The SRA's new reporting requirements: an ethical conundrum for law firms
Non-partners could face serious financial implications when new SRA rules come into force in November unless firms have adequate insurance cover, warns Gideon Habel
Widely trumpeted changes are arriving with the Solicitors Regulation Authority’s (SRA) new Standards and Regulations (STARs) this November, but further changes of day-to-day relevance to both firms and individuals have gone somewhat under the radar. The SRA’s rules that individuals and firms must report suspected professional misconduct are changing to require reporting at a lower threshold than before. In this article, I look at some of the ethical implications for firms, particularly the compliance officer for legal practice (COLPs), compliance officer for finance and administration (COFAs) and managers; and individual employees. Through the lens of the SRA’s minimum terms on insurance and the often significant costs of responding to and defending SRA investigations and prosecution, I probe some of the pressure-points for firms. The questions don’t lend themselves to easy answers but, in these times of heightened regulatory enforcement action, firms must carefully consider their obligations and decide whether they want to take the ethical lead in how a firm treats those who work for its benefit.
LOWERING THE BAR; OPENING THE FLOODGATES?
The new rules go considerably further than the current requirements, which require a prompt report to the SRA when satisfied there has “actually been” serious misconduct. The new rules reduce the reporting threshold and the new requirements will be, in essence, to report any facts the individual or firm “reasonably believes are capable of amounting” to a serious breach of professional rules. The individual or firm must also inform the SRA promptly of any such facts they “reasonably believe should be brought to its attention so that it can investigate” or take any other action necessary in accordance with its regulatory powers. The natural result will be a significant rise in the number of reports to the SRA. This is likely to be as much a result of genuinely reportable matters under the reduced threshold being reported as it is individuals and firms making ‘defensive’ reports; fearful of regulatory consequences themselves should the SRA otherwise become aware of the issue.
INSURANCE: COVERING THE COSTS?
The SRA has been increasingly proactive in taking enforcement action in recent years. Responding to SRA investigations and prosecutions can be and often is eye-wateringly expensive; insurance can be an effective means of mitigating the risks of incurring those costs. Despite this, the SRA’s own minimum terms requirements for PII do not require firms (or, as it happens, individuals) to hold cover against that risk. In fact, that requirement was removed from those minimum terms in 2010. This is despite the obvious potential risk the lack of such insurance (and consequent need to invest significant sums in defending regulatory proceedings) could pose to the financial stability of firms and, therefore, to clients and consumers. To fill this gap, some insurers offer management liability products which include cover for regulatory investigation and/or defence costs. Alternatively, firms can buy cover as a ‘bolt on’ to their PII cover. In general, the costs are modest though they have increased somewhat in recent years and the number of insurers offering the products is small. Worryingly, my anecdotal experience when speaking with compliance officers and partners is they did not know their PII policy will not (unless specifically negotiated) cover them if the SRA comes knocking. If you’re in this sizeable number, it’s worth checking your policy; and if you find you have cover, check the level of indemnity so you can be sure you have enough. Perhaps it is unsurprising that my experience is also that only a small proportion of firms has additional cover that would meet these costs.
FOREWARNED IS FOREARMED – BUT FOR WHOM?
Even when firms have the foresight to buy these policies, they often put compliance officers and partners in a tight ethical spot. The terms typically cover partners and officers only. On one view, that feels appropriate: theoretically, it is partners who might expect to answer to the SRA when things go wrong with regulatory consequences. But increasingly, it seems the SRA pursues action against comparatively junior employees as well as against the firm and/or partner involved; and against that junior employee alone. In either situation, the firm’s regulatory defence cover would not normally cover the junior employee, whereas it would cover the firm/partners. The employee is left to fend for themselves. A proportion of the policies do provide cover for employees – but they are few and the additional cover comes, of course, at a further cost. This leaves a tricky ethical problem for COLPs, COFAs and managers. Life in the law can be, and often is, highly pressured and stressful – and not just at partner level. Employees at all levels can feel the heat, though it is fee-earners who do so most keenly and most often. These employees are exerting themselves in this environment for remuneration, of course, but it is the business owners who (in theory) have most to gain from their efforts. If firms don’t have cover that provides for employees as well as partners, those individuals can find themselves cut adrift when faced with regulatory investigation or proceedings. It can be ruinous. The individual may be financially unable to defend themselves even though they have not committed misconduct. It is an excruciating thought. If they are able to mount a defence, it can have serious financial implications: it is not uncommon to have to take out sizeable loans or sell or re-mortgage their home to fight for their career. And it is money they are unlikely ever to recover. The current position is there is little prospect of recovering defence costs against the SRA before the Solicitors Disciplinary Tribunal – even where the defence succeeds. With these factors in mind, there’s a strong ethical argument that firms should indemnify employees against the costs of defending themselves in regulatory proceedings in most circumstances.
THE REPORTING PARADOX
Mistakes are made in practice and things do go wrong. Some will attract the SRA’s attention of their own accord but some will require reporting by COLPs and COFAs. It is here that the SRA’s new rules bite for compliance officers. It will not always be clear whether there has actually been serious misconduct, particularly in the context of complex client matters or transactions. Previously, a COLP or COFA would have been able to conduct an internal investigation and conclude either way before having to report if misconduct was found. Now, the COLP or COFA will have to ask themselves whether they reasonably believe the conduct could amount to a “serious breach”. If they conclude it could and report, they open the firm up to a costly claim against its policy; if they do not report, they potentially commit serious misconduct themselves. A final possibility is to report, but to refuse to invoke the policy, leaving the employee to fend for themselves – but that would seem to defeat the point of buying the policy to begin with. After proper investigation by the SRA (perhaps even prosecution) some incidents may be found to be innocent mistakes; some may be found more culpable but fall short of being professional misconduct; others will be beyond the pale. But in any case, assuming the firm has invoked the policy in defence of its employee, its impact will be felt financially by the partners in the form an increased premium for a number of years. It all adds up to a testing ethical issue for firms and managers. The profession’s own long-held mantra is that solicitors must aspire to and demonstrate the highest ethical standards in their professional behaviour. Partners stand at the head of their firms and set standards for those they lead. As an associate solicitor (with ambitions) and an employee, my view is that under the present indemnity insurance rules, setting those ethical standards requires firms buying cover to protect both themselves and their employees – an employee’s negligent acts are, after all, covered under PII. That’s not to say, however, that the current rules are right; and it’s this point – and the SRA’s own ethical position in this conundrum – that I will turn to next time.
Gideon Habel is a partner and head of Leigh Day’s regulatory and disciplinary team leighday.co.uk