SPONSORED BY
RISK MANAGEMENT SURVEY 2011
TREADING CAREFULLY Risk teams walk the regulatory tightrope
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marsh.co.uk
CONFIDENCE TO FACE YOUR PROFESSIONAL AND BUSINESS RISKS RISK MANAGEMENT SOLUTIONS FROM MARSH For further information please contact: Sandra Neilson | sandra.neilson@marsh.com | Tel: 020 7357 1050 Andrew Carpenter | andrew.carpenter@marsh.com | Tel: 020 7357 5540 Marsh Ltd. is authorised and regulated by the Financial Services Authority for insurance mediation activities only. Š Copyright 2012 Marsh Ltd All rights reserved
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CONTENTS PART I: OVERVIEW
FINE BALANCING ACT
56-59
Would your firm consider outside investment as a method of raising capital?
58
Will the SRA’s move to outcomes-focused regulation create more confusion over risk management?
58
PART II: KEY RISKS
REALITY BITES
60-64
Legal risk profile 1: what impact would these situations have on your firm?
62
Legal risk profile 2: what is the potential for these situations occurring at your firm?
62
Legal risk profile 3: what is the potential of these professional negligence situations occurring at your firm?
62
What are the biggest underlying causes of professional malpractice claims generally?
63
Claims lodged against solicitors in Chancery courts 2000-10
64
PART III: RESOURCES
CLOSER TO THE EDGE
65-68
What are the main barriers to implementing a risk management culture at your firm?
66
What is the size of your risk team?
67
Who will have the position of compliance officer for legal practice (COLP) in your firm?
68
Will the designated COLP actually fulfil this role instead of delegating?
68
Who will have the position of compliance officer for finance and administration (COFA) in your firm?
68
Will the designated COFA actually fulfil this role instead of delegating?
68
PART IV: PROFESSIONAL INDEMNITY INSURANCE
REMOVING THE SAFETY NET
69-72
Is there adequate competition in the solicitors’ PI market?
70
Do you think your firm’s PII is reasonably priced?
70
What is the annual cost in pounds sterling for each £1m of insurance purchased, within the first £10m of the firm’s coverage?
71
What is the annual cost in pounds sterling for each £1m of insurance purchased, in respect of the total limits of the firm’s coverage?
71
Average total insurance cover for the top 150 UK firms
71 March 2012 Legal Business 55
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56 Legal Business March 2012
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RISK MANAGEMENT AND PROFESSIONAL INDEMNITY SURVEY 2012
FINE BALANCING ACT After years of talking around the subject, alternative business structures have finally arrived. In this, our fifth annual risk management survey, we find out how risk managers are negotiating this period of intense regulatory change MICHAEL NORTHCOTT
I
n our 2010 risk management survey, we reported how the industry was bracing itself for the ‘possibility’ that alternative business structures (ABSs) would be operational from 2011. Now, in our fifth annual report with Marsh, the opportunities presented by the Legal Services Act are in full swing. With the first wave of applications flooding the Solicitors Regulation Authority (SRA) in January, the regulator is reporting that nearly 100 firms have already applied. The first ABS licences could be awarded before the end of the first quarter. This creates a unique, regulation-based business opportunity for law firms; a chance to move quickly in a market that is about to change radically. And, for any innovative or ambitious firms to be able to do that, risk management teams will need to be on the front line, smoothing the way.
