ManagingRisk Winter 2012/13 w

ManagingRisk Winter 2012/13

Table of contents Welcome

BRAVE NEW WORLD 01 A common theme we hear from law firms are “How BEST LAID PLANS 03 does our risk and compliance compare with our peers?” and “How are other firms approaching OFR?” ABS AND THE COLP - HOW WE MANAGED IT 05

SOLICITORS REGULATORY RESPONSE LIABILITY INSURANCE 07 Our survey in 2011 was the first in-depth survey and PATIENCE IS A VIRTUE: THE LONG ROAD TO BECOMING AN ABS 12 benchmarking exercise across the UK Top 100 firms looking at approaches to and resourcing of risk management and compliance. The results of this survey allowed firms to see how they compared with their peers. Some firms were well behind the curve and saw they needed to invest more in risk and compliance, while others had found that they had the right balance between risk and reward.

ABS continues to hit the headlines and we hear what the SRA expect from applicant ABSs as well as the viewpoints of two businesses and their experience in converting to an ABS.

The COLP and COFA positions are now live and we look at the protection that these individuals would be wise to take out, giving them peace of mind should they be at the wrong end of an SRA investigation.

Steve Holland - Senior Vice President Editor PR Global Professions Constantine Okoye Chris Don [email protected] T: 020 7933 2125 T: 020 7933 2634 020 7933 2444 E: [email protected] E: [email protected]

Designer Hector Osholake T: 020 7933 2731 E: [email protected]

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ockton has recently launched its second With the increase in merger activity, Risk and Risk and Compliance Index survey (R+CI) – Compliance teams can be expected to have more providing top 100 UK law firms with a unique reliance placed on them in regards to managing Linsight into how their risk and compliance the due diligence process. Where mergers go procedures compare with their peers. One year ahead, the risk and compliance team is likely Brave New on from Lockton’s first Risk and Compliance Index to have additional responsibility for managing survey and the legal landscape has already the integration of compliance systems and changed significantly: the predicted ‘merger implementing necessarily more complex conflict mania’ is in full swing with no sign of abating; management systems. the number of applications for ABS status has World… exceeded initial expectations; and 2013 sees the As the number of ABSs increases, the variety of long trailed COLP and COFA compliance regime structures and altered risk profiles of practices will The brave new world of legal practice today is jolting law firms into finally become reality. change the shape and responsibilities of risk and compliance teams. External investment will bring a deep-rooted review of their strategic direction and their modes The 2013 R+CI has been updated to take account with it increased expectations of an enterprise risk of operating. Margins are tighter for the majority of firms than of the impact of Outcomes Focused Regulation, management model – and teams are likely to they have been for many years, yet evidence (from The and has been finessed to provide even more be expected to take on more of a strategic role. tailored information to assist firms benchmark the The emergence of multi-disciplinary practices will UK200 Annual Report 2012) suggests that the cost per lawyer as a effectiveness of their risk and compliance functions necessitate an increase in process-risk management percentage of revenue has increased rather than decreased over and the value-for-money they provide. Using and increasingly sophisticated monitoring. Lockton’s particular knowledge of the PI the last 5 years. market, each report then provides a comparative The increasing regulatory burden required to analysis of the levels of cover and cost of the firm’s counteract the new free market models, as Informed decision-making requires insightful management Professional Indemnity insurance. evidenced in the introduction of COLPS and COFAs this year, means that those charged with information. The Legal Services Act means that Risk and Last year’s survey identified that dedicated risk and the regulatory responsibility will increasingly rely on Compliance is now right at the heart of the boardroom agenda. compliance teams are seen as an increasingly their risk and compliance teams. These teams will Firms need to know whether their compliance procedures are fit important part of operations – and the need to deliver the evidence required by the SRA, majority of firms anticipated investment in risk and that the independence of their remains for purpose, and want to be able to measure the value that their compliance increasing in the near future. uncompromised and that they continue to act in risk and compliance functions are providing to the business. There their clients’ best interest at all times. were only anecdotal answers until now. Among the top 100 firms, Risk and Compliance teams tend to be the primary contact point for These additional requirements on risk and AML checks & conflict screening and updating and compliance teams come at a time when negotiating changes to Terms of Engagement. They margins are being further squeezed and there were least likely to be involved in business continuity is extraordinary pressure to streamline processes planning, partnership secretarial arrangements, and wherever possible. long-term strategic planning. The R+ CI index will help participants identify how Interestingly, risk and compliance teams in the top effectively they are using their risk and compliance 21-40 firms had primary responsibility for 28% more function, and where participants might seek to drive key risk management tasks than teams in other improvements in their internal processes. Look out firms, and the information they provided on Partner for our report on the 2013 survey in the spring, or to compliance with internal systems and procedures register your interest in participating in future Risk + was 45% more likely to be used as part of the Compliance reports from Lockton, contact appraisal process. Graham Wynes.

