In depth: Should solicitors hold client money?

How do you make a bank account sound interesting? Disney had a go in its 1964 film Mary Poppins. Trying to convince the child Michael Banks to deposit tuppence, the bank’s head, Mr Dawes Sr, paints a picture in song that draws on the concepts of risk and return, prudence and compound interest. It is a conceptual cut above more recent Disney films. 

In the same vein, the Solicitors Regulation Authority has also pulled off the feat of making bank accounts interesting, judging by the reaction to its Consultation on potential changes to how client money is handled in the legal sector. The paper is part of the regulator’s ongoing review of consumer protection arrangements.

'Why should third-party companies be trusted more than properly regulated officers of the court?'

Anna Newport, Newport Land and Law

Feelings are running high on one suggestion in particular: that law firms should cease holding funds in a client account under the firm’s own control. This is of particular relevance to conveyancing and private client solicitors.

It is at the centre of several areas being considered for change. The SRA is keen to stress that this is a listening exercise – it wants to prompt discussion and reflection, and does not yet have a policy position.

Many solicitors share the scepticism of property lawyer Anna Newport, principal of Newport Land and Law, Wakefield. ‘Why should third-party companies be trusted more than properly regulated officers of the court, who are already bound by stringent rules to safeguard client funds?’ she asks. ‘With the UK banking sector losing £1.17bn to fraud in 2023, it’s also worth questioning whether these external providers, as profit-driven entities, prioritise making money over protecting clients.’

Why now?

Controversy over these proposals has a context: the collapse of law firms Axiom Ince and SSB Group, leading to substantial losses for clients and, because of how the compensation fund works, in the case of Axiom Ince a huge bill for the rest of the solicitor profession. The SRA has been widely criticised for its superintendence of both high-profile casualties.

Peter Steel, chair of the Law Society’s regulatory processes committee, confirms: ‘As the Law Society has pointed out on several occasions, the backdrop to this consultation is the regulatory failure that preceded the collapses of both Axiom Ince and SSB Group.’

A report commissioned by umbrella regulator the Legal Services Board found that the SRA failed to act ‘adequately, effectively and efficiently’. For example, it missed an opportunity to identify the alleged misappropriation of funds from the firm’s client account at least a year before it took action against Axiom Ince. Steel notes: ‘The SRA did not properly use the powers already available to it to prevent… the huge loss of client money.’

The SRA previously dispensed with rules requiring all firms to submit annual accountants’ reports which, Steel says, ‘provided a degree of financial hygiene for practices, and often provided early warning of problem firms, for example, where no report was filed’. A second LSB report, on SSB, is awaited.

The SRA insists its consultation is no knee-jerk defence of its role but part of wider work. The product of what chief executive Paul Philip notes is ‘one of our largest ever and most in-depth pre-consultation exercises’, the consultation, which runs till 21 February, has several key elements. The SRA is asking:

• Whether, in a digital age, and with feasible/credible alternatives becoming more available which may be better at safeguarding client money, in the longer term it is still necessary or desirable for firms to hold client money as widely as currently the case, or at all.
• If rules around interest earned on client accounts, or how long firms can hold client money after the end of a case, need changing so they better serve client interests.
• If changes are needed in terms of the controls, checks and balances firms are obliged to have in place to protect money held in client accounts. This includes obligations regarding accountants’ reports and certain rules regarding control and oversight over client money.
• If changes are needed to how contributions toward the compensation fund are determined. For example, changing the 50/50 split between individuals and firms funding the scheme to a 70/30 ratio. In the long term, it also asks questions such as whether contributions should be varied based on considerations about firm size, areas of law or other risk factors.

On the table

There are certainly advantages to operating without a client account, explains Paul Bennett, partner at specialist professional services adviser Bennett Briegal. ‘The major benefit for law firms is the entire risk matrix of the firm is much simplified: for anti-money laundering, for internal and external fraud, for cyber fraud and human error… meaning the risks are much lower.’

The ‘onus duty’ to remedy any deficit on client account upon discovery is removed, which protects the partners of law firms, Bennett adds: ‘The costs of running a law firm are also reduced by the absence of a client account audit and the lowered PII [professional indemnity insurance] risk.’

However, as he says: ‘Only non-consumer, non-transactional firms can really operate this way. It is a very small group and I would be surprised if it was 5% of the SRA-regulated community.’

‘Firms can already operate without a client account if they choose,’ Steel confirms. ‘The fact that the great majority of firms elect to operate one suggests plainly what the market thinks of the current alternatives.’

‘Choosing whether to operate a client account is a complicated decision,’ says Colette Best, Kingsley Napley’s director of anti-money laundering. ‘But I sometimes hear firms say they won’t hold client money because of the money laundering risk.

