The SRA should act as a reality check for ABSs, not a business adviser

Working through the Solicitors Regulation Authority’s recently-published guide to alternative business structures1 was a bit like being interviewed for a job that no one has done before, with the interviewer not quite knowing what to ask or what to make of the answers.

This is not meant to be a criticism – it’s hard for the regulator to know at this stage who it is trying to keep out and why, and what importance should be attached to the different elements of a legal services business.

Applicants should not be surprised to find the SRA cautious and tentative as it works towards a better understanding of risk and should be prepared to exercise patience with the process and processors. The six-month basic time period for considering an application is likely to be needed in full, at least to begin with.

The SRA’s job is made more difficult because it has no existing benchmarks. It can’t say that there is a basic model for a professional services practice, not least because no two firms are the same and its understanding of the risks associated with different business and financial models must be at an early stage of development.

Obtaining a licence

Against this background, the guide seeks to explain what applicants will have to show to be given a licence to operate as an ABS. Cutting through the detail, the issues that the SRA will want satisfaction on can be divided into two broad categories: control and business operations.

Under the first category, owners having control will have to show that they are suitable persons, as will the management. To its credit, the SRA has acknowledged that there are challenges in dealing with technical ownership issues, but that it wants to find solutions to problems that might otherwise prevent suitable investors from entering the sector.

On the business operations side, from the issues covered in the “information we require” section of the guide, everything – including the kitchen sink – will have to be examined and explained.

This is so that the SRA can feel comfortable not only that all of the mechanical requirements are met – professional indemnity insurance, systems, finance, staffing, governance, client money and so on – but also that the applicant is helping to meet the regulatory objectives in section 1 of the Legal Services Act.

My instinct is that the mechanics will take time to sort out to the SRA’s satisfaction but should not cause problems beyond issues of degree, whereas the softer points are going to be difficult for the SRA and applicants to deal with if they are to have any real meaning. It will take time for policies to be developed and understood and, in the interim, there will be room for disagreement.

For example, if a commercial firm seeks a listing to raise money to set up offices in Asia, how important will its contribution to increasing public understanding of citizen’s legal rights and duties be (regulatory objective ‘G’) when the SRA considers the application?

And, will there be a requirement to pay only lip service to the objectives in the application, say, by confirming that the firm supports the Law Society’s work in this area, or will the SRA see it as an opportunity to oblige the firm to do something that is irrelevant as far as its business is concerned?

In keeping with the desire to allow flexibility for applicants, the guide covers much of the ground in a way that neither presupposes how a business will be structured nor hints at any operational line below which applicants must not slip.

Financial sustainability

A key issue will be financial sustainability. The applicant will have to tell its story through a business plan, but there is no indication of how the SRA will make its risk assessment.

So, for example, will the private-equity backed ABS be allowed to run on 50 per cent debt, with the bulk of its income going out in interest, or will that be considered a risk? It is hoped that investors will be regarded as best placed to determine sustainability and that the SRA will act as a reality check, rather than assume the role of business adviser.

Finally, it is hoped that the SRA will not be drawn towards imposing uniform requirements on financial sustainability or on the many other issues where there can be different ways of doing things. Otherwise, it will stifle innovation and the regulator may eventually believe that there should be uniformity in the requirements for traditional law firms.

Endnote

1 See sra.org.uk/abs