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From the point of view of the risk team, a lot will change if their firm looks to convert to an ABS. Non-lawyers will own law firms, meaning private investors could buy controlling stakes in firms. The suitability of candidates for doing this, although also assessed by the SRA, will be something that firms need to watch very carefully. For business continuity, for example, the conversion process and any ensuing buyout or investment may have clients nervous about the future of the firm and the impact that the changes might have on the advice they are given. Questions on ABS therefore made up a significant part of our survey this year. And while 52% of respondents said that their firms would not consider outside investment as a method of raising capital, notably a significant number (36%) said that they would, a leap of 12 percentage points on last year. In fact, there has
been an increase in both positive and negative responses on last year. In the 2011 survey, 29% of respondents said they did not know whether they would consider ABS, while this year just 11% were unsure. Jonathan Westwell, general counsel at Baker & McKenzie, says he is unsurprised by the increase: ‘It would be interesting to see which types of firms have said yes to ABS. We’re a year closer to it and people have given it some more attention, and more have shown an interest.’ Of the positive responses to the question of external capital, 67% came from firms ranked in the bottom 50 of the LB100 or outside of the LB100, with the remainder of ‘yes’ responses from firms mainly outside of the top 20. Sandra Neilson-Moore, European practice leader for law firms’ professional indemnity at Marsh, explains why she thinks there has been a rise in the number of respondents embracing u
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RISK MANAGEMENT AND PROFESSIONAL INDEMNITY SURVEY 2012
1) WOULD YOUR FIRM CONSIDER OUTSIDE INVESTMENT AS A METHOD OF RAISING CAPITAL? Yes
11.3%
No 36.4%
Don’t know
52.3%
2) WILL THE SRA’S MOVE TO OUTCOMES-FOCUSED REGULATION CREATE MORE CONFUSION OVER RISK MANAGEMENT? 14.3%
Yes 28.6%
No Don’t know
57.1%
‘If firms are thinking of an ABS, one issue is the impact it may have on a firm’s ability to remain independent.’ Craig Perry, CMS Cameron McKenna
u the idea of outside investment: ‘I suspect
that it is the fact that the rule changes are now in effect, coupled with the fact that more firms have been vocal in the press about plans to expand using ABSs and including outside investment.’ Craig Perry, general counsel at CMS Cameron McKenna, says that the introduction of ABSs raises new questions about the management of firms. ‘If firms are thinking of going for an ABS, some of the issues to consider are the impact it may have on a firm’s ability to remain independent and objective and, depending on the business model, quality control and supervision,’ he says. ‘These would be areas where there might be concerns.’ He also describes the concept of ABS as being a ‘tool in the kit’ for firms to think about, but points out that it is only a third of respondents that would consider external capital, and that not all of those will actually end up converting. Neilson-Moore says there are a large number of specific issues that risk teams will be facing with the introduction of ABSs. These include
how firms will make sure that their business is aligned with the SRA outcomes-focused regulation (OFR) (see ‘Reality bites’, page 60); and whether firms will be able to purchase the required professional liability insurance consistently and at a reasonable premium (see ‘Removing the safety net’, page 69). She also notes that there will be key issues surrounding conflicts, asking: ‘How will conflicts, both legal and commercial, be dealt with given that you will have non-lawyers involved in businesscritical and ownership roles?’ The impact of ABSs will also vary depending on the market that the business operates in. As Neilson-Moore explains: ‘I suspect that the competition aspect is compartmentalised in that some firms will see the prospect of competition from ABS organisations for their practice as looming, while others will not.’ While the issues raised by Neilson-Moore are serious, they do not yet have risk teams unduly concerned. Our ‘Legal risk’ tables (page 62) reveal that risk teams generally feel that ABS has much less potential for adversely affecting
their firms in 2012. Although firms feel that the overall impact of competition from ABS firms has not changed significantly, the data suggests firms feel less concerned now that it has finally arrived. The fact that an onslaught of firms converting to ABSs appears to still be some way off is giving risk teams time to fully implement OFR in their internal procedures. Feedback from the survey this time suggests that the initial concern about implementing OFR in firms has been slightly allayed by another year of discussion and planning. Emma Dowden, director of operations and best practice at Burges Salmon, explains that her firm did not find any major issues with the new handbook when it became effective on 6 October 2011: ‘We analysed the new handbook, and we found that there was little change in terms of policy and procedure. There isn’t necessarily a big change to the requirements for us. It’s a new relationship management culture which is the main difference, but it wasn’t a wholesale rewrite of strategy and procedures.’
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Dowden explains that there had been some apprehension at Burges Salmon. ‘There was a fear initially when OFR was being talked about that people would see us as the “risk police”, but actually it seems there won’t be that massive cultural shift. The legal profession could learn from the accountancy model, where they have a separation of powers in that respect. In big accountancy firms there is a distinction between the advisory staff and the audit staff, so the remit of the functions is clearly understood. Similarly, it will be important for law firms to be able to identify who has which reporting obligations and communicate this to staff in order that firms and in particular those with reporting responsibilities such as the compliance officer for legal practice (COLP) can evidence compliance.’
