensation arrangements. If contributions are an obligation of membership, this lends itself to the idea that as a group, regulated entities may choose to support only those consumers who are most in need (or most 'deserving'), irrespective of their own client base. In contrast, if the Fund is underpinned by notions of mutual benefit, all firms (including those with a predominantly business client base) can expect to see a commercial advantage to their firm from contributing to the Fund, which would make it difficult to exclude certain classes of consumer from the protection regime.

    Our research into why the Compensation Fund was established, however, supports the concept that the Fund should predominantly provide for private individuals and small businesses as they had the lowest levels of experience and expertise in dealing with legal services providers out of all claimants. They were also least able to bear a financial loss if a firm could not replenish funds that had been misappropriated.

17. Section 36 (2) of the Solicitors Act 1974 makes provision for rules to be made which set out the circumstances in which grants may and may not be made from the Fund. The SRA must have regard to the differing degrees of experience and expertise of consumers when securing the appropriate degree of protection for them. The information collected (and published on the SRA's website) about the purpose of the SRA's Compensation Fund and the comparative of other jurisdictions highlighted that, in this context, this means that compensation cover should principally be directed toward those consumers who are least able to sustain a financial loss, namely private individuals and small businesses.

10. Given the differential capacities of consumers to protect themselves, the SRA proposes to amend the definition of 'Applicant' in the SRA Handbook Glossary 2011.

    Current definition: 'Applicant' means a person or persons applying for a grant out of the Compensation Fund under Rule 3 of the SRA Compensation Fund Rules.

    Proposed definition: "For the purposes of applying for a grant out of the Compensation Fund under Rule 3 of the SRA Compensation Fund Rules 'Applicant' means:

    • individuals;
    • a micro-enterprise - a business with a turnover not exceeding £2 million;
    • a charity with annual income less than £2 million; and
    • a trustee of a trust with a net asset value less than £2 million."

10. With the evolution of legal services, increased competition amongst providers of services and the changing needs of consumers, we do not consider that it is effective or efficient for the Compensation Fund to be open to all consumers. It is therefore, appropriate for the SRA to restrict protection to individuals and small entities. It is acknowledged that larger and corporate organisations will be affected by proposed criteria. However, based on the fact that the payment from the Compensation Fund is wholly at the discretion of the SRA, the majority of claims made by the larger and commercial organisations tend to be rejected on grounds that the Applicant appears to have other avenues of redress available or has contributed to its loss.
11. In response to this consultation it is important that we consider the views of all impacted by the proposed change. Respondents may therefore want to consider as part of their response:
    • Who has been protected to date?
    • Who else might be covered?
    • Will it be acceptable for some or all clients not to be protected?
    • If not, how should protection for consumers be delivered?
    • Should the scope of claims covered by the fund be extended?
    • Will this impact on the relationship the SRA has with the Legal Ombudsman, particularly if some types of clients can claim on the Fund but have no right of redress to the Ombudsman?

Impact of our proposal

12. We have considered if this proposal is likely to have a disproportionate impact on vulnerable consumers, BME consumers or any other group. At this stage we do not have any serious concerns about the impact of the proposal having a negative effect on the most vulnerable consumers though we do not have quantative evidence with which to make this analysis. We do believe that corporate institutions are able to protect themselves as they do not suffer from significant information asymmetry when engaging the services of legal service providers. An impact assessment will, however, be completed as a part of the review and we are particularly interested in any views, evidence or analysis that will support that impact assessment.
13. The proposals set out in this consultation paper primarily advance our objective of protecting and promoting the interest of consumers by having in place appropriate compensation arrangements. We consider the proposals are compatible with our strategic objective of ensuring that the relevant markets function well. By clarifying the definition of 'applicant' in the glossary of our handbook, we will set out the categories of persons eligible to make a claim on the Compensation Fund.
14. In discharging its regulatory responsibilities, the SRA operates within a statutory framework for regulation provided by the SA 1974, the Administration of Justice Act 1985 and the LSA 2007. The statutory framework provides that the SRA must have regard to, and act in a way that is compatible with, our regulatory objectives. These regulatory objectives can only be achieved if we and our regulated community work together in a spirit of mutual trust for the benefit of clients and the ultimate public interest.
15. We have considered this proposal in line with our regulatory objectives and consider that the introduction of an eligibility criteria will ensure that the interests of those consumers who need support through our regulatory arrangements are adequately protected. Consumers of legal services are entitled to expect a good quality service from those providers they instruct, and they should be able to have confidence that if something does go wrong that there is in place a source of financial redress. The aim of the proposal is to provide those consumers needing support with the assurance and confidence that client financial protection arrangements remain in place.
16. Furthermore, it is anticipated that the proposal will promote competition in the provision of legal services in that providers will look to effective and efficient ways of marketing their businesses and holding client money. Firms advising a consumer will be under an obligation to provide information to their client about the regulation of legal services and what protections are available to them.
17. We believe that limiting eligibility to individuals, small enterprises, charities and trusts will ensure the operation of an efficient and effective Compensation Fund. It is anticipated that the proposal will result in reduced operation costs of managing the Compensation Fund and this reduction is likely to be reflected in future contributions firms make. We will also continue to monitor the criteria to ensure that we achieve the right balance.

Timescales and next steps

18. One of the key challenges in exploring alternatives to the Compensation Fund will be identifying how the complementary aspects of the SRA's client protection regime could be provided or supported by alternative means, and whether an alternative would be sufficiently flexible to give the SRA confidence in the efficacy of its arrangements for consumers.
19. The identification of the optimal compensation arrangements for the future provides regulators, the regulated community and other stakeholders with the opportunity to look at what it means to be regulated by the SRA.
    • What are the benefits and obligations of our regulatory regime?
    • What competitive advantages does it bring to those we regulate?
20. Ultimately, this should form part of the SRA's vision of being the leading regulator of legal services, recognised for the outcomes we achieve in the public interest and the way in which we achieve them.
21. This consultation paper therefore forms part of the first phase of changes to the SRA's compensation arrangements.
22. We welcome comments in respect to all or some of the issues discussed. We also welcome suggestions of other issues which need to be considered in order to develop an authoritative set of policy recommendations for consultation with stakeholders, leading to the identification of a compensation regime which:
    • is in accordance with regulatory principles;
    • meets the SRA's regulatory objectives; and
    • stands the test of time.