Calum MacLean - UK Risk Manager Graham Wynes - Senior Vice President - Professions Lockton Companies LLP Lockton Companies LLP [email protected] [email protected] 020 7933 2266 131 3455 561 01 - ManagingRisk - Winter 2012/13 Winter 2012/13 - ManagingRisk - 02 ManagingRisk Winter 2012/13 Winter 2012/13 ManagingRisk Best laid

Tom Arrowsmith - Partner Kindleworth [email protected] plans 020 7397 2921

BUSINESSES WHICH ARE BEYOND THE INITIAL STAGE OF THE ABS APPLICATION PROCESS, AND NEWLY LICENSED ABSS WHICH HAVE MADE IT THROUGH, ARE OFTEN CRITICAL OF THE SRA’S ABILITY TO GET TO GRIPS WITH THEIR BUSINESS MODEL AND TO MAKE A DECISION ON AUTHORISATION WITHIN A TIGHT TIMESCALE. HOWEVER, IT IS EQUALLY TRUE THAT THE SRA HAS HAD TO REMIND THOSE WHO ARE ASPIRING TO LAUNCH AUTHORISED ABSS THAT THEY EXPECT TO SEE EVIDENCE OF WATERTIGHT BUSINESS AND COMPLIANCE PLANS, WHICH SHOW AN APPRECIATION OF THE RISKS ASSOCIATED WITH THE LEGAL SERVICES WHICH ARE TO BE PROVIDED.

he SRA’s online overview of the ABS funding arrangements and conditions precedent authorisation process, which was last updated are involved. The regulator’s 6 month (or 9 month) on 29th June 2012, warns that applicant statutory stopwatch will also not start to run until the Tbusinesses with complex financing structures fees are paid at the end of stage 2 – best laid plans and ownership models will need to invest time and all that. and effort in assessing the risks associated with their proposed ABS. Based on their experience in COMPLIANCE PLANS managing applications to date, the SRA suggests There will need to be a thorough compliance plan that this is even more important where these in order for the SRA to be satisfied that the ABS The best prepared ABSs will be forearmed with a VARIETY IN THE ABS PIPELINE applications are “being led by individuals who are in- waiting has adequately considered how it will detailed compliance plan, including a Kindleworth have been working with a number of new to legal services and the regulation of those achieve compliance with the SRA Handbook 2011 gap-analysis, to serve as the best possible new ABS entrants, some of which are new pretenders services”. and relevant legislation. For new players in the legal demonstration of the business’ intention to get to in the world of legal services. Others are existing market, the need for appropriate and effective risk grips with the SRA’s outcomes-focused regime. The ‘traditional firms’ considering external capital for BUSINESS PLANS management and compliance oversight, training, plan will also incorporate key legislative compliance, growth or simply looking to bring a non-lawyer into A credible and sustainable business plan will need policies, systems and controls, is particularly acute. including in areas such as data protection, money the partnership structure. to cover more than just financial projections, if it is laundering and financial services regulation. to meet with the regulator’s approval. The SRA will Those at the candidate business, who are There is real ambition and variety out there and expect the applicant ABS to identify the target client responsible for the application and for contact with Finally, it should be noted that the primary many applicants are keeping their best laid plans to base (how will they benefit and be looked after?), the SRA, must demonstrate a good understanding contacts for the application will often also be the themselves. What can be said with certainty is that the intended service lines (how are the associated of the SRA’s regulatory framework – not least nominated COLP and COFA (aka HOLP and HOFA) some of the would-be legal services businesses, risks to be managed?), and the predicted sources the separate business outcomes and suitability at any authorised ABS. That makes it all the more which are currently caught in the ABS pipeline, are of work (are referral arrangements involved and tests. They will need to be clear on any waivers necessary for the SRA to have confidence that set to make quite a splash. what if they dry-up?). In other words, the applicant they require. They will need to have started to they are dealing with professionals who understand must have a “fully articulated business plan and line-up appropriate levels of indemnity cover, legal regulation. Will these individuals be able to commercial purpose”. which necessitates talking to brokers early. The fulfil their responsibilities, by ensuring adherence to ABS applicant could even view the process of professional rules and managing breaches of such Nonetheless, the SRA has made it clear that it will not completing their initial PII proposal forms as a test-run rules, if they aren’t yet familiar with them at the point be bound by the aspiring ABSs’ stated timescales for for the scrutiny they should face from their regulator they are committing to abide by them? implementing the business plan, even where crucial in due course.

