Reporting Material Breaches
Comments made at the Solicitors Regulation Authority’s (SRA) first ever dedicated compliance officer conference on 16 October 2013 highlighted the importance to the SRA of firms reporting material breaches to the SRA in a timely and effective manner.
But what precisely does that duty consist of and, more importantly, what constitutes a material breach for these purposes and when must it be reported?
The stance that the SRA currently take is that a material breach must be reported within 24 hours of it being discovered. That is all well and good provided that it can be determined with a degree of accuracy that a breach is material and that it has a moment of revelation rather than, as so often happens, becoming apparent only after further investigation.
To help us answer the question of what and when we need to report material breaches, therefore, we need to look at the precise nature of the duty and to what it applies.
Source of the duty
The duties to report a material breach lie principally with the Compliance Officer for Legal Practice (COLP) and the Compliance Officer for Finance and Administration (COFA). Those duties arise initially from sections 91 and 92 of the Legal Services Act 2007 (LSA).
Thus section 91(3) requires the Head of Legal Practice (the COLP) to:
“(a) take all reasonable steps to ensure that the licensed body, and any of its employees or managers who are authorised persons in relation to an activity which is a reserved legal activity, comply with the duties imposed by section 176, and
(b) as soon as reasonably practicable, report to the licensing authority such failures by those persons to comply with those duties as may be specified in licensing rules.”
whilst section 91(4) provides that the Head of Legal Practice of a licensed body must—
“(a) take all reasonable steps to ensure that non-authorised persons subject to the duty imposed by section 90 in relation to the licensed body comply with that duty, and
(b) as soon as reasonably practicable, report to the licensing authority any failure by a non-authorised person to comply with that duty.”
The corresponding duty upon the Head of Finance and Administration is to be found in section 92 of the LSA which provides:
“(1) The Head of Finance and Administration of a licensed body must take all reasonable steps to ensure compliance with licensing rules made under paragraph 20 of Schedule 11 (accounts).
(2) The Head of Finance and Administration must report any breach of those rules to the licensing authority as soon as reasonably practicable.”
These duties have been given the force of regulation by the SRA in Rule 8.5 (c) and (e) of the SRA Authorisation Rules 2011 (the Authorisation Rules). These provide that:
- in the case of a licensed body – e.g. an Alternative business structure – they must report to the SRA any breach, material or non-material, as soon as reasonably practicable, and
- in the case of a recognised body – e.g. a partnership, recognised sole practitioner, LLP or company that is not a licensed body – material breaches as soon as reasonably practical.
What is the duty?
Neither the Authorisation Rules nor the LSA offer any specific guidance as to what constitutes a material breach or, indeed, how soon is “as reasonably practicable”. Such are the vagaries of outcomes focused regulation!
Note (x) to Rule 8 of the Authorisation Rules provides as follows:
“In considering whether a failure is “material”, the COLP or COFA, as appropriate, will need to take account of various factors, such as:
- the detriment, or risk of detriment, to clients;
- the extent of any risk of loss of confidence in the firm or in the provision of legal services;
- the scale of the issue; and
- the overall impact on the firm, its clients and third parties.
In addition, the COLP/COFA will need to keep appropriate records of failures in compliance to:
- monitor overall compliance with obligations;
- assess the effectiveness of the firm’s systems;
- be able to decide when the need has arisen to report breaches which are material because they form a pattern.”
Not necessarily that helpful a definition in practice and further complicated by the fact that a material breach could be a breach which, on its own, would not have been material but which becomes material if it forms part of a series of breaches.
Thus, it really has to be a judgment call for each firm as the situations arise.
Furthermore, quite what “reasonably practicable” means is not defined at all.
