Tim Kidd was pleased to contribute an article to The Law Society's Managing for Success magazine, looking at the recent SRA consultation on handling client money. You can read the article here or below:
The changing regulatory landscape for law firms - what does the future hold?
Tim Kidd, Chief Executive of The ILFM
The Solicitors Regulation Authority (SRA) recently closed its consultation on potential changes to the handling of client money, reflecting its ongoing review of consumer protection in the legal sector. The consultation, published on 14 November 2024, will explore significant changes that could reshape the way law firms manage and protect client funds. The proposed changes raise fundamental questions about whether firms should continue holding client money, the rules surrounding interest on client accounts, and the controls and oversight mechanisms in place, and have sparked discussion across the profession, raising questions about how firms will need to adapt and what the future regulatory landscape will look like.
This article outlines the key aspects of the consultation and considers the potential impact on law firms. We will focus on Parts 1 and 2 of the consultation, which examine how client money is held and the protections in place to safeguard it.
1. The Future of Holding Client Money
One of the most radical aspects of the SRA’s consultation is whether law firms should continue to hold client money at all. The consultation acknowledges that in an era of digital banking and alternative financial solutions, there may be safer, more efficient ways to manage client funds. While the use of Third-Party Managed Accounts (TPMAs) is currently limited, the SRA is considering whether their use should be expanded and whether more TPMA providers may emerge in the future. If law firms are restricted from holding client money, this could fundamentally change the financial operations of legal practices, requiring them to adopt new models for handling transactions.
For firms that continue to hold client money, the SRA is reviewing how long such funds can be retained after a case concludes. The current rule requiring firms to return client money ‘promptly’ is open to interpretation. The SRA is considering setting a 12-week deadline for returning residual balances, with an additional 12-week period for tracing owners before funds must be donated to charity or apply to the SRA to do so where funds are in excess of £500. This move aims to enhance clarity and ensure that client money is returned efficiently.
The ILFM consulted its members in order to draw up a response to submit to the SRA as part of the consultation. Unsurprisingly, 100% of members that responded disagreed with the long-term option of changing the model of firms holding client money.
Reasons given by members included the impact on client service levels, delayed transactions, the increased risk to client money being held by a few organisations as opposed to being spread across multiple banking institutions, and an increase in fees.
2. Interest on Client Accounts
The consultation also questions whether firms should be allowed to retain interest earned on client accounts. The SRA suggests that the current approach may not always serve clients' best interests and could incentivise firms to retain funds unnecessarily. It proposes changes that would either require firms to pass all interest to clients or explore alternative uses, including the provision of free legal services and legal education, as seen in jurisdictions like Canada and Australia. While this could enhance consumer benefits, it may also require firms to implement more complex interest-tracking systems.
3. Strengthening Oversight and Controls
The SRA is seeking to improve the safeguards in place to protect client money, with a focus on strengthening accountants' reports and ensuring compliance. Currently, firms must obtain an annual accountant’s report, but only qualified reports need to be submitted to the regulator. The SRA believes this has led to inconsistent compliance, with some firms failing to obtain or submit required reports.
The consultation proposes three potential changes:
Reintroducing mandatory submission of all accountants' reports for non-exempt firms.
Requiring reporting accountants to submit an annual declaration confirming they have provided a report and whether it was qualified.
Introducing an annual declaration for firms confirming whether they are required to obtain an accountant’s report, whether they have obtained a report and if it was qualified.
These changes aim to enhance transparency and ensure better regulatory oversight. Additionally, the SRA is considering requiring firms to rotate their reporting accountants periodically to maintain independence and prevent complacency.
4. Managing Advance Fees and Transfers to Office Accounts
A key issue in the consultation is how and when firms can transfer funds from client accounts to office accounts. The SRA is concerned that firms may be transferring money in advance of work being done (or for a future disbursement not yet incurred). Under the proposed changes, client funds could only be transferred once a firm has issued a bill or other written notification for costs already incurred.
Similarly, the SRA is reviewing the practice of solicitors requesting advance fees. While it is common for firms to request upfront payments, the regulator is questioning whether some firms are taking larger advance payments than necessary, potentially to improve cash flow and because of the interest that they receive on this money rather than serve clients' interests. The SRA is exploring whether to impose limits on advance fees or restrict when they can be requested.
5. Strengthening Compliance and Internal Controls
The consultation also proposes stricter controls over the roles responsible for managing client money within firms. The SRA has identified risks associated with individuals who have significant decision-making power within a firm also holding key compliance roles. To mitigate this, it is considering rules preventing such individuals from acting as compliance officers.
For smaller firms, where such separation of roles may be difficult, the SRA is seeking views on alternative safeguards, such as requiring external compliance reviews or independent audits. Additionally, the SRA intends to introduce new support measures to strengthen the role of compliance officers, ensuring they are equipped to maintain effective financial safeguards within law firms. The ILFM supports this measure - many of our members are COFAs who shoulder the significant responsibility of compliance alone, and can feel unsupported and isolated in this role. Our members have, however, highlighted the potential for an adversely negative impact on smaller firms, should these proposals be implemented. Their concern was that smaller firms would not be able to afford the cost of external compliance support, but agreed that more regular training is paramount.
What does this mean for law firms?
The consultation has now closed, and the legal sector awaits the SRA’s next steps. If the proposed reforms are implemented, they could bring about fundamental shifts in how law firms operate. The potential requirement for firms to reduce their reliance on client accounts, or move towards alternative models, would represent a significant change to long-established practices. This could create both operational challenges and financial implications,
Furthermore, greater regulatory scrutiny around residual balances and interest on client accounts may lead to increased administrative burdens, requiring firms to review their accounting procedures and client money policies. Compliance teams may also need to adapt to stricter reporting requirements and enhanced oversight measures.
Strengthening Client Trust and Confidence
At its core, this consultation reflects a broader regulatory drive towards enhancing transparency and consumer trust in the legal profession. Clients expect their money to be handled securely and in their best interests, and the SRA’s proposals aim to reinforce these protections. By implementing more robust safeguards and increasing accountability, the legal sector has an opportunity to strengthen its reputation and demonstrate a genuine commitment to ethical financial management.
The coming months will be crucial in determining how these changes take shape. Law firms should stay engaged with developments, assess their internal systems, and prepare for any adjustments they may need to make.
The ILFM is also interested to see whether the SRA decides that their current “one size fits all” approach is still fit for purpose - bearing in mind the substantially different challenges faced by large corporate law firms in comparison to small practices, with significantly differing client needs.
Ultimately, while these reforms may introduce new challenges, they also present an opportunity to modernise financial management practices and build even greater confidence in the legal profession.
Tim Kidd is Chief Executive of The Institute of Legal Finance & Management. The ILFM is the leading education and membership organisation in the legal sector, supporting legal finance, compliance and practice management professionals across England, Wales & Northern Ireland. It provides qualifications, training, knowledge, support and information for anyone working in legal accounts, compliance and law firm management. Our members include legal cashiers, accounts managers, compliance officers for finance and administration (COFAs), practice managers, finance directors, CEO's, MLRO & MLCO's and sole practitioners. For further information on how we can help your firm, visit our website: www.ilfm.org.uk
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