DISTANT HORIZON With the storm in a teacup surrounding both ABS and OFR seemingly over, there is another spectre looming over risk teams that could dominate the agenda next year. The SRA’s consultation on regulation of international practice, which ended on 15 February 2012, sought opinions on how UK-based firms operating outside of the UK might be regulated in the future. The SRA says it has not as yet made any concrete decisions about if or when new regulation in this area might come in, but the consultation will give the body some groundwork on which to look into this area in the future. This will affect many firms that have an international footprint, and although many of their compliance functions will run parallel to the London office, others will have some challenges ahead in making sure all offices are fully compliant with whatever regulations the SRA ends up introducing. The SRA makes its rationale clear on the consultation website: ‘to ensure that the standards that clients, courts and fellow regulators can expect of our regulated community are upheld internationally and that clients and consumers can be sure that any legal services delivered under a “brand name” associated with the English and Welsh system comes with clarity about how they are regulated’. Part of the motivation is that the SRA wants to develop the ability to identify and address issues that occur outside of the UK, before a scenario can develop far enough that adverse effects are felt within the UK. The move comes partly as a response to the changing face of the legal industry, as more and more firms expand into overseas offices, and the consumer is at risk from firms selling services back into the
UK from their international outposts, under different regulations. Olswang’s general counsel Simon Callander notes the difficulty this creates for law firms: ‘There is an obvious potential for conflict between applying the SRA principles internationally and the possibility for those principles being incompatible with regulations in other jurisdictions, and it is far from clear how any difference or incompatibility could be resolved.’ He goes on to suggest ways in which the regulator could make any new regulations harmonious: ‘It might work better if they regulate not from the perspective of where the provider of the services is, but from the perspective of where the services are delivered. This could be a way of dealing with selling-back.’ Bird & Bird general counsel and risk management partner Roger Butterworth believes any new regulation will be a good thing, because the current rules regarding overseas offices are ‘arbitrary’. ‘The present rules even as just revamped in October apply large sections of the code of conduct to “overseas practice” which
‘There was a fear that people would see us as the “risk police”, but it seems there won’t be that massive cultural shift.’ Emma Dowden, Burges Salmon
affects branches of a firm’s London partnership. This is a bit arbitrary because all the large firms have large networks overseas,’ he says. ‘The SRA is simplifying the rules, and will expect the firm overall to be well run through some basic rules of management that they expect to apply across all offices,’ he continues. ‘This has been well received by a number of large law firms.’ Since no recommendations have actually been made about any new regulation in this area, it is hard for risk teams to tell what new challenges they may be faced with.
FALLING INTO LINE Deadlines are fast approaching for nominating individuals for the new roles brought in by OFR, the COLP and the compliance officer for financial administration (COFA). The new SRA Handbook, in the section ‘Authorisation and practising requirements’, outlines these positions. The time at which firms are expected to be compliant and have implemented the systems that will support the COLP and COFA is colloquially known as C-Day, 31 October 2012, meaning there is much to consider this year (see ‘Closer to the edge’, page 65). Despite all this upheaval, there are those who feel that the changes are a good development for the legal industry. Tony Cherry, chair of DAC Beachcroft’s internal committee for governance and risk, thinks there is too much criticism of the SRA’s initiatives. ‘I don’t think there is a lack of clarity in guidance from the SRA,’ he says. ‘The OFR just says “you know your own business best so you make your own rules”, therefore I don’t think it does too much good to rail against over-precise regulation and then complain that the guidance is too vague.’ It is clear that risk teams have a lot on their plate, but after a year of piecing together enough knowledge and strategy to get to grips with ABS and OFR, as well as all of the other perennial risks, many risk managers report feeling that the boat is beginning to steady. Our survey bears this out in numbers, and shows firms have a greater level of interest this year in how they can develop themselves along new regulatory lines, and in the wake of the Legal Services Act. Confusion has by no means been eradicated, but our survey suggests that it is abating, and that many risk teams are beginning to find some solid ground in preparation for C-Day. LB michael.northcott@legalease.co.uk Legal Business would like to thank Marsh for its sponsorship of this survey.
