Ensuring integrity and client confidence

In the December Journal John Newall set out the case for the profession itself maintaining high standards of conduct for its members.  He pointed out in passing that unfettered regulation of the profession by the Society on all matters is actually a myth.

A good example of this myth may be found in the case of Scottish Solicitors’ Guarantee Fund which was originally established by the Government under the Solicitors (Scotland) Act 1949.  In other words, for as long as the Law Society of Scotland has been in existence, the profession has been obliged by Government to maintain at its own expense a fund to compensate clients who have suffered loss as a result of a solicitor’s dishonesty.  We in Scotland are by no means unique in having such a fund.  Many of the legal professions in the developing world - particularly in English-speaking countries - maintain a fund for similar purposes.  In some countries it is known as a Compensation Fund, others refer to it as a Fidelity Fund.  A number of bars and law societies in developing parts of the world would like to have such a fund in order to put a seal on their professionalism, but lack the resources to implement such a scheme.  In some jurisdictions the fund is administered by the professional body, whereas in other countries there is governmental control or supervision.  Some funds have an unlimited liability, as we do in Scotland, while others (such as England and Wales) are capped.

The Guarantee Fund in Scotland

As I mentioned, the Society has operated the Guarantee Fund since its original creation almost fifty years ago.  The fund has its current statutory basis in Section 43 of the Solicitors (Scotland) Act 1980.  The operation of the fund goes hand in hand with the protection afforded by the Master Policy scheme, which provides mandatory cover of £1,000,000 to each firm in respect of losses originating from a single course of dishonest conduct, as well as the usual professional negligence cover.

In order to minimise claims against the fund, the Society has since its inception operated detailed Accounts Rules, with which all firms must comply, especially those handling money on behalf of clients.  The Society is required by Section 35 of the 1980 Act to maintain and operate such rules.  As time has gone by the Accounts Rules have become more sophisticated and more comprehensive.  They now constitute a rigorous scheme of financial compliance, imposing clearly defined responsibilities upon solicitors.  These include compliance with the Money Laundering Regulations across all areas of legal practice, not just financial business.  This makes Scottish solicitors unique among lawyers elsewhere in the UK and Europe and distinguishes them from many other professionals operating anywhere in the UK.

For a number of years the Society has held Stop Loss insurance to provide the profession with some protection against large Guarantee Fund claims.  The current level of cover is £25 million, the first £2 million being self-insured.  Fortunately the Society has not required to invoke this policy.  The Guarantee Fund has a present asset base in excess of £1 million, providing a very substantial “cushion” for the profession within the self-insured amount.

Why do we have a Guarantee Fund?

First of all it is the right thing for the legal profession to do.  A solicitor’s relationship with his or her client is a very special one.  Clients invest an extraordinary amount of trust in their solicitors.  That trust is founded upon centuries of integrity on the part of the legal profession.  It will be reinforced by confidence in an individual solicitor’s honesty or in a firm’s reputation, but the underlying faith reposes in the legal profession as an institution.  Why otherwise should clients be willing to entrust their money to relative strangers simply because they are solicitors?

There is much talk these days of “professionalism”.  Some argue that law has ceased to be a profession and is now simply a business.  However, these concepts are not mutually exclusive.  I believe that all good solicitors must be businesslike in the way in which they conduct their profession, and at the same time must show true professionalism in running their business.

In a paper submitted to the IBA Forum on Client Compensation Funds in September 1998, Kenneth J Bossong of the New Jersey Bar Association argued that, although there may be many definitions for a “profession” any meaning is likely to have two components: (1) a learned occupation, (2) the practitioners of which place their clients’ interests before their own.  In this light the existence of a Guarantee Fund epitomises professionalism.  When solicitors pay out of their own pockets to ensure that no client loses out for having trusted one of their colleagues, something profound is being said about the honest majority.  The operation of the Guarantee Fund is an important piece of evidence for those arguing that the law is still a profession.

