Legal update: Update on the world of SRA Accounts Rules compliance

11 July 2023

In the March edition of our Legal Focus, we noted that the SRA were poised to issue further guidance on their often misinterpreted rule concerning the provision of prohibited banking facilities.

With little in the way of fanfare, and shortly after publication of our last edition, the guidance did indeed appear, along with an updated practice note from the Law Society concerning residual balances.

On top of all of this activity, the SRA’s consultation on changes to the Accounts Rules (and wider regulation) closed for public response in early March and so, while we wait for the outcome of that, it is quite easy to lose track of what is going on in the world of SRA Accounts Rules compliance.

For quite a long time, there was very little update from the SRA on Accounts Rules guidance and, prior to the recent activity, the last time anything substantial was issued was back in late 2020 when the SRA released a detailed note on when firms should and should not withdraw money from the client account to pay for disbursements.

Most firms with a March or April year end (and that is the vast majority in our experience) will either be planning for, be in the midst of, or be recovering from this year’s Accounts Rules audit. For those yet to begin the process, the following round up will be a useful checklist of the key issues that your Reporting Accountant will be focusing their efforts on. For those finishing up or reflecting on this year’s visit, this will provide a debrief and reminder of some of those issues that probably did crop up in some way and will help focus the mind on areas of improvement for next year.

New guidance on provision of prohibited banking facilities

Rule 3.3 of the SRA Accounts Rules (as they stand at the time of writing this), states that firms must not allow the client account to be used to provide banking facilities to clients.

In a nutshell, this means that firms should only allow money to pass through or be held in the client account to the extent that the money relates directly to an ongoing legal service that the firm is providing to the client.

This is a fairly straightforward concept, and most firms are well aware of the risks of receiving money from clients and paying that money to unrelated (and unchecked) third parties without any apparent reason. However, the requirement of the rule does not end there, and we tend to see firms unintentionally breaching the rule in a number of ways, such as:

Holding on to rent deposits for clients following completion of a lease arrangement
Acting for property developers and funds are held back for long periods of time to settle future liabilities to various third parties
Acting for trustees on a relatively straightforward administrative basis, but holding large sums of money for indefinite periods of time or paying money on behalf of the trustees from the client account when this should be dealt with by the trustees themselves
Receiving money for clients who are unable to hold the money for themselves – for example when holding compensation payments on behalf of clients who do not have a bank account
Holding money in-between cases for recurring clients in anticipation of future work

Back in 2014, the SRA published a warning notice on the subject, but that mainly considered more extreme (and blatant) examples of non-compliance, and therefore, several years ago, the SRA released further guidance, including a dozen case studies that set out some practical, real life examples of where firms had been misinterpreting the rules.

Those case studies were fairly detailed and provided a useful reference for many of us, but there were clearly some gaps. It is also fair to say there were some areas that revealed a lot of firms that had been unintentionally in breach of the rules for a long time (holding commercial rent deposits being the main point).

Since then, a lot of firms have struggled to bring themselves into line with the requirements of the rules, while still feeling they are acting in the best interests of their clients.

In March 2023, the SRA released updated guidance with the aim of clarifying some of the uncertainty, while also filling the gaps from the original guidance.

The first part of the guidance offered little new, being a simple re-emphasis of the need for firms to avoid providing banking facilities, but the second part of the guidance is much more helpful, expanding the original dozen case studies to 16, while also adding more weight to some of the original examples.

Commercial rent deposits – holding on to deposits indefinitely where a matter has ended is still a breach of the rules. However, there is recognition from the SRA that some firms are holding on to deposits that predate the guidance and warning notices and, in these cases, the SRA does not expect firms to renegotiate the terms of the leases. They do however expect firms to at least look for opportunities to enter into alternative arrangements, such as opening a joint account with the landlord. For Reporting Accountants, this is a particularly welcome clarification, as this has been the topic of countless discussions over recent years. It is an acknowledgement of the difficulties facing some firms, if not an outright relaxation of the requirements, and firms need to be absolutely clear that entering into new arrangements of this type with clients is still prohibited. From the point of view of the Reporting Accountant, this would most likely constitute a reportable breach.
Lasting powers of attorney (LPA) – acting under an LPA and holding the client’s money in the firm’s client account (presumably rather than operating a client’s own bank account) is fine and in accordance with the rules, though firms should consider whether operating a client’s own account or designated deposit account would be in the best interests of the client.
Lenders and mortgage offers – the example used by the SRA is where a firm acts for the lender and the borrower (common practice in conveyancing matters) and a condition of the lender is that certain debts, such as credit cards, of the buyer are paid prior to completion. In this case, the payment to third parties would be allowable, providing the firm acts strictly in accordance with the conditions of the mortgage. This is also a helpful clarification given that acting in this way on most other types of matter would be a clear breach of the rules.
Legal only advice retainers – put simply, where a firm’s engagement with a client is purely to give advice to a client, there is little justification for the firm to be asked to handle client money. The SRA example is based on a firm providing specialist SDLT advice and then being asked to deal with the physical payment of the tax. As Reporting Accountants, it is easy for us to see that there is no justification for the firm to actually receive and pay the tax on this type of matter. In our world, we are always advising clients on tax related matters, as well as commercial arrangements, share sales, property disposals etc. and we never (or at least very rarely) handle any cash transactions arising from that advice. Just because it is normal for law firms to operate a client account for certain types of work, it should not be the default that they will do the same for others.
Divorce matters – another common area of confusion for law firm finance teams arises on divorce cases and, specifically, what to do with funds when things grind to a halt. The SRA makes it clear that, where there is client money held but it can only be distributed with joint instructions, then holding onto that money – even for a long period of time – is not a breach of the rules while the matter is still technically ongoing. Furthermore, if some of those retained funds need to be paid out to a third party, in this case settling a backlog of school fees for a child, then there’s no problem, even when that could be considered ancillary to the legal matter.
Conveyancing matters – the final point we want to highlight is the common issue where firms end up holding on to money at the end of a conveyancing matter, subject to a developer dealing with a snagging list or the local authority adopting a road.
Readers will be happy to note that these scenarios will not be viewed as a breach of the rules, hopefully bringing to an end a lot of debate between COFAs and Reporting Accountants.