'I believe that not operating a client account won’t lower your risk of being used to launder money, and in some cases might increase it'

Colette Best, Kingsley Napley

‘I don’t agree that this is the case. I believe that not operating a client account won’t lower your risk of being used to launder money, and in some cases might increase it. This is because not operating a client account doesn’t change the nature of the transaction you are facilitating or the advice you are providing, but will mean that you have less oversight over transactional payments. If you are operating a client account and have undertaken source-of-funds checks, you have the assurance that money coming into your client account is from the source and in the amounts you expected.’

The SRA, Best notes, stresses that firms are still required to undertake source-of-funds checks, even if the money is not passing through the client account.

Third-party managed accounts

In a reformed system, firms would rely on third-party managed account (TPMA) providers which, Bennett points out, ‘are expensive and pose distinct risks, some of which, given the market is in its infancy, are yet to be fully understood’.  

‘There is a market need for a trusted party to hold funds in many transactions,’ says Suzanne Gill, property partner at London firm Wedlake Bell. ‘At the moment, solicitors are trusted parties. I hope that’s mainly because we are seen as a trustworthy profession, but I’m sure the underlying insurance is relevant too.’

Gill considers what a different approach might entail: ‘I suppose we could all learn to get used to conveyancing deposits being held by “Deposits ‘R’ Us”, for example, in a way which wouldn’t slow transactions, but clients would need to pay for the services provided by “Deposits ‘R’ Us”.’

Even that approach, she says, still leaves gaps: ‘If a tenant client isn’t paying its rent for good reason, they might want to send the rent to their solicitors, to make the point that the money is available whenever the landlord does whatever it’s supposed to do.’

Steel concludes: ‘Alternative mechanisms, such as third-party management accounts, will be more cumbersome and costly for clients, even if viable for many kinds of transaction such as conveyancing or distribution of estates.’

The SRA stresses there is no prospect of immediate change. ‘The concept of alternatives to the model of solicitors holding client money is a longer-term option… We acknowledge that to have a range of products on the market that meets the needs of all aspects of the profession could take years to develop,’ the consultation notes.

Margins and vulnerable clients

From its public engagement, the SRA concludes that the security of client funds is a high priority. It also states: ‘The number and size of firms we have had to intervene into to protect the public has risen sharply, with increasing detriments – money gone missing or not available when needed.’

It is acknowledged that the use of TPMAs would come at a cost. From the perspective of both client and solicitor, that cost lands in a market context where profit margins are already low, which in itself increases risks. Melinda Giles, senior partner at Essex firm Giles Wilson, notes: ‘Residential conveyancing already faces huge challenges. It is a legal service driven down by a lack of respect for the importance of the service it provides to clients when they are usually making the biggest financial investment of their lives.

‘Money needs to pass nimbly from mortgage lender to conveyancer to join funds received from the client…  Any delay is often caused by the variety of systems used by UK banks.’

Giles has other concerns about an enhanced role for the financial services sector. ‘Probate, trusts and Court of Protection are highly sensitive areas of law where we work with grieving and struggling families,’ she adds. ‘UK banks are not fit for purpose in this area. They are currently unable to set up Court of Protection deputy accounts without a solicitor deputy attending in person in one of their rare branches. They release monies from deceased persons’ bank accounts without the correct legal authority.’

Interest and compensation

The SRA consultation also seeks views on the interest accrued on money held in the client account, which can be a useful income stream for smaller firms. ‘Consumer research,’ the SRA notes, ‘found consumers felt that it is their money, and they should receive any interest. As a minimum, they felt interest rates should reflect what they would have received in their own savings account.’

It is also notable that the Solicitors’ Charity and LawWorks both rely on many firms deciding to donate the interest earned on client money.

‘There appears to be no compelling case for change,’ Steel argues. ‘As long as firms have a clear interest policy, and there is full transparency at the outset of a retainer with the client as to what happens to the interest held on their money, it should remain the client’s choice as to whether they instruct a firm that will pay interest over to them or another firm where interest may be used differently.’

An equally weighty, related issue is the future of the compensation fund. Is the case for contributions to be varied based on considerations such as firm size, areas of law or other risk factors, at all persuasive?

Even before its intervention into Metamorph in December 2022, the SRA points out, average payouts from the compensation fund totalled £15.5m over the last six years.

‘It would be difficult to devise a fair and affordable system by which different firms would make different levels of contribution to the compensation fund,’ Steel says. ‘If the SRA were to propose such a scheme, it is vital that they are able to demonstrate the advantages and efficacy of such a scheme relative to the current arrangements – using empirical evidence and sound reasoning.’

 

Find more details on the SRA consultation here