The second important reason for maintaining such a fund is that it is the sensible and prudent thing for the legal profession to do.  Although dishonest solicitors are in a tiny, tiny minority, when they violate the trust of their clients by stealing, that puts a stain on the reputation of all their fellow solicitors.  When the profession makes good those losses, that act benefits all the members of that profession.  Some may argue that precious little good publicity is obtained when the Guarantee Fund does compensate clients who have been wronged.  However, can you envisage the massively impaired esteem of the public towards the profession if no Guarantee Fund were to exist?  I would go so far as to suggest that the future of the legal profession depends upon the protection of its clients.

How does the Guarantee Fund operate?

I appreciate that it may be teaching cashroom partners to “suck eggs”, but I think it may be helpful to mention briefly how the Guarantee Fund in Scotland actually works.

It is managed on a day to day basis by the Chief Accountant’s Department within the Society.  This involves the organisation of a monitoring scheme based on a two-year inspection cycle of all firms, but with additional visits being carried out if circumstances require it.  In addition, every firm must submit to the Society every six months a certificate providing financial information about the firm and confirming compliance with the Accounts Rules.  This certificate must be delivered within one month of the end of each six-month accounting period.  The frequency of the inspection cycle and short accounting period linked to the speed of delivery of the Accounts Certificate are once again unique features of the Scottish jurisdiction as compared with the rest of the UK.

Prior to 1989 random inspection of all small practices (i.e. one and two partner firms) was carried out without having a fixed time cycle.  The random inspection of all legal practices in Scotland, which was introduced at the insistence of the profession itself in the summer of 1989, gave rise to substantial losses being directed to the Guarantee Fund.  These losses related in part to long-established frauds which had been perpetrated for periods up to ten years without being detected by the firm’s own accountants or other partners within the firm.  These major losses were identified during the course of the Guarantee Fund Department’s first inspection of the books of larger firms (i.e. three partners or more).  Once these losses were identified and settled, the experience of the Guarantee Fund Claims Department has been one of a steady reduction in the level of losses being considered each year.  The level of claims met in the year to 31st October 1997 was less than a third of the claims met in the previous year, which was less than a third of the level for the year before that.

Reductions of that magnitude obviously could not continue, but the figures for the year to 31st October 1998 show a continued downward trend.  Net claims for the latest year are only two-thirds of those in 1997.  For the first time since 1985, net annual claims are well under £100,000.  This is a fantastic achievement and the profession have much to be commended for.  Of course it only takes one dishonest solicitor to ruin such a record, but the effectiveness of the present inspection arrangements and the efforts of the profession to comply with the rules cannot be over-emphasised.

Control of the Guarantee Fund rests with the Council of the Society, with the detailed supervision of the work being delegated to the Guarantee Fund Committee.  The committee meets each month and reviews the work of the Inspection Team, discusses any overdue Accounts Certificates, considers applications for grants from the fund and deals with all matters of policy.  This is a busy committee and members, who are unpaid and come from all over Scotland, are required to consider huge volumes of paper and are expected to make significant contributions in terms of time and effort to the running of the fund.  The close link between the committee and the day-to-day management of the department is a strength of the system in Scotland.  It can assist in identifying and dealing with problems at an early stage.  The exchange of information regarding unusual transactions which may give rise to concern is an important by-product of a strong networking system within the legal profession.

The reports produced by the Inspection Team are reviewed by the committee at its monthly meetings.  All breaches of Accounts Rules are brought to the attention of the solicitor.  More serious or more numerous breaches may be dealt with by a compulsory reinspection within a short period, say three months or six months.  If the report has identified areas of real concern about a firm’s systems for compliance with the rules, the partners may be invited to attend for interview at the Society’s Hall in Edinburgh in order to satisfy the committee that in future there will be no problems.

Where there are repeated serious breaches, or in any case where there has been a misappropriation of client funds, it is likely that the committee will recommend the prosecution of the solicitor before the Scottish Solicitors Discipline Tribunal, which may of course result in the solicitor being struck off or suspended from practice.  The Society itself has power under Section 40 of the 1980 Act to withdraw a solicitor’s Practising Certificate in certain cases, and where a firm is insolvent as well as in breach of the Accounts Rules, the Society may ask the court to appoint a Judicial Factor to wind up the practice and dispose of its business.

Are there any alternatives?