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REALITY BITES With a new regulatory framework now in place, falling foul of the SRA is a key fear for risk teams. But our results show it is the same old risks that cause the most problems MICHAEL NORTHCOTT
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I
n this section of the survey we identify key areas of risk and ask firms to indicate, hypothetically, which of those scenarios would have the most impact on their business, but also to judge the likelihood of that scenario occurring. The inevitable result of this type of test is that many of the highest-impact situations are the least likely to occur, and vice versa. This trend is shown in the ‘Legal Risk Profile’ tables on page 62, charting scenario impact and potential as separate indices. It is clear that operating within new regulatory framework, including compliance with the Solicitors Regulation Authority (SRA)’s outcomes-focused regulation (OFR) will be foremost in the minds of risk teams in 2012. Craig Perry, general counsel for CMS Cameron McKenna, says: ‘Whether [complying with the new framework] will take up too much time, or whether in fact risk teams should be focusing more on financial risk at a time when there is a suspicion that there will be a double-dip recession, is an important question.’ Indeed, while OFR has been on everyone’s lips since it was announced, our survey shows that, as a key risk, teams are expecting OFR to have only a moderate impact, with an average rating of 2.3 out of 5. The probability of OFR becoming a problem for law firms has fallen from 2.7 to 2.4
out of 5, possibly reflecting the strides that many firms have made in implementing the relevant systems and procedures over the last 12 months. Tony Cherry, chair of DAC Beachcroft’s internal committee for governance and risk, thinks the risk environment has stabilised. ‘I think there’s an element of “more of the same” this year,’ he says. ‘Obviously we’ve had the regulatory changes, but they were known about and planned for.’ Notably, the number of firms concerned that OFR will create more confusion among risk teams has plummeted from a whopping 68% in 2011, to a much more moderate 29% in 2012. As Bird & Bird’s general counsel and risk management partner Roger Butterworth puts it: ‘A year ago there was great uncertainty about OFR and how to deal with it, but the world did not come to an end in October 2011. There has been a lot more acceptance since then, as firms continue to implement the new regime.’ However, firms are generally less confident about the extent to which they have implemented the right systems and processes for complying with OFR. Just 52% of firms said they had completed their internal processes for dealing with OFR, and just under a third (30%) said that these processes were not ‘completely effective and u understood’ within their firms. On balance,
Illustration AKZIDENT
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marsh.co.uk
CONFIDENCE TO FACE YOUR PROFESSIONAL AND BUSINESS RISKS RISK MANAGEMENT SOLUTIONS FROM MARSH For further information please contact: Sandra Neilson | sandra.neilson@marsh.com | Tel: 020 7357 1050 Andrew Carpenter | andrew.carpenter@marsh.com | Tel: 020 7357 5540 Marsh Ltd. is authorised and regulated by the Financial Services Authority for insurance mediation activities only. Š Copyright 2012 Marsh Ltd All rights reserved
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u
LEGAL RISK PROFILE 1: WHAT IMPACT WOULD THESE SITUATIONS HAVE ON YOUR FIRM?
Situation Liabilities exceeding resources, including insurance (eg professional negligence claim in excess of policy limits) Disaster/business continuity failure IT security breach/data management accident or breach Unwittingly becoming involved with client fraud Credit or other financial problems Serious legal or commercial conflicts of interest Reputational damage to the firm (eg from media, ex-employee, disaffected client) Loss of key partners/staff Inability to attract new partners/staff Loss of firm’s biggest client Failure to meet strategic plans Bankruptcy/acquisition of significant clients Poor performance of key lateral hire(s) Competition – including from Alternative Business Structures SRA’s new Outcomes Focused Regulations Employment claims from former partners/staff Alternative Business Structures rule changes in 2012 Currency fluctuations
Impact (mean score out of 5) 4.2 3.9 3.8 3.7 3.6 3.4 3.3 3.1 3.1 3.0 2.9 2.8 2.7 2.4 2.3 2.0 1.9 1.6 Source: Marsh/Legal Business RM survey
HIGH IMPACT
LOW IMPACT
LEGAL RISK PROFILE 2: WHAT IS THE POTENTIAL FOR THESE SITUATIONS OCCURRING AT YOUR FIRM? Situation Poor performance of key lateral hire(s) SRA’s new Outcomes Focused Regulations Loss of key partners/staff IT security breach/data management accident or breach Bankruptcy/acquisition of significant clients Competition – including from Alternative Business Structures Loss of firm’s biggest client Failure to meet strategic plans Reputational damage to the firm (eg from media, ex-employee, disaffected client) Unwittingly becoming involved with client fraud Alternative Business Structures rule changes in 2012 Serious legal or commercial conflicts of interest Disaster/business continuity failure Inability to attract new partners/staff Currency fluctuations Employment claims from former partners/staff Credit or other financial problems Liabilities exceeding resources, including insurance (eg professional negligence claim in excess of policy limits)
Potential (mean score out of 5) 2.5 2.4 2.4 2.4 2.4 2.3 2.1 2.1 2.1 2.1 2.1 2.1 2.0 2.0 1.9 1.9 1.6 1.5 Source: Marsh/Legal Business RM survey
HIGH POTENTIAL
LOW POTENTIAL
LEGAL RISK PROFILE 3: WHAT IS THE POTENTIAL OF THESE PROFESSIONAL NEGLIGENCE SITUATIONS OCCURRING AT YOUR FIRM? Professional negligence situation Errors made by staff/lawyers on complex, high-value transactions Errors made by staff/lawyers on routine bread and butter transactions Increased claims as a result of pressure on fees and the need for ‘instant’ advice Lawyers advising outside area of expertise Inadvertently advising third parties Infringement of regulations Insurance claims emanating from foreign offices Errors made by confusion caused by SRA’s outcomes-focused regulatory approach
Potential (mean score out of 5) 2.7 2.6 2.5 2.3 2.0 1.9 1.8 1.6 Source: Marsh/Legal Business RM survey
HIGH POTENTIAL
LOW POTENTIAL
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u however, a third of firms (33%) said they did believe that the processes were completely effective and understood in their firm, showing that the market is almost equally divided into firms that have their processes sorted; those that have not; and those that are somewhere between both camps. But the telling statistic is that twothirds of firms have not achieved a fundamental understanding of how OFR works yet. Simon Callander, the new general counsel at Olswang, says that OFR is forcing firms to ‘think differently’ about risk. ‘We’re transferring from a checklist or tick-box environment to one where the regulator will want to see pro-active and applied thought about the risk issues and environment from the firms themselves,’ he says. While the deadline for firms to be compliant with the new framework is March 2012, Richard Turnor, partner at private client boutique Maurice Turnor Gardner, thinks that there will be some leniency from the SRA towards firms which are serious about complying. ‘I don’t think the SRA is going to expect anyone to be perfect [straightaway],’ he says. ‘As long as firms are client-focused and systematic in their approach to compliance then I don’t think they will find themselves in any trouble.’
