To invite open debate about how management of the legal function sits within the Senior Managers Regime (SMR), the FCA has published its Discussion Paper (DP16/4 – Overall responsibility and the legal function).

Although the SMR came into force on 7 March 2016, and steps are underway to apply it to all financial services firms from 2018, it is clear that there is continuing significant uncertainty about how the SMF 18 (“Other Overall Responsibility Function”) should be applied to in-house lawyers with responsibility for managing a firm’s legal function. The FCA seeks feedback by 9 January 2017.

The debate in DP 16/4

In DP 16/4, the FCA states that stakeholder feedback received following the publication of the final rules on SMR about the responsibility for a firm’s legal function would probably have affected its earlier policy-making. In particular, the FCA notes the challenges to legal professional privilege, confidentiality and independence of advice that the designation of Senior Manager in charge of the legal function may cause.

The Discussion Paper outlines the arguments both against and in favour of keeping the head of the legal function within the SMR and asks whether the FCA is “right” to conclude that the management of the legal function should be captured as a senior management responsibility. The main arguments are summarised at the end of this update.

Importantly, the debate is around the designation of the head of legal or general counsel as a senior manager, with obligations such as FCA pre-approval and a duty of responsibility, rather than the general position of legal staff that are clearly in the scope of the Conduct Rules. The current requirements of the SMF designations capture in-house lawyers if they are fulfilling the function of another SMF, regardless of professional capacity, training or obligations.

Current position

One purpose of the management responsibilities map that relevant firms must prepare is to help confirm that the firm has a clear organisational structure. A firm must make the allocations of responsibilities so that it is clear who has which of those responsibilities, avoiding gaps. At present each ‘activity, business area or management function’ within a relevant firm must be allocated a respective Senior Manager with overall responsibility for that area.

While the FCA recognises that overall responsibility for the legal function is not included in the indicative list of business activities and functions it sets out in Annex 1G to SYSC 4; its view is that responsibility for the legal function has not been excluded from the SMR and so should be considered as part of the management responsibilities map the firm should maintain (see the FCA’s January 2016 statement as discussed in our previous website alert.)

Therefore, the FCA considers that many firms should have identified the management of the legal function as an SMF18 (or, in the case of non-EEA incoming branches, as an SMF 22 (Other Local Responsibility Function)) when allocating senior management responsibilities.

Where the management of the legal function is covered expressly in the responsibilities of another SMF in the firm (such as Compliance Oversight (SMF 16) or a PRA SMF (e.g. chief Risk SMF 4)) it would not be necessary to set it out as an SMF 18 function. The FCA believes its approach allows firms to allocate responsibility to the person who is in practice accountable for this area, which means the approach needed will vary from firm to firm.

Any firm that has tried to make a decision about whether or not the person filling the head of legal role requires approval should not change its position while the FCA clarifies its view.

What’s next?

The FCA is seeking stakeholder feedback on two specific questions (see below) as it generally moots whether the head of the legal function should continue to be included within the SMR. Feedback can be submitted by 9 January 2017 via the FCA website. If you wish the response to be confidential, this should be made expressly clear. The FCA will analyse responses and release a feedback statement, clarifying what is required in this area, which may include further consultation.

The Law Society of England and Wales has been quick to issue a strong public statement on this, stating that “The Law Society is clear that legal functions should not be included in the regime because it can create conflict and erode legal professional privilege”.

The FCA’s questions

Q1 – Do you agree with the FCA’s summary of the key policy arguments for and against inclusion of the management of the legal function in the SMR (see Chapter 3 of DP16/4)? Has the FCA missed any key arguments?

Q2 – Do you believe the SMR should include a requirement to allocate overall responsibility for the management of the legal function to a Senior Manager? Why?

  • The legal function is not an ‘activity, business area or management function’.
  • It is an advisory function.
  • The ability of General Counsel and legal function to provide impartial and independent advice to the business may be affected.
  • If the senior manager is a lawyer, analysis of “reasonable steps” required for the duty of responsibility may involve reviewing legal advice given by them to the firm. The privilege in the legal advice is the firm’s (not the individual’s) to waive.
  • Senior Manager Conduct Rule 4 requires a Senior Manager to disclose information which the regulators would reasonably expect notice. This appears to cut across privilege more than Conduct Rule 3, which applies to all employees (including in-house legal).
  • There is potentially overlapping and conflicting regulation from the relevant legal sector regulator.
  • Including in-house lawyers within the Certification Regime delivers many benefits without compromising independence. This is not perceived as the case if included within the SMR.
  • As much of the head of the legal function’s role relates to providing legal advice, the laws of legal professional privilege may practically restrict the regulators from using their powers over such Senior Managers.

FCA’s arguments for keeping the head of legal in the SMR

  • The legal function is an ‘activity, business area or management function’ – in the FCA’s view these terms cover everything a firm does, including internally facing functions, such as legal. It is the management of the function and not the provision of legal advice that brings the head of the legal function into the SMR – the requirement is to allocate overall responsibility for every aspect of its business.
  • Systemic failings in the management of the legal function could create risks that can in turn impact the wider business
  • The focus of the SMR is on effective management and governance, which is relevant to the legal function as much as any other aspect of a business, rather than the provision of legal advice. The duty of responsibility is just one aspect of the SMR. Arguably legal advice would not necessarily need to be considered to ascertain whether the head of legal has taken reasonable steps to ensure a business controls its affairs effectively; and requirements such as pre-approval do not impact legal privilege or independence.
  • The duty of responsibility places the burden on the regulators to prove whether or not reasonable steps have been taken – not the senior manager. It will be difficult for the regulators to bring a successful action for breach of the duty of responsibility without additional evidence, particularly if a firm has chosen not to waive privilege.
  • The privilege argument is not specific to the head of the legal function. Existing legislative protections against breaches of legal privilege (e.g. section 413 of the Financial Services and Markets Act 2000) will counter the perception that the independence of the legal function is compromised by the inclusion of the head of legal in the SMR.
  • The SMR does not mandate who should be allocated overall responsibility for the legal function, firms have the flexibility to designate the most suitable personnel to have overall responsibility, and this does not necessarily have to be the General Counsel. There is guidance in SYSC 4.7 (e.g. 4.7.15 G) on how to allocate responsibilities.