New Law Firm Regulations in England and Wales Will Affect U.S. Firms

New law firm regulations in England and Wales will affect U.S. firms Frank Maher and Anthony E. Davis The National Law Journal July 21, 2011 Legal Risk’s Hinshaw & Culberston’s Frank Maher Anthony E. Davis A nascent regulatory scheme governing U.K. law firms that will go into effect on Oct. 6 is likely to have profound implications for U.S. firms with U.K. offices. The new rules represent a significantly different approach to the regulation of lawyers — and law firms — than the prevailing structure in place in the United States. Since the new rules will affect all partners in U.S. law firms with London offices, either directly or indirectly, those lawyers and their firms’ leaders will ignore the new structure at their significant peril. The Solicitors Regulation Authority (SRA) published its draft handbook on April 6, including a new Code of Conduct and Accounts Rules dealing with the handling of attorney-client trust accounts that contain wide extraterritorial effect. The new rules will shortly be followed by provisions in the Legal Services Act that permit both external investment in law firms and nonlawyer involvement in the practice of law through the medium of alternative business structures. There are already reports of interest both from private equity funds and from “high street” retail and banking chains that would like to move into the legal services marketplace, and national firm Irwin Mitchell has become one of the first law firms to give notice that it will seek external investment. What makes the new rules so distinct from anything remotely familiar to U.S. lawyers and firms is the underlying premise of “outcomes-focused regulation.” Instead of a detailed set of ethics rules governing permissible and impermissible conduct, the new rules instead focus on mandatory outcomes. The introduction to the Draft Code of Conduct states: “Outcomes-focused regulation concentrates on providing positive outcomes which when achieved will benefit and protect clients and the public. The SRA Code of Conduct (the Code) sets out our outcomes-focused conduct requirements so that you can consider how best to achieve the right outcomes for your clients taking into account the way that your firm works and its client base. The Code is underpinned by effective, risk-based supervision and enforcement.” By Oct. 6, the SRA hopes to: • Put in place a new outcomes-focused code of conduct as part of a handbook of all regulatory requirements. • Regulate using a risk-based and outcomes-focused approach. Of critical importance in understanding this new approach, law firms will not only be required to achieve the designated outcomes, but also to demonstrate that they are achieving them. “Indicative behaviours” will assist the regulators in determining compliance with the outcomes. In addition, the primary responsibility both for achieving and demonstrating compliance will be in the hands of the law firms themselves, subject to supervision by the SRA. However, that supervisory role will be undertaken in the context that the SRA will have real teeth in carrying out its enforcement responsibilities — and those teeth will be directed at firms as much as individual lawyers. A report in The Lawyer on April 11 said, “The terms of the Legal Services Act give the regulator stronger powers to discipline firms, and [the SRA’s chief executive, Antony] Townsend insists that it will be using these. ‘We’ll be publishing a lot more than we used to,’ he adds. ‘We have the power to reprimand firms publicly and fine them up to [2,000 pounds ($ 3,300)].’? “ While fines of $3,300 may not seem excessively punitive, the reputational impact of a “name and shame” policy cannot be ignored, and in more severe cases the Solicitors Disciplinary Tribunal has power to impose unlimited fines on all members and employees of law firms. In implementing this new approach, the SRA plans to shift its supervisory emphasis toward assessing a firm’s risk-management systems and identifying whether they are achieving the requisite outcomes, rather than a detailed consideration of law firms’ individual processes. The level of supervision a firm will experience will depend on the perceived risk that its internal systems (or lack of them) pose to the regulatory objectives. Supervision will also be tailored to take account of factors such as firm size and risk-management protocols, as well as the firm’s previous compliance history and positive engagement with the SRA. The SRA’s vision is to: • Concentrate on dealing with firms that pose serious risk. • Encourage firms to assess and tackle the risks themselves. • Concentrate on those that cannot — or will not — put things right. The SRA recently launched its consultation on the new rules under the strapline “Freedom in Practice.” However, this encouraging formulation needs to be treated with caution: It means there may be more than one way to comply with a requirement but does not mean lawyers will be able to avoid the consequences of what they do — or don’t do — to comply with the regulatory scheme. 