Walking a knife-edge: the exposure of law firms to regulatory investigation and prosecution defence costs
Posted on 06 January 2020
Walking a knife-edge: the exposure of law firms to regulatory investigation and prosecution defence costs
In 2019 Leigh Day commissioned IRN Research to survey and report on how law firms deal with regulatory and compliance matters. The findings from responses from 200 law firms, including 30 in-depth telephone interviews, show that less than 50% of firms have insurance cover that would give them the possibility of affordable equality of arms with their regulator, in almost all cases the SRA.
This means that many firms are walking a knife-edge with inadequate insurance cover to protect themselves against an investigation or a prosecution by their regulator, primarily the Solicitors Regulation Authority (SRA).
Whilst Professional Indemnity Insurance (PII) used to cover these sorts of costs, the rules changed in 2010 and that is no longer the case. This research suggests that, despite the passage of time, this fact is something that seems to be lost on much of the profession.
This lack of cover leaves the profession dangerously exposed and can lead to firms and solicitors being sanctioned by (or accepting a sanction with) the SRA or at the Solicitors Disciplinary Tribunal (SDT) whether or not there has actually been misconduct, simply because they do not have the financial means to instruct experts in solicitors’ conduct and regulation who can advise and assist them to defend themselves.
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Summary of results by type of practice
The issue for the legal profession of exposure to regulatory defence costs is very real. Leigh Day has more direct experience than most of dealing with the SRA, having spent four years between 2014 and 2018 successfully defending a complex and wide-ranging SRA investigation and prosecution of the firm and three of its solicitors. That the allegations were dismissed at the SDT is widely reported. What is less well-known, but more important for the profession to understand, are the lessons in terms of the costs implications defending an SRA investigation and prosecution can have for lawyers and law firms.
SRA investigations often come out of the blue and responding to them is resource intensive, whether dealing with them internally or with external, expert help. Once concluded, the SRA might decide to take things no further, leaving you with a clean bill of health but a hefty financial one, through lost fee earning time or external legal bills. These costs can be crippling, particularly for smaller firms.
If things progress further and, ultimately, to the SDT, the costs rules are barely more favourable. In all but the most exceptional cases, the SRA’s position as a public interest regulator protects it from adverse costs orders, even where all its allegations are dismissed by the SDT.
In the case against Leigh Day, investigation costs alone were over £2 million and the costs of defending the prosecution were approximately £7 million. The firm was fortunate to have ‘Directors and Officers’ (D&O) insurance (also known as ‘Management Liability Insurance’ (MLI)1) that covered some of those costs, but a sizeable balance still had to be met by the firm’s partners. Whilst the case against Leigh Day was particularly complex, every regulatory investigation will have resource implications for those obliged to respond to it.
In 2018, after the appeal by the SRA against the SDT ruling was dismissed, the internal team at Leigh Day that successfully defeated the SRA case turned its attention to helping other solicitors and firms facing similar scenarios. In doing so, the team, which now specialises in advising solicitors and firms on regulatory and professional conduct matters, has talked with firms across the country. It appeared to us that very many firms do not have suitable or sufficient MLI despite the financial risks and the SRA’s proactive approach to investigation and enforcement.
Given the recent changes to reporting requirements in the SRA’s new Standards and Regulations (and despite the SRA’s pledge to trust in the exercise of professional judgement), as well as the SDT’s recent move to deciding cases on the “balance of probabilities” as opposed to “beyond reasonable doubt”, that approach does not look to be changing any time soon.
To find out the real picture across the sector, Leigh Day’s Regulatory & Disciplinary team commissioned this research from IRN to learn more about the extent to which firms are taking out insurance that would help them in a regulatory investigation or prosecution – essentially “before the event” planning – and what they would do if a problem actually arose.
