Breaches of the SRA Accounts Rules 2011 can happen in any firm, no matter how well managed. But there are things you can do to minimise their occurrence.
The breaches can range from minor bookkeeping errors to sophisticated employee frauds. No compliance officer for finance and administration (COFA) can prevent a senior and trusted member of the accounts department intent on committing a fraud from misappropriating client money and concealing what has happened by clever manipulation of the accounts software.
If a fraud of that type happens, the Solicitors Regulation Authority (SRA) will investigate and the COFA will be in the firing line.
It is all too easy to judge the aftermath of a fraud with the benefit of hindsight. The COFA could face allegations of breaches of rule 8.5(e) of the SRA Authorisation Rules 2011 (which requires the COFA to ensure that the firm, its managers and employees comply with the SRA Accounts Rules 2011) and principles 8 and 10 of the SRA principles 2011 (which require solicitors to carry out their role in the business effectively and protect client money). It is often difficult for a COFA to defend allegations of that type when there are few documents available to demonstrate the COFA’s careful and diligent work over the previous years.
This article contains a number of practical steps which can be taken to reduce the possibility of a breach occurring and place the COFA in a position where there is a paper trail that can be produced to demonstrate to the SRA that the COFA has performed his or her duties in a diligent and careful way.
Client account reconciliations
COFAs should always ensure that they check and sign the client account reconciliations. The signed document should be a three-way reconciliation that reconciles three figures: the balance on the bank account; the balance on the cash ledger; and the cumulative balances on the client ledgers (rule 29.12 SRA Accounts Rules 2011).
When the SRA carries out an investigation, the SRA always asks to see the recent client account reconciliations and, often, asks to see those from the previous six months. If they have not been signed by the COFA, the SRA will be concerned that the COFA has not been checking them. It is particularly important to be able to demonstrate that the reconciliations have been checked if the firm suffers a crisis such as an employee misappropriating funds.
Although most sophisticated frauds on client account cannot be detected by client account reconciliations because a sophisticated rogue will ensure that bookkeeping entries mask the fraud (by, for example, manipulating the software), a failure to sign the client account reconciliations will send a message to the SRA and to the Solicitors Disciplinary Tribunal (if the matter leads to a prosecution) that the systems in place in the firm have not been properly managed.
It is open to the COFA to carry out interviews on an annual or six-monthly basis with all members of the accounts department, including junior members. If the interviews are carried out on a confidential one-to-one basis, the members of staff can be given an opportunity to raise any matters of concern relating to the firm’s bookkeeping work. The interviews can also be used to obtain suggestions for methods of improving the firm’s systems and procedures relating to bookkeeping. In practice, if interviews of that type are carried out and attendance notes are kept and the SRA subsequently discovers an accounting irregularity, COFAs will be able to demonstrate that they have gone the extra mile to try to ensure that adequate systems are in place.
Similarly, the COFA could hold an exit interview with any member of the accounts department who resigns from the firm and keep a record of it. Again, the interview should be held on a one-to-one basis to increase the chance of a frank discussion. There is always a possibility that a conscientious member of the accounts department decides to resign to distance themselves from what they consider to be poor bookkeeping practices.
The auditors’ function during each annual audit is limited to an audit of the previous year’s client account. It does not normally extend to an instruction to advise on the accounting systems in place. Many auditors carry out work for a number of different solicitors’ practices and it is always worthwhile asking the audit manager who has physically attended the firm’s premises on a day-to-day basis during the audit to say whether any of the firm’s accounting systems or procedures could be improved by changes to the manner in which the work was carried out. The question could be asked during a meeting held to discuss the outcome of the audit. An attendance note of a discussion recording auditors’ advice that no changes are necessary could be extremely helpful if the SRA subsequently alleges that inadequate systems were in place.
Most COFAs will, as a matter of course, obtain reports on at least a monthly basis on the firm’s financial performance. It is worthwhile extending the scope of the monthly reports to include reports on particular aspects of client account activity which could detect breaches of the SRA Accounts Rules 2011.
Common matters of concern identified by the SRA’s forensic investigation officers include credit balances on office account, round sum transfers and client-to-client transfers.
Credit balances on office account are often a sign that client money has been placed wrongly in office account. Frequent or unusual round sum transfers could be a sign that office-to-client transfers are being made prior to delivery of bills (on terms that the transfers are subsequently allocated to bills once they have been issued). Frequent client-to-client transfers by one fee earner could be a sign that a shortfall on a client ledger has been masked by a series of unauthorised transfers. A COFA could introduce a procedure for the accounts department to provide on a monthly basis print-outs of the client-to-office transfers, the credit balances on office account and the client-to-client transfers.
SRA guidance and warning notes
The SRA periodically publishes guidance and warning notes on areas of concern which give rise to the risk of breaches of the SRA Accounts Rules 2011. The COFA should keep abreast of the guidance and warning notes and when necessary introduce systems and staff training to address the SRA’s areas of concern. There is an obligation to do so under rule 8.5(e) of the SRA Authorisation Rules 2011, which states that COFAs must take all reasonable steps to ensure that employees and managers comply with obligations imposed upon them under the Accounts Rules. Two current areas of concern relate to banking facilities and retentions, and those are considered below.