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Under the , COLPs are “In addition, we introduced a register of decisions In April this year, law firm Russell Jones & personally responsible for their organisation’s pertaining to non-compliance. This way, if it’s compliance with its licensing terms, its compliance decided that a breach is not material, there’s a Walker (RJW) received approval from the with all regulatory and statutory obligations, and for record as to the thinking behind that conclusion,” reporting any breaches as soon as is practicable. she says. The firm collaborated with the SRA on the SRA to convert to an alternative business In order to do that, COLPs have to put effective OFR project before it was launched, and is in the systems and controls in place to enable the process of rolling out training on OFR compliance structure (ABS) and shortly thereafter firm to meet OFR’s requirements as well as to firmwide. identify, monitor and manage risks to continued completed its planned acquisition to compliance. As a firm they built their own computer “Being a COLP is a hugely responsible role - in a systems around VisualFiles which automate its sense you are a whistleblower with the ability to become part of Australian law firm Slater & risk register compilation and complaints tracking shut the whole firm down - but essentially it is all process to help Rebecca in meeting her reporting about cultivating openness and transparency. The Gordon (S&G). obligations. process works best when you have an open-door positive compliance culture. Yes, it’s about reporting “A key aspect to the process was ensuring we any instances of non-compliance, but it’s just as Managing Risk caught up with Rebecca Having that experience on tap more than offset the mapped and managed every conceivable risk to important that you record discussions on how you Bell, Slater & Gordon’s UK General multi-jurisdictional multi-regulatory challenges of achieving and maintaining compliance. We took have interpreted and implemented a compliance Counsel and Compliance Officer for providing vast amounts of information to reassure all a highly systematic approach to compiling a risk regime internally and documenting the reasons for Legal Practice (COLP), to learn more interested parties about the fitness and properness register that covers the full spectrum from financial, the decisions you have made.” M reputational and strategic to regulatory issues. Out about the reality of implementing and securing SRA of our management and investors. approval for the formation. of that you gain a deeper insight - not just into what Rebecca Bell - UK General Counsel How had Rebecca found the experience of working you need to do to ensure compliance - but also Russell Jones & Walker what will make you a better business. We discovered We first asked about the challenge of carrying out with the SRA we wondered? “They were actually a [email protected] a change of business structure and a merger in real pleasure to work with. RJW was one of the very a number of areas where improvements could 020 7657 1721 tandem. “It was a lot to take on at once,” Rebecca first UK law firms to convert to ABS - just as our new be made - including on data protection and on agrees, “but once we had identified this opportunity parent S&G were the first listed law firm in Australia recording hospitality properly. All of that has benefits to create a stronger business for the future and five years ago - and in a sense the people at the far beyond technical compliance. an ideal partner in S&G, the timetable began to SRA were as new to it as we were. We were speaking be put together. I have a background in project two or three times a day over the phone and they management, so perhaps I didn’t find it as daunting were really helpful in terms of getting approval forms as I might have otherwise.” and issuing them. It was all very collaborative.