SAME BUT DIFFERENT Over the past five years, the bread-and-butter concerns of risk teams have usually received similar scores from respondents. But some of these typical and persistent risks have seen notable shifts in this year’s survey. For example, the potential impact and the likelihood of a key lateral hire performing poorly are very closely aligned. Scoring an average of 2.5 out of 5 for likelihood (the most likely), and 2.7 for impact (the second most serious category), this is one of the most serious risks for all firms. The data would suggest that firms are more concerned about laterals and their performance, which is perhaps unsurprising given that the lateral hire market picked up dramatically in 2011, with more firms taking a punt on expanding into resurgent practice areas. After all, economic conditions do not lend themselves to foolhardy investment, and key laterals need to earn their keep if the firm isn’t to lose out. In addition, the ability of laterals and longer-standing partners to work in line with a firm’s risk-minimising procedures is essential. When asked for the leading causes of professional malpractice claims, by far the most resounding response from risk teams was that lack of communication with clients and/or internally was the standout risk, with 69.8% of
WHAT ARE THE BIGGEST UNDERLYING CAUSES OF PROFESSIONAL MALPRACTICE CLAIMS GENERALLY?* Cause
% of all respondents citing: 4.7%
Partner/staff turnover
69.8%
Lack of communication with client and/or internally
?
27.9%
Poor record keeping Lack of evidence to defend
9.3%
Incoherent professional guidelines
7%
Quality of staff
14%
Pressure of work/pressure of deadlines
58.1%
Lack of supervision
41.9%
Inattention to detail
46.5%
Failure to manage client expectation
55.8% 7%
Other 0
10
20
30
40
50
60
70
80
*NB respondents usually provide more than one cause each
respondents citing it as a leading cause. In the 2011 survey, pressure of work and deadlines took the lead with 62% of respondents naming it one of the leading causes. This year that figure had fallen slightly to 58%. Failure to manage client expectation has also risen as a cause of malpractice claims, cited this year by 56% of respondents, compared with last year’s 39%. Perry says that these three causes of claims – lack of communication, pressure of work and deadlines, and failure to manage client expectation – have always been an issue for firms. He says that where management focuses on improving an area, or where circumstances change (for example where a period of tight timetables and urgent work eases off), one factor may overtake another as the leading cause of complaints. This does not necessarily mean there is a trend of lawyers failing to improve clear and regular communications with clients and internally. ‘[All three causes] have always been an issue and are a regular cause of client complaints,’ he says. Andrew Clark, general counsel at Allen & Overy, agrees and says this change in the commonly cited leading causes may reflect the changing nature of client demands: ‘Client expectations are certainly greater now. Clients are not just looking for first class legal advice, that is a given, but also for lawyers who really
understand them and their markets. They want not just a lawyer but a businessperson capable of appreciating the commercial elements of the market and the context in which advice is being given.’ In last year’s report, we mentioned data released by RPC showing the number of professional negligence claims brought in London against solicitors in the High Court (see table, page 64). At that time, the figure had risen from 80 in 2008, to 210 in 2009 – the highest number since 1998. In the latest figures, which are for 2010, the number of claims had fallen back to 144, which although almost double the 2008 figure, is still a fall of 32% on 2009 and therefore a notable improvement.
