SRA wants to stop solicitors pocketing interest on client money

Law firms should not be able to profit from holding money on clients’ behalf, the Solicitors Regulation Authority asserted today as it launched a wide-ranging consultation on consumer protection.

The regulator is considering whether to change its rules to prevent firms retaining any interest earned on client money, In research carried out this year, the SRA said it had not received any compelling evidence of how firms retaining any interest is in the consumer’s interest.

The SRA accounts rules require firms to pay their clients a ‘fair’ sum of any interest earned on client money, but there is no definition of what ‘fair’ means in practice.

Members of the public told researchers that they considered a ‘fair sum’ meant receiving all of the interest that their money earned, but they would consider allowing interest to be used to reduce legal fees.

Much of the thinking behind the consultation was trailed last week as the SRA answered questions on its handling of Axiom Ince. But the detail in the consultation, and the commitment to changing how client money is held, is new.

In its most recent financial benchmarking survey, the Law Society estimated that firms could have made as much as £27m total net income in interest on client money in 2022/2023. The SRA said firms had reported that by retaining some of the interest earned on client money, they can keep costs down, and improve affordability and therefore access to legal services. Some small firms told the SRA they relied on interest from client funds to remain viable or retain staff, especially in price-competitive areas such as conveyancing. Larger firms also reported increased profits because of client interest.

‘We are concerned that, particularly with large sums of money, the potential financial benefit may be driving behaviours that are not in the interest of clients,’ says the SRA consultation. ‘And we do not think it is appropriate for firms to continue to profit from holding money on behalf of clients. We consider that it is likely to be in the client’s best interest to receive all the interest from their money, and for firms to reflect their true operating costs through the fees that they charge. This is fairer to individual clients, more transparent and arguably would better promote effective competition.’

The SRA’s impact assessment acknowledged that smaller firms may be affected by cutting off the interest tap but that the proposal should bring positive impacts for the effectiveness and accountability of the profession.

In the short term, the SRA proposes to ensure that money held on behalf of clients to pay for legal fees is not transferred into the firm’s office account until it is ‘appropriate’ to do so. There is concern that the current rules on transfers offer too much flexibility about when money can be moved to the office account. If the client decides to terminate their retainer, the firm may not have money readily available to repay the money which the client paid to the firm. If the firm becomes insolvent, the client’s money would not be in a ringfenced client account.

A longer-term project is to look at whether firms should be able to hold client money at all. The SRA states that at present, the market for third-party alternative methods is not there.

Scrapping the client account for a centrally-held deposit function is popular with most consumers, and would reduce the need for a compensation fund, Such a system already operates in other jurisdictions including France.

The SRA said: ‘We want to consider the extent to which the number and type of TPMA providers may increase in the future and what other alternatives may look like.’

The consultation is open until 21 February and the coming weeks will also feature a series of engagement events for the SRA to collect views.

Law Society president Richard Atkinson said: 'Firms should continue to be able to operate client accounts, as they are vital for the effective and efficient delivery of many legal services.

'There is a danger that radical change will add cost and delay for clients and simply transfer the same or even greater risk from the current client accounts system to any new one. 

'Following the Legal Services Board’s decision to take enforcement action after its independent review into the SRA’s handling of the collapse of Axiom Ince, a key question that must be asked is how the SRA can improve its own monitoring and enforcement around these kinds of risks as part of its core regulatory function. Simply passing regulatory responsibility elsewhere is unlikely to be the answer.

'We look forward to working with our members to develop our response to this important consultation.'

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