SRA Risk Papers
The Solicitors Regulation Authority have published two papers in their Risk Resources section:
- Navigating stormy seas: financial difficulty in law frms; and
- Catching a chill: law firms and the risk of group contagion.
In the first of these – the one dealing with financial difficulties – they address the results of the recent data collection exercise which they undertook, designed to allow them better to understand the risks posed by the financial position of law firms. As a result, they have identified a number of poor practices associated with higher risk firms. These included:
- inability to measure or control financial performance;
- excessive use of borrowing and debt;
- excessive partner drawings and remuneration in relation to profit and revenue;
- over dominant senior partners or managers;
- lack of transparency on financial performance amongst appropriate levels of management;
- inappropriate use of client account;
- weak process for collecting on bills for completed work;
- inadequate planning and due diligence for diversification of legal practice or acquisitions of other firms; and
- narrow focus on a single type of legal work.
The second paper dealing with group contagion looks at a risk that has only arisen recently in the legal profession and is most likely to be found in large conglomerate structures that contain several firms and entities within a single group. Mostly, therefore, this will apply to business such as ABSs and those firms practising through more complex legal structures.
The paper states that there are effectively two main forms of group contagion:
- Direct contagion – financial shock to one firm in the group spreading through the rest of the structure through direct financial links; and
- Indirect contagion – outsiders reacting to an event at one firm in the group, with impacts on the rest of the structure.
So far as the former is concerned this is best dealt with through firewalling whilst the latter is harder to control where a single brand is used and can result in reputational harm.
The report argues that both forms of contagion can lead ultimately to financial loss and on to other associated risks, such as disorderly closure or misuse of client money. This can in turn lead on to a risk to the regulatory objectives of the business and the legal market as a whole including damage to the interest of consumers, damage to public trust in legal services and independence of the legal sector.
The paper concludes by encouraging firms to adopt effective firewalls between the legal and other parts of their business and to have in place procedures which can deal with the reputational risks that might arise and so control wider damage.