IN THE CLOUDS IT is an omnipresent concern to risk teams and this year was no exception, particularly the risk of data protection breaches or data management accidents. The aggregate score for this risk, drawn from both impact and potential, is 6.2, the highest aggregate score of any scenario in the ‘Legal Risk Profile’ tables. While only in the ‘moderate’ zone in the tables in terms of potential, the likely impact of an IT security breach came third to an insurance crisis or a disaster affecting business continuity. The fact that a breach is perceived u to be a high-impact scenario, and that it also
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CLAIMS LODGED AGAINST SOLICITORS IN CHANCERY COURTS 2000-10 250
Number of claims
200 150 100 50 0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010 Source: RPC
u has a moderate to high chance of happening
legitimises the concern that surrounds IT. By way of comparison, the aggregate score of the risk of a poorly performing lateral hire is 5.2, which, while at the top of the potential table, appears more moderate in terms of impact. IT is the front-runner for risk despite the unavoidable gamble that is taken with every hire. ‘The sense I have is that the risk teams are very worried by the sheer scale of what could happen if large amounts of confidential data somehow got out of the firm’s control and/or the firm’s systems failed completely,’ says Sandra Neilson-Moore, European practice leader for law firms’ professional indemnity at Marsh. ‘I suspect the reason it is not graded as a key risk in terms of potential, is that the firms’ IT departments believe it could not and will not happen to them because their systems are robust enough to protect them.’ Concerns over the use of cloud computing technology where the security of data is critical are prevalent among some of the more conservative IT departments in the City. The fact that clients’ data would be stored in a location away from the law firm’s offices, or even stored in a different jurisdiction could be seen as a vulnerability to a data breach. Cloud services can be served to your computer from a data centre thousands of miles away. In terms of business continuity, there is the added risk that a data centre may fail, or servers crash, leaving the enduser (the law firm) powerless to fix the problem manually. In October last year, BlackBerry suffered a damaging server crash which caused a blackout of e-mail, internet and BlackBerry Messenger services for millions of its customers across Europe, the Middle East and Africa.
Many speculators maintain that the phone’s manufacturer, Research In Motion, will suffer market-share loss in the long term as a result of the crash, which left users unable to connect for several days. The outage was one of the most high-profile examples yet seen of major issues with cloud computing, and a problem which is hypothetically possible at any server-centre providing such services. But Cherry thinks the issues, as far as risk teams are concerned, are over-hyped: ‘IT people are very good at identifying risk, but the same issues as normal arise with cloud computing: how secure is it, and how much does it cost?’ Many law firms will no doubt shy away from using cloud services until they sense that the creases in a new technology have been ironed out. Butterworth is similarly sceptical about the extent to which risk teams are currently facing a major new hurdle in cloud computing: ‘I think it is fair to say that IT is very high on the agenda, and cloud computing is a step that many firms may now be looking at. But law firms tend to be quite conservative, so it may not materialise as a big area of risk in the next 12 months.’ However, data-handling processes remain risk-critical even without the advent of cloud computing. Take ACS:Law, which was fined £500,000 in 2010 for losing the personal details of thousands of people under investigation for illicit file-sharing. Just a year later, in May 2011, one of the firm’s solicitors was hit with a £1,000 fine by the Information Commissioner because of a data breach that saw the personal details of 6,000 people, targeted by ACS:Law, leaked online through the firm’s website. Similarly, the insurance industry received a strong message from the Financial Services Authority (FSA) when
it fined the UK operation of Zurich Insurance £2.3m for losing the personal details of 46,000 of its customers in 2010. This was reported to be the largest-ever fine for a data protection breach. Data risk ties in with another high-impact category chosen by respondents to our survey: reputational damage to the firm. Such a highprofile fudging of protocol is guaranteed to cause consternation among existing clients, and perhaps dissuade new ones from looking any further into a firm’s offering. In the ‘Legal Risk Profile’ tables (see page 62), the category was ranked in the middle of the range for the likelihood of occurring, and in the extreme danger zone of the impact index, at 3.3 out of 5. When asking firms to rank this particular risk scenario, we included reputational damage from across the media, from outspoken former employees of the firm, and from disaffected clients. This is why avoiding mismanagement of client expectation, and data breaches revealing confidential documents, remain a priority in the survey responses each year. One area not covered by the survey was the damage to reputation caused by the fraudulent activity of individuals within the firm, which became the most talked about risk issue for many firms in 2011 (see ‘Do the right thing’, LB218, page 32). This area was not included in the survey as although