Many firms assume that their Professional Indemnity Insurance (PII) would cover them if they are investigated or prosecuted, but that is no longer the case. In 2010, the SRA successfully applied to change the minimum terms and conditions for solicitors’ indemnity insurance. One of the changes it sought resulted in regulatory defence costs falling outside of the mandatory scope in policies.
This has meant that firms and solicitors have increasingly found themselves exposed to a brutal choice when the SRA has come knocking: fork out significant sums of their own money to defend themselves; or, regardless of the reality of there being any rule breaches or misconduct, close their business (and potentially leave the profession) whilst trying to resolve things with the SRA at as low a financial cost as possible.
Leigh Day’s experience with the SRA showed the wisdom of planning for the worst. Like so many, the firm believed that “it would never happen to them”. When it did, the seriousness of the allegations (and the complexity and cost of investigating and defending them) had the potential to close the firm down.
It also demonstrated the importance of firms ensuring they have the resources to be able to fight their corner, so that they can keep the SRA’s exercise of its powers in check by subjecting its enforcement activity to proper scrutiny. This is vitally important to the firm’s own position, the wider profession and to ensuring the regulatory enforcement system operates fairly.
Having adequate and appropriate MLI cover that actually assists with the costs of defending regulatory investigation and prosecution is therefore crucial. The value of the cover Leigh Day had was the difference between the firm surviving and thriving and being forced to close; it enabled the firm to test the SRA’s case in a way that simply would not have been possible otherwise. In short, having the resources to allow the firm to instruct external advisors practising in the area of solicitors’ regulation and discipline was vital.
Despite the lessons that are there to be learnt from what Leigh Day went through, our experience from speaking to other lawyers and law firms suggests that very few actually have the sort – or the extent – of cover that would enable them to protect themselves properly. This research seeks to find out whether this is actually the case and what arrangements firms have in place to deal with the sort of situation we found ourselves in.
The research involved two stages:
The first stage was an online survey of legal professionals from firms of different sizes and in different locations across the UK. A total of 200 people responsible for managing risk and ensuring compliance in their practices responded to our survey.
The second stage of the research involved follow-up telephone interviews with 30 of the online respondents. Researchers were able to ask participants more detailed questions and to gain a better understanding of how risk and compliance is managed in those practices.
In brief: what did we learn?
The research indicates that many firms are walking a knife-edge with either no cover or the wrong sort of cover to protect themselves against having to pay SRA investigation and defence costs. The research showed that relatively few firms take out adequate and appropriate MLI cover to provide them with the financial security needed to offer them the best chance of protecting their practice and their reputation.
In fact, less than 50% of firms had MLI that would cover these costs and fewer still had policies that would trigger at the appropriate time to allow them the sort of help that affords equality of arms with the SRA in an investigation.
“This suggests to us that, with the SRA continuing to take a very active approach to investigations and enforcement, firms are taking considerable risks and essentially trusting that it will not happen to them. These risks are compounded by the SRA’s new reporting requirements, which are sure to result in a considerable increase in reports and self-reports by solicitors and others in the profession.” Gideon Habel - Leigh Day, Regulatory & Disciplinary
In detail: the results
In this section we set out the questions and results of greatest interest and relevance to the profession and our observations about them.
Question 1: ‘Does your organisation have Management Liability Insurance (sometimes called Directors & Officers liability or “D&O” insurance)?’
Almost two thirds of respondents (63%) reported that their firm has some form of MLI covering regulatory investigation and defence costs. Whilst we are pleased to see a majority of participating practices have MLI, we are aware that it was likely a somewhat “compliance conscious” pool of respondents. Additionally, this statistic cannot be taken in isolation and it is necessary to understand precisely what the cover consists of, to assess whether it is suitable and sufficient. Subsequent research questions were designed to paint a fuller picture.
Our experience has taught us that having responsive and comprehensive MLI cover is an essential element of any good toolkit for managing risk and compliance within a firm. It is therefore concerning that over a third (37%) of those who took part reported that their firm did not have – or they did not know if their firm had – MLI.