Banking facilities – rule 14.5
Rule 14.5 SRA Accounts Rules 2011 states: ‘You must not provide banking facilities through a client account. Payments into, and transfers or withdrawals from, a client account must be in respect of instructions relating to an underlying transaction (and the funds arising therefrom) or to a service forming part of your normal regulated activities.’
From a COFA’s point of view, it is problematic to police rule 14.5, as it is difficult to set up a computerised system which readily identifies potential breaches of the rule. In consequence, staff training is the most important way of preventing breaches, and, if a breach occurs, evidence of staff training is the best way of demonstrating that reasonable steps were taken to comply with rule 14.5.
Historically, the rule was linked to SRA concerns relating to money laundering (as use of a client account as a banking facility could facilitate such activity). As there is a common link, training on rule 14.5 can easily take place at the same time as the firm’s regular training on money laundering issues. It is also advisable to hold specific training sessions with the accounts department so that cashiers are aware of tell-tale signs of breaches of rule 14.5 (such as internal vouchers containing requests for payment of school fees or rent) and are aware of the need to check that the narrative on a voucher and the identity of the payee indicate that the payment out is a type which would normally be expected from the matter description for the underlying work.
Retentions – rule 14.4
Rule 14.4 SRA Accounts Rules 2011 states: ‘You must promptly inform the client (or other person on whose behalf the money is held) in writing of the amount of any client money retained at the end of a matter (or the substantial conclusion of a matter), and the reason for that retention. You must also inform the client (or other person) in writing at least once every twelve months thereafter of the amount of the client money still held and the reason for the retention, for as long as you continue to hold that money.’
The COFA should ensure there is a system for identifying client account retentions and ensuring that fee earners notify the client or other beneficiary of the retention on an annual basis. In practice, most retentions can be identified by printouts of balances held on client ledgers which have not had any time entries or bills over the previous six months. It is advisable to keep a central record of retentions and to appoint a cashier responsible for ensuring that annual notices of retentions are sent to clients or beneficiaries. The COFA should watch out for future SRA guidance on rule 14.5 (relating to banking facilities) as there is a possibility that the SRA may soon say that retentions for rent deposits amount to a breach of the rule preventing use of client account as a banking facility.
Suspense accounts – rule 29.25
The SRA Accounts Rules 2011 contain limited guidance on the use of suspense accounts. Rule 29.25 states: ‘Suspense client ledger accounts may be used only when you can justify their use; for instance for temporary use on receipt of an unidentified payment, if time is needed to establish the nature of the payment or the identity of the client.’
In practice, a suspense account is needed in order to deal with unidentified receipts, which cannot be allocated to a specific client ledger. The suspense account will contain a running account balance, and it can be difficult to tell whether any issues relating to historic receipts have been resolved by either identifying the client ledger to which the receipt relates or returning the funds to the sender. To ensure that the account balance relates to recent unidentified receipts, a cashier could be asked to ‘contra out’ matching payments in and out.
The COFA should also check the suspense account on a regular basis as it can sometimes reveal problems which have arisen in the accounts department. For example, if the accounts department is short staffed, a member of staff may start allocating receipts to a suspense account to save time.
Records of breaches
Rule 8.5(e)(i)(B) of the SRA Authorisation Rules 2011 states that the COFA must ‘take all reasonable steps to … record any failure … to comply [with the SRA Accounts Rules 2011] and make such records available to the SRA on request’. The guidance note to rule 8 states that the register is needed to monitor overall compliance with obligations, to assess the effectiveness of the firm’s systems and to decide when breaches which form a pattern become material (note (xi)).
There is no requirement for the register to be kept in any particular form and the COFA can add positive events to the register such as annual reviews of the firm’s residual balances, retentions and suspense account, and periodic reviews of the minor breaches recorded in the register.
It would then be possible to rely on the register to demonstrate that the COFA has been careful to comply with his or her obligations under the rules.
Independent reviews of the accounts systems
The guidance notes to rule 8 of the SRA Authorisation Rules 2011 contemplate that COFAs will be able to carry out regular checks on the accounting systems (see guidance note (x)(b)). The COFA should consider whether to instruct an independent firm of accountants (not the auditors) to carry out a review of the bookkeeping procedures relating to client account and to advise whether any of the procedures could be improved. If a review of that type is carried out, and if an SRA investigation subsequently leads to an allegation that the COFA has failed to implement proper systems, the fact that the COFA instructed an independent firm of accountants to review the systems would provide very powerful mitigation in any subsequent prosecution.
The steps set out above may reduce but will never dispel the risk of an SRA prosecution. That leads to one final point. COFAs should always consider whether to obtain an indemnity for their own legal costs and any adverse order for costs from their firm and whether to take out insurance to cover those costs.