there were at least four high-profile examples of partner fraud to emerge last year, the general feeling is that this was an aberration and something that the firms concerned dealt with effectively to minimise impact. There is no doubt that while there have been some important movements in the scenario rankings for impact and potential, OFR remains the talking point of the profession for risk teams in 2012. Some remain confident about the ability of firms to implement the changes however. Jonathan Westwell, general counsel at Baker & McKenzie, says: ‘I think there is greater awareness with regards to risk management, and what it means for us as a law firm. Have the risks changed? No. The likelihood of some of those risks arising might have changed, but that’s more to do with the economic and operational environment rather than any changes made by the SRA.’ For a great number of firms, the concern of 2012 will be compliance. The new system will take some implementing, and making sure that any progress that has been made over the years with fostering a risk-aware culture in firms is not lost, will be of paramount importance. And key risks themselves? Well, they’re never going to go away. LB michael.northcott@legalease.co.uk
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CLOSER
TO THE
EDGE Lack of buy-in from partners remains a perennial issue for risk teams finding a voice internally. However, the introduction of a compliance officer for legal practice may change all that in 2012 MICHAEL NORTHCOTT
A
ttempting to foster a culture of risk management throughout a firm rather than just within the risk and compliance teams is a tough job. However, this year teams have made some changes to combat the usual complaints and temper the effects of regulatory changes. Every year we ask firms what they consider to be the main barriers to implementing a risk management culture at their firm and a typical response is ‘a lack of time and resources’. This year was no different (see table, page 66). Our survey also shows that risk teams have grown in size on last year, from an average of 23 to 32 people. At face value, this looks like a simple way of dealing with the problem, but teams still have difficulty eliciting partner buy-in, and cultivating risk awareness throughout the firm. Many firms again this year have cited this as a nagging issue and in some cases even ‘partner resistance to change’. u
Illustration AKZIDENT
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WHAT ARE THE MAIN BARRIERS TO IMPLEMENTING A RISK MANAGEMENT CULTURE AT YOUR FIRM? LB100 rank
Selected comments
Top 20
Size and complexity of the organisation.
Top 20
Culture across multiple jurisdictions.
Top 20
Resources.
Top 20
Geography.
Top 20
Resistance to bureaucracy.
21-50
Lack of senior/partner buy-in.
21-50
Cost/lack of investment.
21-50
Pressure to focus on chargeable activities.
21-50
Volume of new regulation.
21-50
Integration of lateral partners/groups coming from other risk management cultures.
51-100
Awareness.
51-100 Time. Body (First Para) Body (Light Indented) 51-100 Not being convinced that Code of Conduct is workable. 51-100
SUBHEAD
Lack of accountability.
51-100 Partner independence. Body (Light) Body (Light Indented) LB Sign-off 100+ DecentralisedWriter practices. e-mail 100+ Cost of resource to implement. 100+
Complacency.
100+
Not linked to appraisal or reward structure.
100+
Not seen as part of the fee-earning structure. Source: Marsh/Legal Business RM survey
u
Many of these issues can be seen in the responses from a variety of firms, meaning very few of the complaints identified by our survey can be viewed as anecdotal. However, the introduction of the compliance officer for legal practice (COLP) role this year is perceived by many respondents to be a potential catalyst for at least some degree of change in the standing of risk teams and risk issues in the operation of firms. The structure of risk teams will look markedly different by the end of the year: the make-up of teams should be overhauled by 31 October 2012, the date by which the Solicitors Regulation Authority (SRA) will have approved firms’ nominated COLP and compliance officer for finance administration (COFA). The creation of these roles through the SRA’s new handbook has divided opinion in the City and further afield, as both will be required to report any breaches of the regulatory code by their firms to the SRA. But the main challenge lies in actually choosing who will take up the roles. Given that the head of risk and compliance at a large firm plays a major role as the trusted adviser to lawyers, and that mid-sized or small
firms may not actually have a full-time risk head (if they have a risk department at all), this means that the ‘one size fits all’ approach of this particular requirement can present a number of obstacles. Tony Cherry, chair of DAC Beachcroft’s internal committee for governance and risk, says there may be a challenge in properly communicating the importance of the new COLP role to the firm: ‘The biggest single challenge is to get across to people that compliance has not just been miraculously dealt with, it needs to be communicated well.’ However, Bird & Bird’s general counsel and risk management partner Roger Butterworth sees the upside. ‘It will mean that the risk function will be seen to have a place at the table of core management, where it used to be advisory and somewhat detached,’ he says.
COLP ABILITY The COLP will be responsible for overseeing the entire risk process in legal practice, and while maintaining the traditional advisory role, will be required to report any breaches of regulation.
