Known unknowns

The Solicitors Regulation Authority must be pleased. Within days of going live as a licensing authority for alternative business structures, it has already received 34 applications. That's 50 per cent more than what it was expecting on the basis of informal discussions it had with interested parties before Christmas.

The solicitors' regulator has made much of its intention to be the regulator of choice for ABSs. It has experience in regulating a diverse range of legal professionals, from sole practitioners to large City firms, so on paper at least it appears to be the natural Legal Services Act regulator for new entrants.

But the challenges could be greater than they seem after a succession of events dented the SRA's credibility. The delay in being designated as a licensing authority sticks most vividly as the obvious snag in the process. Even though the main reason for this delay was a glitch in the parliamentary timetable, this gave a bad impression. The troublesome roll-out of mySRA, the online renewal system for solicitors, did little to comfort interested parties that the regulator was suitably equipped to deal with unusual situations. And the new code of conduct, with its new outcomes-focused regulation, has failed so far to enthuse the legal profession.

This doesn't undermine the confidence of Ann Morgan, the SRA's Exceptions Manager at the Authorisations Directorate, that the regulator is ready - and the most able of all frontline regulators - to tackle the challenges new entrants will present.

Morgan heads a team of 25 staff whose task is to scrutinise complex applications for authorisation to provide legal services falling under the remit of the SRA. In practice, this means alternative business structures, and their main job will be to ensure that owners and managers of legal businesses meet the new suitability test.

Assessing a UK applicant's fitness to own and manage is unlikely to raise new challenges. Already the SRA runs a series of checks with various agencies for solicitors as they enter the profession. Morgan agrees that such checks are unlikely ever to contain the inclinations of individuals with a criminal intent, but she confirms that as a matter of due process the regulator will carry out checks with Companies House, with the Criminal Record Bureau (CRB), and require full disclosure of an applicant's employment history for the past five years.

Disappointingly the process at this stage is far from clear. Applicants will need to fill in a 'stage one' expression of interest form online before the SRA prepares a bespoke 'stage two' application pack requesting detailed information about the individuals behind the ABS, the two compliance officers '“ the famous COLPs and COFAs '“ and the sources of funding. But this opaque two-stage process also reflects the uncharted territory into which the SRA '“ and other ABS regulators '“ are venturing.

Expecting the unexpected

Beefing up its forensic capability is the decision the regulator has taken to make sure it is prepared for the unexpected. Morgan accepts that regulating individuals who are not lawyers or even regulated professionals raises new challenges.

'The ownership and management of an ABS is almost infinite in its structure and the type of people that could be involved; you could have the greengrocer at the top of the road teaming up with the local lawyer and opening up a legal shop in that way,' Morgan says.

So how will the SRA make sure its systems are robust not just theoretically but in practice too? Morgan's response is that the new 'very strong handbook' has been written with ABSs in mind and that there is 'a huge resource within SRA for regulating legal services'.

She also underlines that the SRA's jurisdiction has been and will continue to extend only to the regulation of legal services. 'So if the greengrocer opens a legal shop with the local solicitor, we're not going to regulate the weights and measures, that's not where our jurisdiction is; our jurisdiction is within the legal services, and that's where our experience is and we are very experienced at that,' she insists.

However, in anticipation of challenges beyond its competence, the SRA has also lined up external consultants it will call upon, Morgan reveals. The former financial services executive says the SRA has 'a number of professional organisations on a panel which we'll make referrals to in cases of highly complex corporate structures or international structures set up for tax purposes'.

Morgan prefers to keep the names of these firms confidential at this stage, only saying that there are 'a number of firms we've been speaking to for some time which are on stand-by depending on their areas of expertise'. Wannabe ABSs will not be told either if and to whom the work will be referred.

What she can say is that these organisations are 'top and medium tier consultancy practices' with expertise in corporate structures, transaction services, tax advisory matters, and due diligence work. Some will have worked on large merger operations and in financial services, undertaking due diligence on clients of large organisations. Think McKinsey, PKF, or PwC. Work will be put out to them depending on volume and type.

