Risk management: Client and transaction vetting

“Risk comes from not knowing what you’re doing”

(Warren Buffett)

In this article we aim to highlight why properly vetting prospective clients and instructions is so important.

What is the point?

The starting point for client and transaction vetting processes is to obtain up-to-date, relevant information about your client and what it is that they are asking you to do. Armed with that information, an informed analysis should be undertaken to determine whether you are able to accept instructions from that client or in relation to that particular instruction. Although the purpose of this article is not to discuss the Law Society of Scotland’s rules and regulations that cover client identification and engagement, we do strongly recommend familiarising yourself with them and the regularly updated guidance and information relating to COVID-19 published on the Society’s website.

Of course, solicitors have specific responsibilities relating to the prevention of money laundering – primarily under the 2017 Money Laundering Regulations and the Proceeds of Crime Act 2002. One of these responsibilities is to undertake risk assessments and due diligence on clients and transactions. This involves, for example, making checks on the legitimacy of the funds to be used in a transaction. There is anti-money laundering (AML) training available and firms should ensure that they are familiar with the regulations and guidance and have robust controls in place.

But the decision about whether to take on a client or a new piece of work is actually wider than AML considerations.

Without properly understanding (i) what you will require to do; (ii) who is asking you to do it; and (iii) what is the reasoning for doing it, you may find yourself exposed to issues which might otherwise be avoided or mitigated.

The vetting of clients and transactions should be proportionate to the circumstances, but there are certain key considerations to bear in mind.

Client vetting: know your client, know the risks

If asked, most solicitors would not struggle to list factors which would be on their minds when determining whether to take on a new client. Criminal convictions (other than for criminal practitioners), past or current insolvency, a history of failing to pay fees, geographical distance – these would all be points at the forefront of most minds.

And yet, despite those individual factors being readily identifiable, it is still the case that inadequate investigation can lead to something being missed which might influence your decision on whether to accept a client’s instructions.

Repeatability

Client vetting processes should be consistent and adhered to, and regular refresher training in them provided to all members of staff. Review your processes on a regular basis – what might have been appropriate a couple of years ago may no longer sit well with your business model or the planned direction of your practice. We all know the obvious red flags we are looking for. The challenge is to ensure that client vetting is carried out, and that whatever else that process achieves, the red flags are not overlooked.

Not seeing the wood for the trees

Prospective clients should be viewed in the round. Vetting processes should be robust enough to flag up those less obvious problems even when minds might be focused on other things. It is easy to become embroiled in the instruction itself, particularly if there is a time bar or closing date approaching, before we have taken a step back and given thought to whether this is something we actually want to, or can, do.

When the facts change, change your mind

Client vetting should be an ongoing process. Circumstances can change between transactions, and an updated assessment of the relevant issues at play is best done at the outset of each new instruction, even with longstanding clients. A client’s situation can change at short notice: bankruptcy and loss of capacity are two examples. However, circumstantial changes can be less obvious and easier to miss.

Third parties – the dangers of relying on others

Reliance should not be unduly placed on due diligence carried out by third parties. It is never sufficient to proceed on the basis that due diligence has been conducted by another firm and no checks are required by your firm – you should not take it as read that the other firm has done what it ought to in terms of its due diligence.

A further consideration is the fact that your firm’s circumstances will never be identical to those of another firm: what may not present any issues for another firm may in fact pose a significant issue to your firm, which could only be identified through your firm’s own vetting processes. Another firm’s appetite for risk may be quite different to your own.

Fairness

Vetting processes can scrutinise a client’s affairs in a way that they might find intrusive, unnecessary or objectionable. Care must be taken to ensure that the client appreciates why you are asking questions and why, in some cases, you must decline to take on the client. Questions about a client’s personal background or their source of funds might feel uncomfortable, but asking them is important for both your and the firm’s protection.

Transaction vetting: steering away from trouble

If good client vetting allows you to understand exactly who it is that you are being asked to act for and what, if any, potential issues accompany that client, transaction vetting aims to identify at the outset whether what you are being asked to do is realistic, achievable, and within acceptable risk parameters.

Just as you wouldn’t cross the road without looking both ways to check for traffic, so you shouldn’t take on an instruction without having first checked for any issues which could arise and which might be avoided. Make sure you have discussed the instruction sufficiently with your client to clarify their objectives and avoid any ambiguities. If there is anything about the instruction which makes you hesitate, consider asking a colleague to give their opinion on it. Again, the potential red flags are often easily recognisable, and the trick is to make sure that they are not overlooked.

To return to the Warren Buffett quote, there can be real risk created where a solicitor does not know the full context of what they are being asked to do. Equally, risk is created when the solicitor agrees to take on instructions which, for whatever reason, they are not capable of achieving.

Context – painting a complete picture

It is important to appreciate the risk that solicitors can become embroiled in others’ disputes even where their own client is happy with the service, and good transactional vetting is the most effective tool for mitigating that risk.

Claims and complaints from third parties are perhaps less common and are difficult to anticipate, but they do occur. The basis for such a claim or complaint can often be a factor which might have been identified in the course of transaction vetting, for example, the existence of a relationship between the client and the third party giving rise to an allegation of conflict of interest, or allegations of breach of trust or fiduciary duty on the part of the client.

Effective transaction vetting will allow you to understand the context in which your client is instructing you and the intentions of the other parties involved, and not just focus on understanding your client’s objectives in isolation.

Avoiding overpromising and underdelivering

Good transaction vetting can identify situations where you are just not able to achieve the result that your prospective client is seeking.

Vetting should always involve considering the nature and complexity of the matter and assessing honestly whether the firm has the appropriate level of professional skills to do that work, bearing in mind the chance that the instructions may grow arms and legs and increase in complexity as things progress.

If this standard cannot be met, think about whether you should assume the risk. You must have regard to your obligations under, for example, practice rule B1.10: “You must only act in those matters where you are competent to do so. You must only accept instructions where the matter can be carried out adequately and completely within a reasonable time. You must exercise the level of skill appropriate to the matter.”

Some solicitors worry about turning down work, especially in times of economic uncertainty. Experience shows though that clients may, in fact, react positively if their solicitor is forthright about their limitations and is willing to refer the client on to an appropriate specialist if and when potential instructions fall outside the scope of their usual practice.

Certainly, in the long run, the client will be far happier having to make alternative arrangements and engage someone else than finding themselves in the position of having to consider a claim or complaint. The risk to the firm of taking on an instruction it is not equipped to carry out and which then goes wrong is a claim from the client which far exceeds whatever the potential fees might have been.

In summary

If there is one takeaway from this article, it is that failing to vet clients and their proposed instructions at the outset leaves you unable to understand fully what you are being asked to do and who is asking you to do it. In turn, that creates a risk issue for firms, no matter their size or area of specialism.

The good news is that by putting in place robust vetting procedures and being committed to proactively assessing new work, firms can significantly reduce risk.