It is useful for firms to be fully up to date with all of these cases studies, especially for those firms currently undergoing the annual audit. Some, less experienced, Reporting Accountants may raise issues that were previously viewed as a breach but may now be viewed differently in light of the updated guidance.

The updated list of case studies can be found here.

Residual balances – The Law Society has updated its practice note

The concept of having to deal with residual balances is not new – the requirement to deal with them has been around for 15 years now – but that does not mean the problem has gone away.

In our experience, and along with the provision of prohibited banking facilities, this is the leading source of qualified Accountant’s Reports.

The updated Law Society practice note, issued earlier this year, acts as a useful reminder of the steps firms should be taking when trying to locate their clients.

Bearing in mind the SRA requirement that firms take reasonable steps to locate their client before donating the balance to charity (or making an application to the SRA for permission to do so), firms might view this note as a handy checklist of steps needed.

The practice note can be found here.

Client’s own accounts – where are we now?

As reported in our last Legal Focus, a recent SRA consultation looked at easing the requirement on firms to reconcile clients’ own accounts every month.

Since the consultation closed on 8 March, we have not heard any more on the subject, though we understand that the SRA are in the process of carefully considering the responses they received.

While we wait for the SRA decision, here is a reminder of the things you should be doing to ensure you stay compliant – pending any update to the rules:

Make sure all staff members understand what a client’s own account is, and make sure they tell you if they are operating one, or are just signatories on one, even if they do not initiate any transactions. It is important that you can identify them all and keep a central register of them, making sure that the register is available to your Reporting Accountant.
Where possible, you should reconcile these accounts every month. Eventually, this monthly requirement will more than likely move to a 16-week requirement, but be aware that if you can reconcile these accounts, then you should. Only where you have a valid reason for not reconciling – for example, where the account does not provide regular statements, or where your firm is not the only party initiating transactions – are you able to justify not doing so.
Where you cannot reconcile the accounts, you need to keep a record of transactions originating from within your firm and make that available to the Reporting Accountant too. We have seen well-managed firms carry out an internal review of these records by somebody independent of the signatory.

There are no longer exceptions for COVID-19

Most of you will remember that, back in the midst of the COVID-19 lockdown a few years ago, the SRA released some temporary guidance for firms struggling to remain compliant due to offices being closed or members of staff being forced to isolate.

There were a few allowances relating directly to the Accounts Rules:

Obtaining an Accountant’s Report more than six months after the reporting date was not considered a serious breach of the rules, as long as the reason for the delay was COVID-19-related
Late preparation of client account reconciliations was not considered a serious breach, if as a direct result of COVID-19
Being unable to bank client money ‘promptly’ due to COVID-19 was allowable, as long as the money was kept safely in the meantime

We are aware of some firms that believe these relaxations still apply, but it is important to note that the SRA expects firms to be fully compliant.

So, it is back to business as usual.

Reporting deadline extensions are a thing of the past

Another point that is often misunderstood by firms is the possibility, or not, of extending the deadline for obtaining an Accountant’s Report.

Rule 12 of the Accounts Rules requires firms to have a report prepared by their Reporting Accountant within six months of their reporting year end. Up until the regulatory amendments that took effect from November 2019 (including the updated and shortened 2019 Accounts Rules), it was possible to obtain an extension to this by simply emailing the SRA, explaining why an extension was needed and the period of additional time required. In our experience, the SRA would usually grant an extension of up to three months with little resistance.

We understand that this is no longer possible, and the SRA has made it clear that there is no mechanism whereby a firm can apply for any sort of dispensation.

Put simply, if a firm requires an Accountant’s Report, the audit must be completed and the report must be prepared within six months of the firm’s year end, even if the report is unqualified and does not need to be submitted to the SRA. Any failure to meet this deadline is a breach of Rule 12.1 and will usually be classed as reportable.

If in doubt, get in touch

Our dedicated Legal Team consists of 45 accountants and tax specialists who deal with law firms all day, every day. If you have any questions at all about past, current or future regulation, please just get in touch – we are always more than happy to help.