“With something like this, the devil really is in the Conscious of the “people” risk involved in any detail. We had an extraordinarily detailed project merger, Rebecca and RJW’s board went to management plan - based on PRINCE2 - that great lengths to ensure that the process was as helped us ensure we covered all the detailed work transparent as possible. “We obviously had to required to get to each milestone. We had a great communicate and consult internally to make sure team in place, with work stream leaders across the everyone was comfortable with where we were business playing a pivotal role. Everyone showed going,” Rebecca notes. “We carried out 6 staff fantastic commitment and put in a phenomenal consultation meetings over a 3-month period and amount of hours. appointed 15 reps across the firm to make sure we addressed any questions and concerns people “We also had the assistance of some very capable might have. We have always had an open and external advisors in the shape of Smith & Williamson consultative approach, which helped lay the ground and who brought an invaluable work, and we recently carried a staff survey that external perspective to bear and were particularly identified career planning and development as helpful on the planning and drawing up action key concerns. This is something the new structure lists and of course Lockton in helping us place our clearly addresses; another key attraction of the ABS professional indemnity insurance! business structure was the ability it gives us to reward employees more widely than under a partnership “We also had the benefit of working closely with and offer attractive career paths to everyone within S&G who have been through a lot of these issues the firm.” previously and also understood how everything works with the Australian Stock Exchange and the Australian Shareholders Association.

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Solicitors Regulatory Response Liability This policy responds not only to a Solicitors Regulation Authority enforcement action for your Insurance nominated COLP or COFA but also to What is Regulatory Response cover and why do I need it when I already have Professional Indemnity Insurance (PII)? actions brought by other regulators including SOCA or the FSA. ost law firms focus their risk transfer solutions on their PII. While PII will Compliance Officer for This policy also extends to investigations Scenario 1 – maverick rainmaker who protect you and the firm against initiated against your MLRO. ignores compliance procedures: claims arising from your professional Legal Practice (COLP), M services, this will not cover risks associated with the It is a well known fact that litigation A firm’s COLP exhibits a breach of duty management of the business. Individuals can be Compliance Officer increases in an economic downturn. when observing, but not reporting, the held personally liable for their actions resulting from With this exposure, coupled with the SRA’s practises of the firm’s new ‘maverick’ a wide range of legislation. This includes health for Finance and new approach to Outcomes Focused litigator who: and safety actions, regulatory proceedings and Regulation (OFR) and enforcement, you investigations, employment law, as well as criminal Administration (COFA) are at an increased risk of an action being • Routinely ignores client due diligence or civil actions recognised as offences under any brought an investigation can be triggered procedures of the following acts, amongst others: by various sources, including: • Does not complete the internal anti and Money Laundering money laundering client vetting • Members of the public or the requirements • Legal Services Act 2007 Reporting Officer profession • Does not complete any pre-inception • Companies Act 2006 (as amended) • Whistleblowers – external or internal matter risk assessment • Financial Services and Markets Act 2000 (MLRO) Liability • Other regulators • Does nearly all of his/her work either on • Insolvency Act 1986 • Outside shareholders the road or from home (making him/ • The her difficult to supervise) The Lockton Regulatory Response liability insurance • Your clients • Contrary to the firm’s own best practice for law firms protects not only the law firm but also • The firm itself. requirements, the litigator is not the individual members from personal liability submitting files for file audits and no incurred in their managerial capacity for regulatory In the following hypothetical scenarios, one knows what’s happening on them. actions. we discuss the impact of an investigation being brought against the firm or its A visit from the SRA uncovers this lack of compliance officers and the potential cost control and undertakes a full investigation to individuals: into the breaches. The Regulatory Response policy would cover the costs of the investigation and potentially any imposed where insurable by law.

