The Solicitors Regulation Authority (SRA) is set to question the appropriateness of solicitors retaining interest earned from client accounts due to concerns about financial reliance.
The issue has gained attention following a recent report indicating that client account interest contributes over 10% of turnover for one-sixth of surveyed law firms. This inquiry forms part of broader consultations linked to consumer protection, as previewed at the recent SRA compliance officers conference in Birmingham.
The consultations aim to address the management of client money, including potential alternatives to the current model, protection measures, and the funding of the Compensation Fund. Anna Bradley, SRA Chair, expressed worry about the motives for potentially misusing client funds, highlighting concerns over ‘residual balances’ being repurposed as income through interest.
Some firms, she noted, might struggle financially without this interest, sparking fears of misuse. A proposed measure includes setting specific time frames for returning residual balances to clients, rather than the existing ‘promptly’ requirement.
Aileen Armstrong, the SRA’s Executive Director for Strategy, Innovation, and External Affairs, stated the consultation would explore if retaining any interest is ever appropriate. A survey by accountants Crowe revealed significant interest earnings for city and regional firms, with 41% earning over £1m and some exceeding £7m. For 17% of firms, this accounted for more than 10% of their revenue.
Issues surrounding VAT implications due to client account interest were also exposed, as more than 78% of firms generated interest over 1% of turnover. This development may affect VAT recovery under partial exemption rules.
Earlier in 2024, a financial benchmarking survey from the Law Society showed net interest earnings rose dramatically from £2.6m in 2022 to £27.5m in 2023 among 147 firms. Crowe partner Ross Prince noted that while some firms pay all generated interest to clients, this is uncommon. Most apply interest rates from their bank’s savings accounts.
Different minimum levels for client interest payments could also be introduced, acknowledging the varied significance of interest amounts to different clients. Vulnerable private clients, in particular, could find these amounts critical.
Sean Hankin, the head of the SRA’s forensic investigation, stressed transparency with clients about interest policies at the start of engagements. Acknowledging government interest, discussions explore redirecting some client account interest to fund legal aid for those unable to afford services.
Next week’s consultation may reinstate broader reporting requirements for accountants’ reports on client money handling, potentially revisiting practices abandoned in 2015. This could involve annual submissions of reports or declarations from reporting accountants or law firms.
Further discussions will consider whether those making unilateral decisions on client money should also hold compliance officer roles, particularly in small firms.
The forthcoming consultations led by the SRA seek to critically examine the financial practices of law firms regarding client account interest. By addressing potential conflicts of interest and ensuring transparency, the SRA aims to protect consumer interests and uphold the integrity of legal financial management.
