SRA consultations – Armstrong Watson’s views on potential changes for client money, residual balances and interest

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Significant reforms to the Accounts Rules in 2015 aimed to introduce what the Solicitors Regulation Authority (SRA) described as a “more flexible, principles based approach to regulation”. Ten years on, and following the high-profile collapse of Axiom Ince, the SRA is now considering whether a move back to more prescriptive rules is necessary in certain circumstances.

Proposed changes to SRA Accounts Rules

In November 2024 the SRA began consulting on:

1. The model of solicitors holding client money: Should the SRA be looking at ways to reduce the client money held by solicitors?
2. Protecting the client money that solicitors hold: What controls, checks and balances are appropriate?
3. Delivering and paying for a sustainable compensation fund: How should payments from the legal profession be calculated and payments from the Fund to reimburse consumers be allocated?  

As a firm that advises a significant number of law firms, we have read the consultation and considered how the proposed changes in part 1 and part 2 may affect firms. A well-regulated legal sector is key for the functioning of the economy and the safeguarding of client monies is critical for consumer protection and maintaining confidence in the legal sector. Below we outline our thoughts on the proposals and whether some of the significant changes proposed will have a positive impact on consumers and the legal sector.

1. The model of solicitors holding client money

Alternative methods of holding client money

Proposals to prohibit firms from holding client money are not new. Such a proposal would have implications for both firms and consumers.

Firms holding client money directly can execute transactions more swiftly than firms that utilise a third party. Timely execution of most legal transactions is vital – delays will have an adverse impact on consumers.

If firms are unable to hold client money the cost of the provision of legal services will also increase. This would be driven partly through the cost of using a Third Party Managed Account (TPMA) and partly through a reduction in the amount of client money interest received, on which firms currently make a profit that pays for the cost of administering the client money. The price charged to consumers will increase as a result.

Our position is that firms should continue to be allowed to hold client money. Whilst TPMAs are a viable alternative, mandating their use in response to the actions of a minority of firms disregarding the rules appears disproportionate. Fundamentally, a change that results in a reduction in service levels coupled with an increase in consumer costs will further damage the profession and adversely impact consumers.

Residual balances

The current rules require that on the conclusion of a matter, client money is returned “promptly,” however, this is undefined, leading to different interpretations by different firms. The consultation suggests defining a timeframe for the return of client funds and asks firms for their opinion on whether a 12-week period for the return of excess funds would be sufficient.

Whilst some firms would welcome clarity on the timeframe for the return of client funds, there is a risk that a move to a prescriptive rule in this area will lead to firms’ delaying the repayment of funds and, in a small number of cases, considering the 12-week residual balance amount as a source of working capital. Many firms already repay balances well within a 12-week threshold so this change could lead to an adverse impact on consumers. A potential compromise may be to continue to require such money be repaid promptly, with there being an expectation that repayment would be made within less than 12 weeks.

Interest

In recent years, many firms have generated a significant return on client money as interest rates have increased. This has led to some disquiet as firms could be seen to be profiting from monies that belong to clients. For some firms, the interest income has enabled them to remain profitable.

The consultation asks for firms’ views on whether retaining interest on client monies should be prohibited, subject to a de-minimis.

Our position here is linked to our view that solicitors continue to be allowed to hold client money. Given that solicitors’ ability to hold client money facilitates timely execution of matters and helps keep costs low, it appears reasonable that firms be permitted to retain some portion of interest generated on client accounts. Rather than this be treated as a windfall this could be considered as a contribution to the cost that firms incur operating the client account.

The consultation does pose further questions regarding the calculation of interest. The current rule is that firms account for a “fair sum of interest”. This is a principle-based rule that is open to interpretation. Unsurprisingly, firms’ interpretations of “fair” can differ considerably. To enable clients to assess whether the amount received is fair, the SRA could issue a table of the amounts held and appropriate rates of interest compared to base rate that should be applied. This would enable the client to receive the fair amount of interest for their balance and for the firm to receive a fair amount for their administration. This could be over-ridden by a set de-minimis limit that is periodically approved by the SRA, for example £50.

2. Protecting the client money that solicitors hold

There are other ways that consumers can be protected. One of the proposals is to require all Accountants Reports to be submitted to the SRA, regardless of whether they are qualified (contain breaches) or not. Until 2015, when the SRA moved away from such a prescriptive regime, all reports were required to be submitted to the SRA. Since 2015 only qualified reports require submission, and even then “qualified” does not mean all breaches, but only material breaches. This change increased the risk that some firms may not be commissioning Accountants Reports at all.

We are of the opinion that mandatory submission of all Accountants Reports would enhance the regulatory regime. We consider that the guidance to accountants to only qualify reports if breaches are material should remain unchanged. The SRA would only need to review the qualified reports. This change would provide the SRA with:

• improved oversight over which firms have obtained reports
• which firms have received qualified reports
• which firms have obtained reports within the 6-month period

This change would not impact the consumer experience nor the cost of legal services. The additional regulatory burden would be minimal – most firms comply with the regulations already and mandatory submission of a document that is already in existence will not substantially change what they need to do. Our position is that mandatory submission of Accountants Reports would be a positive change for consumers and firms.

The consultation period ends of 21 February 2025.