For information on the SRA’s current limits on financial penalties please see http:// www.sra.org.uk/sra/how-we-work/decision- making/criteria/financial-penalty-decision- to-impose.page. The SRA can refer cases of very serious breach to the Solicitors Disciplinary Tribunal, which has the power to raise or lower fines imposed by the SRA.

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Scenario 2 – COLP unable to convince The consortium commits fraud on its lender, Scenario 4 – London based firm with an The job of the MLRO is to act as the focal board of firm to report a material breach which sues the firm in negligence. The board international client portfolio point within the firm for the oversight of all tells the COLP to report the matter to the SRA activity relating to anti-money laundering. A COLP has been trying to persuade her as a breach. The SRA investigates and fines A partner of the firm is working with an They need to be informed of any relevant management board to adopt the risk the COLP £2k and the firm £20k. In such a overseas client on a potential UK knowledge or suspicion and in turn pass management system and mortgage fraud scenario, the Regulatory Response policy acquisition. on issues to SOCA as appropriate. They policy she devised, without success. The would cover the costs of investigation and are to liaise with SOCA on any question board, as well as heads of department see potentially any fine imposed where insurable Adequate background checks of the and whether to proceed with a transaction both suggestions as bureaucratic business by law. client’s financial position and legality were under the circumstances. inhibition which the firm’s falling profits not carried out by the UK law firm. After cannot accommodate. The firm’s turnover Scenario 3 – UK law firm with 3 UK offices, negative publicity in the press surrounding The Lockton Regulatory Response policy has decreased from £1.7m to £880k over exploring expansion the origin of funds to be used for the will ensure that your COLP, COFA and the last 3 years. An instruction worth £500k merger transaction, the Serious Organised MLRO are protected for their compliance comes into the firm’s conveyancing practice The firm is exploring the opportunity of Agency (SOCA) launches an and managerial duties within the firm. (which is limited to standard residential forming an Alternative Business Structure investigation specifically asking the MLRO to Dependent on the size of your firm, a work) from a consortium of Spanish buy-to (ABS), resulting in potential outside respond. retention may apply. This retention is only let investors in respect of a new property investment. A prospective third party investor applicable in the event the firm cannot development outside Milton Keynes. The raises a complaint with the SRA alleging After review of responses, SOCA confirms indemnify the individual due to insolvency, work falls far outside the scope of the firm’s misrepresentation within the prepared that the firm has acted in accordance with legal prohibition or wrongful refusal. usual practice but the conveyancing head financial statements. In turn the SRA initiates compliance procedures and no penalties of department takes a unilateral decision a formal investigation against the firm, with were imposed. For further information and more specific to accept the instruction without reference the purpose of investigating the COFA. details of our exclusive Regulatory Response to the risk assessment or mortgage fraud It is deemed the COFA was in breach of Even though penalties were not imposed, policy please contact Steve Holland. policy, referring it to the risk committee who the SRA Accounts Rules for the provision the Regulatory Response policy would have rubber stamps it. The instruction proceeds of inaccurate financials and a £2k fine is been triggered and any defence and other in the absence of enhanced supervision imposed. costs resulting from the investigation would and monitoring measures the COLP has be indemnified under this cover. Steve Holland - Senior Vice President recommended in her proposed mortgage The Regulatory Response policy would Global Professions fraud policy. cover the costs of investigation and any fine [email protected] imposed where insurable by law. 020 7933 2444 The COLP tells her board she intends to report the acceptance to the SRA as a As part of the OFR the idea is to focus firms material breach. Her board instructs her on managing and minimising risks at the otherwise as the income it represents is right level for their firm. The SRA Accounts crucial to the firm’s continued solvency and Rules require that all principals must ensure existence. compliance by everyone employed in the firm. This duty is extended to the COFA of a firm.