The Law Society have been unable to shed any further light on the matter at this stage either. They repeat in their Practice Note for Compliance Officers the guidance provided by Note (x) to Rule 8 and go on to say that :
“Compliance officers must remember that the SRA Code covers a wide range of issues including business management and financial stability and notify the SRA if they believe the practice is in serious financial difficulty.”
whilst in their practice advice FAQs they state:
“What is ‘material’ will depend on the firm and the circumstances around possible failures to comply with the SRA Authorisation Rules, and the SRA will judge each case on its own merits. As set out above, factors such as the detriment or risk of detriment to clients, the scale of the issue and overall impact on the firm will need to be considered in deciding whether a failure is ‘material’.”
Neither statement takes us any further forward.
The reluctance of the SRA to provide further guidance is a frustration for many firms. In a speech by Samantha Barrass, Executive Director of the SRA, to the COLP and COFA conference on the 18 October 2012, she said :
“…we have resisted the pressure to produce more detailed guidance on breaches for good reasons. First, we do believe well run firms should be able to use their own judgement on what constitutes risk and a serious breach. Second, providing detailed prescription on what is and isn’t a material breach is a fools errand. If you’re wondering whether or not a breach is material, then it probably means it is material. Moreover, we are always happy to have a conversation in the context of any particular issue, to advise on whether the matter is something we need to know about.”
Examples of potential material breaches
Whilst clearly we cannot provide a comprehensive list of all of the circumstances that could constitute a material breach, the following may be helpful in assessing whether a particular action or omission within your firm does constitute a material breach.
The list is by no means exhaustive and is there simply to give an idea as to some of the situations which could give rise to a need to report a material breach.
Therefore, because an issue is not included in the list does not mean that it might not, in certain circumstances, be regarded as material – especially if it forms part of a series or pattern of breaches.
As the regulations provide, the circumstances of the breach are all important in determining whether the breach is material.
It is also worth mentioning that, notwithstanding the statement by Samantha Barass quoted above, the SRA are reluctant to give you any guidance as to whether a breach is material – even if you contact the Ethics Helpline or Contact Centre. They are likely to tell you that you have to make that decision yourself and then refer you to note (x) to Rule 8.
Accounts Rules Issues – it is probably safe to assume from the outset that most issues relating to a breach of the accounts rules should be regarded as material unless they are of a particularly minor nature. Thus, for example, the following are potentially material breaches – especially if they have occurred more than once:
- holding, and in some cases simply paying, client money in office account,
- paying client money into the wrong client account,
- unauthorised withdrawals from client account,
- fraudulent withdrawals from client account,
- making a secret profit (e.g. marking up disbursements with an “admin” element ),
- use of client account as a banking facility,
- failing to pay interest due to client,
- failing to account to client promptly for excess balances on client account at the conclusion of a matter,
- failing to keep adequate accounts,
- paying money to one client only where the instructions are joint instructions,
- paying client money to the wrong third party,
- holding client money outside of client account either when not done because it is in the client’s interests or when done as a general or blanket policy,
- withdrawal of costs from client account before a valid bill has been delivered to the client,
- placing money on account of costs into client account or withdrawing money on account of costs before a valid bill has been delivered
- attempting to exclude liability below the minimum level of cover required by the SRA Indemnity Insurance Rules;
- repeated failure to inform clients of their right to complain or to refer issues to the LeO or failure to correct that when discovered;
- failure to inform current clients if you discover any act or omission which could give rise to a claim by them against you;
- repeatedly failing to inform clients about costs;
- repeatedly neglecting to discuss fee sharing or referral arrangements with the client;
- failing to take account of a client’s vulnerability, such as incapacity or duress;
- acting for a client who proposes to make a gift of significant value to you or a member of your firm or family without requiring the client to take independent legal advice;
- ceasing to act for a client without good reason and without providing reasonable notice;
- entering into unlawful fee arrangements such as an unlawful contingency fee.
Equality and Diversity
- intentional discrimination by a member of staff against a client, third party or employee;
- failing to take on a client for reasons connected with a discriminatory factor,
- failing to employ someone for reasons connected with a discriminatory factor,
- harassment and bullying within the firm,
- being subject to any decision of a court or tribunal that you have committed, or are to be treated as having committed, an unlawful act of discrimination.