It is argued by some that other professions do not provide a guarantee that clients of a dishonest colleague will be compensated.  It is pointed out that accountants, surveyors, claims handling agents, etc., some of whom compete with solicitors in the market place by providing legal services or quasi-legal services, are not subject to a similar requirement to make contributions to a Guarantee Fund.  Accordingly it is said that there is no “level playing field”.  I hope I have explained above why I think that the solicitor-client relationship is special and why the existence of the Guarantee Fund is good for the legal profession.  Moreover, it must be remembered that non-solicitors licensed by the Conveyancing and Executries Board also have a fund to compensate victims of dishonesty, albeit that their liability is capped.  It would be conceivable (subject to a change in legislation) to replace the Guarantee Fund with a compulsory fidelity insurance scheme.  After all the Society itself has already arranged Stop Loss insurance cover.  However, it is inevitable that the cost of such an insurance scheme would be greater than the cost of the Society administering the fund as at present.  Any insurer would require to recover not only the cost of administering the scheme (namely, the value of any claims together with all administration and handling costs), but also an element of commercial profit.  Furthermore, the relatively reasonable premiums presently paid for Stop Loss cover are predicated upon the maintenance of a fairly substantial self-insured amount and the continuation of effective monitoring by the Society’s Inspection Team.

Accordingly, there is no prospect of an insurance-based scheme enabling monitoring to be down-scaled.

I have already mentioned that in some jurisdictions there is a “cap” or upper limit placed on the liability of the legal profession to make good losses sustained by a client as a result of a solicitor’s dishonesty.  For example, in England and Wales the liability of the fund is capped at £1 million for any one claim.  In Scotland there is no limit.  It has always seemed to me to be unfair that the profession in one part of the United Kingdom should have a potential liability without limit whereas the very much larger profession in England and Wales should have a restricted liability.  It is to be hoped that the devolution to the impending Scottish Parliament of legislation regulating the legal profession north of the Border may provide an early opportunity for this anomaly to be addressed.  Certainly, the excellent monitoring scheme conducted by the Society and the consequent low level of Guarantee Fund claims should be of assistance to the Society in future dialogue with the Scottish Parliament.  I imagine that the maintenance of Stop Loss cover, perhaps at a higher level than at present, may also be a persuasive factor.

In John Newall’s article last month he expressed the view that the removal of regulation of the profession from the Society would not bring about any improvement in the handling of matters or reduction in the relative cost which the profession has to meet.  I would respectfully associate myself with those views, and indeed, so far as the Guarantee Fund is concerned, I would go a little further.  I think it would be astonishing if any external regulator, appointed by the Government or otherwise, could conceivably maintain the same level of effectiveness in monitoring the financial integrity of the profession.  This is evidenced by the remarkably low claims experience in recent years.  Accordingly, there would in my view be a substantial risk of the level of claims rising which would still have to be met by the profession.  It is also conceivable to me that any external regulator could deliver anything approaching the current monitoring arrangements without a substantial increase in the administration costs which the profession would undoubtedly have to meet.

It seems to me that any concerns expressed about self-regulation are based upon a perceived conflict of interest between the profession and its clients.  It is argued that the Society focuses too much upon regulation of its members and not enough upon representation of the interests of those members.  As John Newall has explained, the perceived conflict of interest does not actually exist.  It is nothing more than an inaccurate perception engendered partly by publicity given to the conduct of a very small minority of solicitors, and partly by historical failings on the Society’s part in telling its members the full extent of the work it does for them.  These failings are understandable.  The Society, like its members, does not wish to be seen “blowing its own trumpet”.  It is also regrettably true that some members of the profession are not particularly interested in hearing what the Society has to tell them unless they are directly affected themselves.

However, it is recognised by the Council of the Society that there is a need for the provision of better and clearer information to the members about its representative work, and that need has been increasingly addressed over the last few years, as readers of the Journal and the Council Newsletter will attest, along with those who attend Society roadshows and faculty visits by the office-bearers and others.  There is still some room for improvement in communicating with the Society’s members, but the key does lie in communication, and not in the abandonment of self regulation together, in my view, with professionalism.

The integrity of the profession is still good for solicitors’ business and, I venture to suggest, always will be.

Alastair Thornton is a Partner with A & W M Urquhart in Edinburgh.