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Patience is a virtue: The long road to becoming an ABS

have been engaged for many months in the process of seeking, on behalf of a company in which I have an interest, a licence to become an Alternative Business Structure. I haven’t yet succeeded I in this objective but share my experience of the process so far’. Having been in private practice in the for over 40 years, I have for a long time been an interested observer of the process of “liberalising” the legal services apparatus in this country ever since the Clementi Report (after a lot of lobbying by bodies such as The Consumer Council) came up with its proposals. I could see many advantages, both for those who work in law firms and for consumers of legal services.

Many people doubted if the Clementi proposals would see the light of day but legislation did eventually follow and the Legal Services Act finally made its way through Parliament. Even at the last minute there was some doubt as to whether it would fall foul of the legislative timetable and fail to achieve the . As we all know, however, it was indeed passed and became the 2007 Act.

Progress since then has been equally glacial. It was only in 2011 that the prospect of creating the long-awaited Alternative Business Structures became a reality. A date of 6 October 2011 was trumpeted as the start of this brave new world. Overexcited journalists predicted “Big Bang for the legal profession”. Anti-climax followed. The 6 October date was quietly sidelined, to be replaced with a new date of January 2012 - but even this was dependent on the SRA being approved and ready to start receiving applications.

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As the months of 2011 ticked by, businesses that were interested in acquiring ABS status naturally wanted to know what the process would involve, what information would be sought by the regulator and what the touchpoints might be before a successful application. The difficulty has been that this has been a novel experience for all concerned, not least the SRA. In mid-2011, I took up the sensible suggestion of the SRA to discuss the sort of ABS that we had in mind, but unfortunately this proved to be less than enlightening as the personnel I encountered had little idea of how the process would be carried out and crucially had no information of the form and content of the all-important application forms.

Come 2012, Applicants were able to find out that there were to be two stages: the Stage 1 Application form was generic and did not seem to require information about the type of ABS or the business plans of the proposed ABS. Completion of these outline forms (akin to an “expression of interest”) was then followed by the requirement to complete Stage 2 forms. These forms are a challenge, even to those used to completing Practising Certificate applications - indeed they seem to have been based closely on the sort of information-gathering required from Solicitors practices as part of that exercise. Unfortunately they do not give much scope for explanation of the plans for the particular ABS: there are lots of drop down menus with little scope for individual comment or explanation. A frustration is that the form- filling provides no scope for an applicant to explain how an existing solicitors’ practice could become part of a multi-disciplinary practice, which was my particular interest.

Another problem of a form-based system is that it seems to require the Applicant to make a declaration of its owners and managers at a particular point in time, without providing any indication as to how changes of ownership are to be accommodated (it being fairly obvious that any business is a dynamic entity and will constantly change - look at any law firm partnership!).

Given the history of the legislation and its infrastructure, I did not expect this I didn’t expect the ABS process to be a rapid process. It has not been. Many months on, the SRA are still at the stage of assessing our application. In the meantime, the SRA has to be an easy one or a rapid one. introduced a stage 3 into the process, giving an opportunity for the SRA to have discussions with the applicants and allow for modification of the I remain an optimist that “we will application in the light of such discussions. That is obviously common sense and to be applauded, albeit that it still further delays the point of a decision. get there in the end” and this has It perhaps also indicates that this is a process where both Applicants and regulators are learning on the job and responding to the new challenges as done nothing to diminish my the process rolls on.

David Simon - Managing Partner enthusiasm for the concept of Robin Simon LLP [email protected] new structures in the legal sector. (0) 333 010 2888

13 - ManagingRisk - Winter 2012/13 Winter 2012/13 - ManagingRisk - 14 You’re unique. So is the service we offer. Winter 2012/13 ManagingRisk Solicitors’ Professional Indemnity NOTES 0845 0501 471 www.lockton.com/solicitors [email protected]

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