Some of the aspects these consultants will be expected to assist with will be the use of complex structures designed to be tax efficient and whether the resulting complexity conceals any untoward intent such as money laundering. The BCCI debacle looms large in the background. 'With these corporate structures we do need to be absolutely confident, particularly if they are multinational, that we understand how they operate and where the true control lies within the organisation', says Morgan.

'If we are not convinced the applicant has disclosed the ultimate beneficial owner of organisation then we will undertake investigations to make sure we are fully satisfied that we do understand who the official owner of the organisation is and who is in control', she continues.

International interest

A significant element of the concern over fraud has been in relation to foreign owners, with fears that criminal organisations from certain countries could enter the UK's legal profession using ABSs.

While she acknowledges these concerns Morgan is keen to point out that the SRA's process is jurisdiction-neutral and that the same criteria that will be used to filter all applicants irrespective of nationality or origin.

A few of the prospective ABSs that have been in conversation with the SRA since the summer are from outside the UK, Morgan says. Although here again, she declines to name the countries, saying there was a risk this would identify the applicants in question, some of whom had specifically requested confidentiality. Asked whether applications had come from outside Europe, including the US, Morgan could only say that there was 'worldwide interest'.

The starting point for foreign applicants will be the UN's sanctions list. Applications which involve individuals or corporates from countries on the sanctions list will 'obviously cause us problems', Morgan says. Commonwealth jurisdictions with a similar public accountability culture to the UK's are unlikely to raise major problems but others will require the SRA to be particularly vigilant. The regulator will use the links it has through the legal profession to obtain information but difficulties are expected where the individuals or entities involved are not legal practices or lawyers. In such cases, the SRA will go through specialist agencies such as Kroll or Thomson Reuters-owned World-Check, which undertake international due diligence through a network of local branches around the world.

Morgan acknowledges there are risks '“ after all, it was only just over a year ago that the SRA paid out £9m to clients of the 190-year-old English firm, Wolstenhomes, left high and dry after the firm's demise in 2009 amid allegations of dishonesty '“ but she considers the processes in place to be the most robust possible.

Closer to home

Which brings us back closer to home with issues such as referral arrangements and outsourcing.

While neither are obstacles to becoming a recognised body at present or an ABS in the future, they have been flagged as potentially presenting risks. 'If an organisation has complex referral arrangements or undertakes outsourcing for some of their processes, particularly if they're a new firm, it could raise points we might want to look at', Morgan says.

The forthcoming ban on referral fees has prompted a number of organisations to consider whether they should review their business arrangements. Shares in insurance group Admiral, whose business model is largely dependent on referral income, dropped sharply after the government announced plans for a ban in September last year. This was followed by press reports three months later that the group was considering ABS conversion as a way around the ban. And as far back as 2008, legal expenses insurance DAS made clear its intention to convert to an ABS and bring in-house the legal work it sent out to panel firms.

Morgan says the SRA is expecting applications from the insurance sector but that, in the meantime referral arrangements did not, as such, raise immediate regulatory issues. However, more complex arrangements, such as those including multiple referral arrangements with third parties or where a firm is reliant on one referrer for a large proportion of its business, will involve 'more engagement' with that firm to ensure there are processes in place to mitigate the risk to clients if these contracts were lost.

Outsourcing is the other big item on the SRA's risk list. Not that the risk has suddenly emerged this month, but it is making the regulator a little jittery.

'Traditional firms use outsourcing models and we're not saying that this is a higher risk,' Morgan says. 'It's a model '“ a way of doing business '“ which from our perspective we need to understand in more detail; how the firms are going to manage the exchange and flow of information to outsourced partners and the kind of procedures and protection they put in place for the client matters as they transfer data to the organisation.'

Outsourcing may be common for human resources and payroll functions but ABSs could encourage the outsourcing of functions closer to legal processes, raising possible concerns in terms of public and client interest.

None of the organisations that have shown interest in ABS status so far are proposing to outsource any more than traditional firms do at present, according to Morgan, but because it is 'certainly a possibility going forward', the authorisations directorate will need to understand in each case how organisations propose to structure and manage the process.