Don't Bank on it

Within the profession, there is a perceived lack of clarity in respect of the rules surrounding the provision of banking facilities, which can lead to potentially serious ramifications. The Solicitors Regulation Authority (SRA) stresses the importance of compliance in this area in an attempt to reduce the risks of solicitors aiding money laundering, the avoidance of satisfying insolvency obligations, or concealing assets in disputes. In the 12 months preceding August 2018, the SRA prosecuted 20 solicitors and three firms; and issued £763,000 in fines in relation to breaches of the banking facilities rule. In a single case, fines have been as high as £500,000. Although previously prohibited, the 2019 accounts rules have been accompanied by a renewed focus in this area. Rule 3.3 states: “You must not use a client account to provide banking facilities to clients or third parties. Payments into, and transfers or withdrawals from a client account must be in respect of the delivery by you of regulated services.” In our experience, breaches of this rule do not tend to be caused by deliberate action. Instead, in attempting to help your clients, banking facilities may be incidentally deemed to have been provided as an unintended consequence.

HOLDING UNCONNECTED MONIES

There are several SRA examples highlighting common scenarios where you may risk breaching rule 3.3. One of the most discernible ways in which firms could breach it is by holding money on behalf of clients when no regulated service is being provided. This may arise where clients arrive in the UK and seek to open a bank account; or the firm may be asked to hold funds and pay routine outgoings for clients based abroad. Similarly, holding unconnected monies, for example, for the purposes of obtaining a more beneficial interest rate, would give rise to a breach. There is no underlying legal transaction to facilitate legitimately holding funds in the client account here. However, if the same monies are held to satisfy a contract, where payments are released over the term of the contract and the law firm will continue to advise on contractual and payment obligations, then a breach is unlikely to occur. In this instance, the funds are held in relation to the provision of a regulated service, with any incidental interest accounted for appropriately. Fee-earners should monitor situations to ensure that proper justification for holding funds is maintained. Furthermore, it is key for compliance officers for finance and administration (COFAs) to ensure that fee-earners assess the source of all funds to be received and whether they are connected to the provision of a regulated service.

BEYOND COMPLETION

Law firms must also consider whether they are providing banking facilities by retaining funds after completion of a matter. From our experience, this is a key risk area and often where firms breach the rules. A common example, given by the SRA, is holding rent deposits indefinitely. To ensure firms do not fall foul of this, they need to ensure the deposit is connected to the regulated services provided and is returned or paid out promptly upon completion. If deposits are held over the course of the lease, law firms must consider whether they are continuing to provide a regulated service in relation to advising on or managing the lease. To ensure strong compliance, COFAs could review a selection of lease files, ensuring that deposits held relate to commercial leases.

Residential deposits need to be held in a government-backed tenancy scheme, therefore any instance where a residential deposit is held in the client account is likely to breach rule 3.3. When considering commercial rent deposits, COFAs should ensure they understand the nature of the on-going transaction (eg continuing advice on dilapidations) in order to justify retention. As part of their testing, reporting accountants review slow-moving balances. From our experience, strongly compliant firms have COFAs who regularly query with fee-earners the nature and propriety of the on-going legal transaction for slow-moving balances. This ensures that the client account is not used for client convenience. Where a regulated service is no longer being provided, client balances should be returned as soon as possible. COFAs should ensure that fee-earners continue to question why they are receiving or holding funds throughout the client relationship. Funds may also be retained over a long period of time for lasting power of attorney (LPA) engagements. In this instance, it is unlikely that holding funds and making payments on behalf of a client, due to mental or physical incapacity, would give rise to a breach. However, it may be that holding money in the firm’s client account contravenes other requirements and guidance, such as that of the Office of the Public Guardian. COFAs should therefore make sure their policies and procedures encourage fee-earners to critically assess whether funds should be received into the client account at all. For trust administration or LPA work, it may be more appropriate to operate the client’s own account as signatory (or in LPA cases, a designated deposit account) thereby avoiding payments passing through the client account altogether in these instances.