- knowingly acting in a conflict situation,
- selling to, lending to, buying from or borrowing from a client without that client having obtained independent legal advice;
- becoming aware that a member of the firm or a member of staff has used a power of attorney to gain a personal advantage.
Confidentiality and Disclosure
- emailing a third party in error and disclosing confidential client information,
- loss of file, papers or electronic equipment containing client data,
- firm’s network or web site being hacked resulting in third party access to client data,
- disclosing client details whilst social networking,
- disclosing the contents of a will on the death of the client without the consent of the personal representatives.
Issues relating to the Court
- knowingly allowing a client to mislead a court,
- misleading the court,
- failure to comply with directions from the court,
- being in contempt of court,
Introductions, referrals and fee sharing
- repeated failure to notify client of a referral fee or fee sharing,
- failing to account to a client for commission received as a result of their instructions.
- ongoing failure to provide adequate supervision,
- breach of an undertaking,
- negligence other than trivial negligence – could include missing deadlines and court hearing dates, continued delay in progressing a client matter and delivering incorrect legal advice to the detriment of the client.
This is, as was said earlier, only a sample of the kinds of issues which could constitute material breaches.
Putting things right
Although it will usually be appropriate for the firm to take steps to remedy breaches immediately, this does not necessarily obviate the need for compliance officers to record the breach and make a report in compliance with Rule 8.5 where appropriate.
Clearly the circumstances will again be a relevant factor. Thus, for example, if a member of staff steals money from a client account then, even if the firm makes good the loss, dismisses the staff member, informs the police and puts in place procedures to ensure that the situation does not arise again, there should still be a report of a material breach to the SRA. However, if a fee-earner fails to notify a client of their right to complain at the outset of a transaction but realising their mistake does so without the client have incurred any loss then this would in most cases (unless for example it formed part of a series of such events) not constitute a material breach.
What do I do if a material breach occurs?
If a material breach does occur then, as the Authorisation Rules require, the firm should make a report to the SRA. This should be in writing and may be made either to the SRA at its offices in Birmingham or to the email address email@example.com.
The thorny question of when the report should be made arises also. The SRA currently take the view that it should be within 24 hours of the breach being discovered. However, this does not take account of the fact that it may not be possible to make an adequate report until further investigation has taken place or until the facts are known. Perhaps the best advice is to say that it should be reported at the first opportunity to do so after it is discovered. This may mean not waiting until steps to remedy the breach have been taken or it may mean, in circumstances where remedy is more important than report, taking steps to remedy the problem first. AS with so much else in this area, the circumstances will dictate when it is appropriate to do so.
Where it is possible to do so, the firm should take all reasonable steps to correct the breach – whether or not it is a material one, and should also take steps to ensure that procedures are put in place to prevent such a breach arising in the future. Clearly this will not always be possible. However, where it is this is likely to be something which will make the SRA look more favourable on the firm.
Not all reported material breaches will necessarily result in any action being taken by the SRA towards the firm. Again it depends upon the nature of the breach and the outcomes that arise from it.
A final word – bear in mind that this article relates to material breaches to be reported to the SRA as a consequence of the COLP and COFA roles. It has not addressed any of the reporting requirements dealt with in Chapter 10 (You and Your Regulator) of the SRA Code of Conduct.
If you have an issue relating to reporting of a material breach and you would like some assistance – whether it be in determining if it is a material breach, making an appropriate report or putting in place procedures to ensure that the issue does not arise again – then please contact the Lawyers Defence Group:
- by phone on 0333 888 4070;
- by email to firstname.lastname@example.org;
- by requesting a callback using the form in the right hand menu and someone will call you back; or
- by writing to Lawyers Defence Group at one of the addresses on our contacts page.