When the SRA launched its “Risk Outlook” in July there was no doubt that the most significant risk identified was financial difficulty/stability. At the heart of the matter is Principle 8 of the SRA Handbook:
“you must run your business effectively and in accordance with proper governance and sound financial and risk management principles”
The Risk Outlook was followed by an SRA e-mail campaign, which saw the regulator requesting sensitive financial information from over 1,000 firms in order to assess their financial stability. The main focus of this particular exercise was firms that the SRA feel could be particularly vulnerable to recent changes to personal injury or legal aid work.
The SRA have since identified 495 firms as being high risk of becoming financially unstable, and have started ‘intense engagements’ with 55 of them. (There was no choice for those firms but to respond – it is of course a further requirement to “deal with your regulators…in an open, timely and co-operative manner” (Principle 7)).
The regulator’s concerns are understandable – there is a direct link between financial instability and the dishonest misuse of client money, which is itself potentially the biggest reputational threat to the profession. Indeed, the SRA also recently revealed that the number of disciplinary cases involving this type of dishonesty has doubled in the past two years.
Of particular concern, and another trend identified by the SRA via interventions, is the fact that financial issues are often ignored by firms in difficulty – the temptation being to bury their heads in the sand and plough on regardless.
So, what should we do?
We hope that the following tips will get you get you thinking about ways to practically manage your financial stability, and stay on the right side of the regulator:
1. Check that none of the following characteristics apply to your firm (as all have been highlighted by the SRA as indicating a firm in difficulty):
– Management weaknesses – such as excessive concentration of power and limited sharing of financial information between partners/management
– Accounting weaknesses – inadequate budgetary controls or weak cash flow planning
– Change handling – such as failure to adapt to changing markets or the changing needs of clients
2. Carry out a full review the systems and processes that you have in place for managing the on-going financial stability of the firm and risks to funds entrusted to you by clients. This goes beyond your mandatory accountant’s report, and could involve asking your accountant to identify any structural and procedural weaknesses
3. Get a financial management policy in place as part of your overall Compliance Plan. It will help the COFA to perform their role by explaining to staff and management what financial management is and why it is so important, and explain what needs to be reported to the SRA. A well-worded policy will help build a culture of financial awareness and prudence in your firm and will evidence that the COLP and COFA are taking reasonable steps to ensure compliance with the rules.
4. Once all of the above points have been addressed ensure that the financial stability of your firm is regularly monitored. The COFA will be looking at the figures on a daily basis, and we recommend that the bigger picture is considered and documented on a monthly basis by the COLP, COFA and management. This should enable you to spot potential trends, and nip any issues in the bud before they become problematic.
5. Use the SRA traffic light system to help assess your financial stability. Green if none of the indicators below apply, Amber if 1 applies, and Red if 2 or more apply –
– Drawings exceed profits
– Borrowings exceed net assets
– Your firm is simply borrowing too much
6. Remember the obligation to report any of the following to the SRA promptly:
– serious financial difficulty
– indicators of financial difficulty (e.g. inability to pay PII premium, salaries or overheads)
– the firm becoming not financially viable as a going concern, and
– any other serious issues that your monitoring identifies.
The SRA believe that early engagement with them will help to give a financially struggling law firm the best chance of survival. Given the regulator’s track history of adding misery to woe, firms will have their own views on this. The cold fact is that there is an obligation to report financial problems (a personal one for the firm’s COLP and COFA), and we are likely to see more firms having to go down this road. Just recently, the Gazette reported that more than 1,000 firms ceased practising over the course of 12 months, with predictions that even more small firms will struggle when the economy does start to pick up, due to a lack of cash during the recovery phase.