THIRD-PARTY PAYMENTS AND RECEIPTS

Payments may be made to third parties only when they are connected to the regulated service being provided. The more connected the payments are to the underlying transaction the less likely a breach is to occur. However, where legal services are solely advisory in nature, a reasonable connection is more difficult to establish. This increases the risk of enforcement action, so firms should always consider and query why money cannot be paid directly to the client. If it’s unclear why the payment could not be made by clients themselves, funds should be transferred to clients directly for them to make payments to third parties. Payments to third parties may be acceptable where funds are aggregated. The SRA gives an example where a law firm acts for a seller of a private equity house. The seller undertakes the lead role on behalf of other sellers. To avoid breaching the rules, the firm must satisfy itself that there is proper reason to receive funds from the buyer, for instance, completion would otherwise be unfeasible. We would recommend documenting on file the due diligence checks undertaken on the other sellers, before transferring their share of the proceeds.

Contrary to this, clients may ask the solicitor to make a payment to a third party out of their share of sale proceeds. At a recent Solicitors Disciplinary Tribunal (SDT) hearing in January 2020 it was upheld that solicitors should be fully aware of rule 14.5 (the previous rule in relation to banking facilities) and, by extension, rule 3.3. They should refuse to make payments where the client’s instructions are not in relation to the underlying transaction forming part of the regulated services provided. It was sustained that the law firm should instead have transferred funds to the client for them to make payment themselves. These allegations formed part of the case against the solicitor, which resulted in strike-off. Facilitating payments with no underlying transaction can also lead to large fines.

Fines of £75,000 were issued in Fuglers LLP & Ors v Solicitors Regulatory Authority (2014) where the client account had been used to provide a banking facility to a football club whose bank account had been frozen following a winding-up petition. Subsequently, payments were made through the client account that favoured certain unsecured creditors. This instance highlights how payments made to third parties through the client account can help a firm to avoid insolvency obligations. Law firms may also receive monies from third parties, for example, when acting for a client who is part of a group of investors acquiring an investment. It may be that the firm is required to receive money from its client and other investors, to aggregate funds and complete the investment. In the SRA’s example case, this is needed in order to complete the investment outside of normal hours. Rule 3.3 is unlikely to be breached here, as the firm is advising on the transaction and without its involvement in collating funds and completing outside of normal hours, the transaction may not have been possible.

To ensure compliance with rule 3.3, it would be vital that the law firm understands the source of funds received to prevent aiding money laundering. It must also appropriately consider and mitigate the risk of inadvertently providing credibility to investment schemes. This area appears to be particularly high-risk, therefore it would be advisable to document relevant risk factors and justifications for receiving and moving funds in relation to the transaction. In an SDT hearing in late 2019, it was found that a law firm had provided banking facilities by receiving investment monies from the client’s investors, deducting the law firm’s fees then forwarding the balance to the client. Although regulated legal services had been provided to the client, the receipts from investors into the client account could not be connected to these services.

Furthermore, the client was said to have stressed to investors the security provided by paying into a solicitor’s client account, undermining public trust. This led to a two-year restriction on the solicitor’s practice. Law firms should therefore avoid retainers limited to payments only (excluding advice) as these are often a red flag for the SRA. Law firms must ensure, especially when acting in an escrow capacity, that they identify and understand the transaction; that a regulated service is being provided; and that there is legitimate reason for the firm to hold money. In contrast, where firms act as trustees a clear, regulated service is provided. Paying beneficiaries or third parties, and receiving income, is unlikely to breach rule 3.3. A breach is still unlikely to occur from firms acting for trustees, despite solicitors’ more limited role. However, the mere provision of the regulated service is not sufficient to prevent a breach. Where law firms hold large sums of money, they must ensure they are satisfied that funds are legitimate, the arrangements proper and the trust genuine. To mitigate the risks in relation to moving money, COFAs should ensure fee-earners are aware of the rules, especially in high-risk sectors; and establish open communication with fee-earners to discuss any issues. If unsure, COFAs should contact their reporting accountant or the SRA helpline for further guidance before processing transactions, to ensure a breach does not occur.

STRONG POLICIES

It is vital that COFAs understand the importance of complying with rule 3.3, due to the potentially serious ramifications of non-compliance – significant fines or even being struck-off. It is key for law firms to understand the risk factors associated with transactions passing through the client account, ensuring that they relate to an underlying legal transaction; and that those receiving the money are appropriately connected to the regulated service being provided. COFAs must ensure that fee-earners understand the source of funds received and the importance of ensuring that any retention or movement of funds is related to the continuing provision of a regulated service. Strong policies and procedures such as regularly reviewing slow-moving balances, which in our experience is a high-risk area, will help firms to avoid fines and penalties.