Could law firms be brought under the FCA’s regulatory regime?

Could law firms be brought under the FCA’s regulatory regime?

What would it mean if the Solicitors Regulation Authority (SRA) were to withdraw from the Financial Conduct Authority’s (FCA) designated professional body regime for the purposes of consumer credit activities?

Ian Cockerill, compliance director of SIFA, says this would have a major impact—not just in respect of consumer credit—but in relation to other hitherto exempt financial services activities.

Original news

Consumer credit activities—the way forward for firms, LNB News 14/10/2014 82

Firms that carry out regulated credit activities may have to be authorised by the Financial Conduct Authority (FCA) under proposals by the Solicitors Regulation Authority (SRA). A consultation by the SRA seeks views on its proposal to withdraw from the FCA’s designated professional body regime for the purposes of consumer credit activities. This would mean SRA-authorised firms carrying on regulated credit activities would need to apply to the FCA for authorisation, rather than being able to rely on the exemption set out in the Financial Services and Markets Act 2000, Pt 20 (FSMA 2000). The consultation will run until 15 December 2014.

Why have SRA-authorised firms historically been able to rely on FSMA 2000, Pt 20 exemption?

One of the issues confronted by the government in advance of the Financial Services Act 1986 (FSA 1986) was the realisation that certain aspects of solicitors’ legal work would fall within the proposed definition of the activities which would require authorisation and regulation by the new financial services regulator. Potentially, this might have necessitated the regulator taking onto its books over 10,000 law firms and large numbers of accountancy and other professional firms in addition to the financial firms which were the main object of the legislation.

The solution which was adopted was to provide exemption from the requirements of FSA 1986 for firms which were prepared to confine their financial services activities to those which were purely incidental to their legal work, and to delegate to professional bodies such as the Law Society the authority to regulate such activities. The great majority of law firms were, and still are, regulated only for such exempt incidental business and are now identified on the FCA web site as exempt professional firms.

FSA 1986 also empowered the professional bodies to regulate those financial services activities which fell outside the exemption—these powers were removed by FSMA 2000—which vested in the Financial Services Authority the sole responsibility for regulating what then became known as ‘mainstream’ regulated activity.

FSMA 2000, Pt 20 maintained the exemption relating to exempt activities, which remained under the jurisdiction of the professional bodies (now re-named designated professional bodies). These bodies were required to create rules appropriate to their own members. The rules created by the Law Society have been carried forward as the SRA Financial Services (Scope) Rules and the SRA Financial Services (Conduct of Business) Rules.

When responsibility for consumer credit activities was passed to the FCA on 1 April 2014 the Law Society group licence for such activities was removed and the various exemptions applied to consumer credit in the same way as to financial services activities.

Why is the SRA calling for a change?

The SRA, in order to act as a designated professional body, needs to enact appropriate rules for firms carrying out non-mainstream consumer credit activities. The organisation appears to take the view that the detailed nature of the FCA’s rules, and the need for these rules to be effectively enacted into the SRA’s own rule book, would be incompatible with the outcomes-focused approach adopted by the SRA. Additionally, it seems clear from the consultation paper that the SRA has some misgivings about the FCA’s guidance and particularly the efficacy of the exemptions:

‘FSMA 2000 regulated activities may be carried on by a member of a DPB who is not authorised by the FCA where the regulated activity “...arises out of, or is complementary to, the provision of a particular professional service to a particular client...” (FSMA 2000, s 332(4)) and the regulated activity “...must be incidental to the provision by him of professional services...” (FSMA 2000, s 327(4)). In their respective consultations in 2013, the Financial Services Authority (FSA), the FCA and HM Treasury focused on the second point which concerns the way that the services are provided overall by the firm—the less demanding aspect of the test therefore, easier for most SRA authorised firms to satisfy. However, the requirement in s 332(4) necessitates an assessment of the services provided on a case by case basis rather than by the firm overall. In the SRA’s view this is a problem.’

What would be the immediate and long-term effects if the proposed change were to go through?

It is clear that more firms will need to at least consider the issue of whether authorisation will be required to carry out consumer credit activities. There has been considerable doubt as to whether a number of such activities benefit from FSMA 2000, Pt 20 exemption—the decision to opt out by the SRA would remove all such doubt. However, the result may not be popular with firms seeking to benefit from the exemption.

An additional impact of this proposal is that firms that become authorised by the FCA to carry on consumer credit activities will no longer be able to benefit from the FSMA 2000, Pt 20 regime in relation to any other FSMA 2000-regulated activities. The SRA cites the example of insurance mediation activities. What may not have been considered is the wider range of investment activities and the impact on, for instance, private client solicitors handling probate, trust and wills matters—which often involve dealings in shares and gilts and other investments in a way which meets the conditions attaching to the exemption. However, matrimonial lawyers would also be affected when dealing with joint and individual assets as part of the settlement process. Company and commercial work also demands access to the exemption insofar as lawyers may be involved in the negotiation of commercial deals, the provision of advice on legal aspects and the consequential business and financial considerations.

In effect, without the exemption such matters would become ‘mainstream activities’ and the full weight of the rule book would apply including, potentially:

  • FCA disclosure
  • know your client provisions, and
  • the need for qualified advisers

It is not clear whether or not the SRA is actually aware of these further consequences of its proposals. It is essential for practitioners that they understand what new regulatory burdens are imposed upon them.

What actions would firms need to take?

Firms need to consider whether to respond to the SRA consultation. It would be unfortunate to sleepwalk into a situation where they were FCA-regulated, with rules that will be very difficult to comply with, if there is a way to maintain a more palatable status quo.

In the longer term, and assuming the proposal to disallow FSMA 2000, Pt 20 in relation to consumer credit goes through, it will be necessary to consider whether the firm carries out consumer credit activities not subject to any other exemption.

The FCA authorisation process is an onerous one, even if the permissions being sought are considered to be low risk by the SRA, and we have no guarantee that this is the case. It bears a passing resemblance to the SRA’s alternative business structure authorisation process and firms will need to think along the lines of that in terms of time taken and also complexity of information required.

How would this change the structure and arrangements around consumer credit activities?

Firms will be far more likely to require authorisation by the FCA. This will have a major impact not just in respect of consumer credit, but far more in relation to other hitherto exempt financial services activities. Either firms will need to consider ceasing to conduct consumer credit activities (difficult in respect of such client focused activities like debt counselling, debt adjusting, credit brokerage or debt collection) or may need to work out how to comply with the onerous FCA rules on investment business in relation to previously exempt activities. At first sight it is difficult to see how this is possible without forming some type of alliance with an independent financial adviser.

It seems that we will have gone full circle with the potential for the regulator to have to take on 10,000 law firms and large numbers of accountancy and other professional firms in addition to the financial firms which were the main object of the legislation. In the absence of the FCA bringing in some form of non-mainstream regime (which is extremely unlikely) it is difficult to appreciate the full scope of the difficulties that will result.

Ian Cockerill is compliance director of SIFA, the support group for professional financial advisers. He was formerly head of investment business in the Law Society, managing the monitoring and investigation unit, relationships with other regulators and the solicitors’ profession. Ian is an accredited Lexcel consultant and regularly provides regulatory training to solicitors, accountants and financial advisers.

Interviewed by Nicola Laver.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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