On 22 April 2013 the SRA published new guidance to Chapter 7 of the Code of Conduct 2011. It focuses on financial stability issues which – in the light of recent high profile business failures – they class as a critical risk.
Whilst the guidance should not contain anything new or surprising to the COLP and COFA, it does give a useful insight into the regulator’s thinking. Note in particular what they class as ‘poor’ and ‘good’ financial behaviours:
- Drawings exceeding net profits
- High borrowing to net asset ratios
- Increasing firm indebtedness by maintaining drawing levels
- Firms controlled by an “inner circle” of senior management
- Key financial information not shared with “rank and file” partners
- Payments made to partners irrespective of “cash at the bank”
- All net profits drawn, no “reserve capital pot” retained
- Short-term borrowings to fund partners’ tax bills
- VAT receipts used as “cash received” resulting in further borrowings to fund VAT due to HMRC
- Partners out of touch with office account bank balances
- Heavy dependence on high overdraft borrowings
- All partners regularly receive full financial information including office account bank balances
- Drawings are linked to cash collection targets and do not exceed net profits
- Provision is made to fund partners’ tax from income received
- A capital element is retained from profit, and a capital reserve account built up
- Premises costs are contained
- Profitability levels are tested and unprofitable work is (properly) dropped
Of course, that does not mean that a business which, for example, relies on facilities for cash flow and capital expenditure is necessarily a risk to clients. It is for the COLP and COFA (arguably more of a COFA responsibility) to asses the finances of the business and make sure that any risks are identified and dealt with.
Remember that all principals – not just the compliance officers – are ultimately responsible for the firm’s financial health.
As a general point, the profession is rightly nervous about the lack of practical detail in the Code of Conduct, and anything the regulator can do to help firms apply the Outcomes must be welcomed. More, please!