The fact that sole practitioners were the least likely to take out MLI was concerning to us. It is often these sorts of practices that attract the SRA’s attention and where the consequences of an investigation and prosecution can be felt most acutely.
Question 2: What type of Management Liability (or D & O) insurance does your organisation have?
According to the research, 62% of respondents (of the 63% who reported their firms have cover) reported that their firms had MLI that includes cover for both regulatory investigations and prosecutions.
In 8% of instances, cover was reported as being only for prosecution and in 6% of cases, only for investigations. Surprisingly, despite reporting that their firm has MLI, almost a quarter of those with insurance do not know whether it covers regulatory defence or investigation costs.
One interviewee said that it was only when preparing for the research interview that they discovered that their firm’s MLI was limited to investigations and not prosecutions. In our experience, this lack of knowledge about what a firm’s MLI actually covers is common in the profession; it is only when the need to check a policy carefully arises (when an issue has already arisen) that it emerges that cover is not what it was understood to be, either in terms of when it triggers or the level of indemnity. It is essential that firms take care to check with their brokers or insurers that the cover will do what is needed if it is called upon.
Whilst the research indicates that just over three quarters (76%) of those with MLI have cover for one or both of a regulatory investigation or prosecution, this equates to less than half (48%) of respondent firms overall.
Question 3: What is the level of the financial cap on cover?
We were reassured by the levels of indemnity that firms have secured, where that information was known to the participants. Even in relatively straightforward investigations, the costs of external expert assistance can quickly mount. Our team’s experience in the Leigh Day case has taught us that it is worth paying for comprehensive cover, because it could be the difference between being limited in what you can do to defend your position and having the sort of resource that would afford equality of arms with the SRA. That is also the case where insurers determine the rates paid to firms instructed to advise and assist you.
“The questions that practitioners everywhere should be asking are: whether they are covered, when that cover triggers and how much it is worth. Those managing firms should also consider the question of cover for staff who are not managers or partners from an ethical perspective; all those who are regulated should be appropriately equipped to respond to regulatory scrutiny.” Emma Walker – Leigh Day, Regulatory & Disciplinary.
Conclusions: what does the research tell us?
The research suggests that, despite best intentions in the profession to protect against regulatory investigation and defence costs, a worryingly low proportion of firms take out MLI of the sort or extent that would give them the financial clout to offer them the best chance of protecting their business and reputation, particularly in light of the 2010 changes to minimum PII terms. Less than 50% of firms that participated had MLI that would cover these costs at all and even fewer have policies that trigger at the appropriate time to afford financial assistance at all stages of an SRA investigation or prosecution and enable the regulated to have equality of arms with their regulator.
According to the SRA’s data from 2017-18, it received over 11,500 reports about conduct in that period. That’s a ratio of one report for every 13 practising solicitors or more than one report for every firm. Out of those 11,500 reports, the SRA opened investigations into over 6,000. There can be no doubt about the SRA’s proactive approach to investigation and enforcement activity.
As we publish the report today, Gideon Habel, from the Regulatory & Disciplinary team, concludes:
“The recent changes to reporting requirements in the SRA’s new Standards and Regulations mean there will surely be an increase in the number of reports to the SRA. At the same time, the SDT has just lowered the standard of proof it applies when deciding cases before it to the civil standard. Despite what the SRA says about wanting to put more trust back in solicitors when exercising their professional judgement, we do not see its overall approach changing in the foreseeable future.
“It seems something of a perfect storm for firms and solicitors at the moment, particularly given the findings of this research which show that uptake of insurance for defence cover is still low, despite the risks. We would urge all firms to check their insurance provision with the findings of our research in mind. In particular, we would encourage law firm decision-makers to consider carefully whether, if your firm had to respond to an SRA investigation tomorrow, your insurance would allow you to build the team of experts you need to help you to respond as decisively and comprehensively as such a situation demands.”