2 The net effect is more regulation than English lawyers have hitherto experienced. The handbook contains more than 200,000 words — compared with just above 40,000 in the Solicitors’ Practice Rules 1990 and associated rules and codes in force when the previous government launched its regulatory review of legal services in 2004. The hand book includes 10 requirements for policies; 14 monitoring requirements; and 17 reporting and information requirements. According to SRA’s Cost Benefit Analysis, “[Outcomes-focused regulation] is quite different from the traditional rules-based approach to regulation in the legal services industry. It seeks to eliminate detailed rules in favour of rather broadly described outcomes, and allows firms flexibility to decide how to achieve outcomes. The outcomes, however, are mandatory. Firms must also be able to evidence their achievement of outcomes.” The handbook also contains significant detailed and prescriptive regulation. Underpinning the new rules are 10 core principles — many of which reflect the standards to which lawyers subscribe the world over and will be familiar to U.S. lawyers, but a notable addition is the inclusion of a business-management requirement: “You must run your business effectively and in accordance with proper governance and sound financial and risk management principles.” This has been included as a core requirement following the failure of a number of law firms as a result of economic pressures, including, most recently, Halliwells, previously a U.K. top 50 firm with profits of approximately $130 million, and Howrey, which dissolved earlier this year. The requirements for business management include: • A clear and effective governance structure and reporting lines. • Effective systems and controls. • Identification, monitoring and management of risks in compliance with all the principles, rules and outcomes and other requirements of the handbook. • Maintaining systems and controls for monitoring the financial stability of a firm. • A system for supervising clients’ matters, to include the regular checking of the quality of work, by suitably competent and experienced people. Numerous disciplinary investigations and prosecutions have demonstrated that the last requirement — supervision — can be satisfied only by proactive systems; passive, “open door policies” will not suffice. Firms that decide not to carry out file reviews will need to justify their stance, which may be challenging. Firms that already have a system need to review its adequacy. Firms in the regulated sector for anti-money laundering purposes should have systems for “monitoring and managing compliance” under regulation 20 of the Money Laundering Regulations 2007, but it is consistently an area of weakness the writers’ firms finds on audit. The business-management rules also include requirements for compliance with anti-money laundering and data-protection legislation. Anti-money laundering legislation in the United 3 Kingdom is extensive in its effect and may require lawyers in certain circumstances to breach client confidentiality and report clients to the authorities. The anti-money laundering requirements also extend to counter financing of terrorism and sanctions compliance, which is gaining increasing significance because the legislative requirements are onerous. Breaches of data-protection legislation can attract fines of up to 500,000 pounds (more than $800,000); there have been two significant cases involving lawyers, albeit not in private practice. The case of ACS Law, a firm whose systems were hacked, attracted much publicity worldwide and is now being prosecuted by the SRA. Indicative behaviors suggest that firms should also have whistleblowing policies. London offices with lawyers regulated by the SRA (including U.S. lawyers who are U.K. “Registered Foreign Lawyers”) will be required to comply with every element of the new rules. Whether and in what manner other offices of U.S. firms — those in the United States and other jurisdictions outside the United Kingdom — will be required to comply with the new regulations remains to be seen, and may vary depending on the nature of their structure. Some otherwise “purely” U.S. firms have a small number of U.S. partners who are also members of the U.K. practice, and those firms will clearly be regulated in the United Kingdom within the new scheme. Others firms operating in the United States, however, also have an SRA-regulated practice (either head office or branch office) located in the United States, and these firms will also be exposed to regulation by the SRA in a way that they have never experienced in the past. Under the new scheme, all partners (“managers” in the language of the rules) are individually responsible for compliance, but in addition — and unlike anything in place in the United States (other than New York, where law firms as such are at least theoretically subject to professional disciple) — law firms themselves will also be responsible for compliance.

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