Additionally, the COLP must be a lawyer. The COFA performs the same function on the financial regulation side, and the same person may hold both positions, but the COFA need not be a lawyer. One of the main criticisms of the COLP role is that the requirement to report breaches is universal, and many feel that it undermines the traditional role of the risk team as having a trusting advisory relationship with lawyers. Andrew Clark, general counsel at Allen & Overy, highlights the core of the issue: ‘A number of firms are expressing a worry that people may be more circumspect about discussing aspects of a deal or piece of work with the COLP if they feel that the COLP may then be under an obligation to report them to the SRA. Firms and COLPs will have to think carefully about how they will play that.’ Bill Richards, head of risk and compliance at LG, attests to the level of debate in the marketplace over how to select the right person. ‘One of the things firms try to foster is a culture where if you think you may have done something wrong, then you would seek advice from the risk
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WHAT IS THE SIZE OF YOUR RISK TEAM? Average number of individuals involved in this function either full-time or part-time
team,’ he says. ‘If you felt you might be reported to the SRA for a breach of the rules you might not be quite so minded to beat a path to the door for advice in the same way as before.’ This worry is shared by more than a few firms. Given that the function of the risk team has traditionally been to institute processes that avoid risk, the new breach-reporting responsibilities change the dynamic between risk teams and all other staff. Some are concerned that the responsibilities will render the risk team a ‘police force’ inside the firm. It is worth noting however, that the same duty to report regulation or legal breaches is already in operation in the field of accountancy, with accountants that spot any malpractice required to blow the whistle on their employer. Craig Perry, general counsel at CMS Cameron McKenna, thinks that the implementation of the COLP role will not generally be an issue for the profession: ‘As far as day-to-day client work is concerned, if people have been complying with previous regulation and providing a good service, then there probably won’t be too much difference.’
8 7 6 5 4 3 2 1 0
6.3
6.4
6.3 2.9
Conflicts
Compliance Professional Complaints liability
Sandra Neilson-Moore, Marsh
3.9
4 Regulatory Operational
Social
Area of risk management
Olswang’s general counsel Simon Callander is sceptical that the ‘trusted adviser’ role of the risk team will be undermined by the creation of the new position. ‘My take is that we are transitioning from a castigating type of regulation, to a much more mature form of regulation where reporting may be a positive thing to do in terms of enlisting the regulator’s understanding and perhaps even assistance,’ he says. ‘We need to be careful about assuming that reporting to the regulator is a negative thing.’
CORRECT CHOICES
‘I expect that the reporting and recording functions of the COFA role will be the province of a senior partner.’
2.4
Given the sensitivity of the COLP role in the running of a firm’s risk function, the selection process varies considerably between firms. In our survey, there was limited consensus about which existing member of staff would take the role, if indeed the candidate was chosen from the existing pool of staff. Only 28% of respondents said they would be nominating their existing head of compliance for the role, 14% said their general counsel, while 19% said their managing partner would take the role. The largest group by far, 40%, said ‘Other’, specifying a range from just ‘an equity partner’ and ‘a board level partner’, to ‘as yet undecided’. Notably, very few firms surveyed (just 5%) said that they had not yet decided, an encouraging sign given that the deadline for submitting nominations to the SRA is 31 March 2012. While many firms see the existing head of risk and compliance as the natural choice for the role, others have taken a different approach. Callander was brought in during December 2011 partly for the purpose of filling the COLP
position. He is unsurprisingly positive about the new role. ‘It will provide an identified focus for risk and compliance around which those functions will naturally gather,’ he says. As for the way firms choose a candidate, Callander says he has seen a variety of approaches, and ‘some have been looking at bringing in external resources that can perform [the duties of the COLP] in a broader role’. Where smaller firms are concerned, Richards estimates that while every single law firm is required to have a COLP and a COFA, only up to 70 out of over 10,000 firms in the UK will actually have an existing head of risk and compliance, placing an extra burden on staff. ‘Firms of our size already have a head of risk and compliance, but if you’re a four-partner firm, it’ll be very different,’ he says. We also asked firms if the designated COLP would actually fulfil the role instead of delegating their responsibilities to a non-partner administrator in the risk team. 71% of firms answered that the COLP would fulfil the role, and 5% said they would delegate. One respondent said that the responsibility would be delegated because their COLP would be the managing partner of the firm, and that he would delegate responsibility to the risk and compliance team. Nearly a quarter of respondents were unsure whether the COLP’s duties would be delegated or not, an unsurprising reflection of how sensitive the issue of responsibility for the role will be.
STRAIGHTFORWARD FINANCIALS As for the responsibility for the COFA role at firms, the responses are more straightforward. u 73% of respondents said that the financial
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u director would take the role, while only
2% said their managing partner would fill this position. In addition to this, there was a much higher proportion of respondents conceding that the COFA responsibilities would be delegated to some degree – just 63% said the COFA would fulfil all of the responsibilities without delegating. Marsh’s European practice leader for law firms’ professional indemnity Sandra Neilson-Moore thinks this difference between the two roles and how risk teams are planning for them, is rooted in the question of equity. ‘I expect that the reporting and recording functions of the role will, in many firms, be the province of a senior partner or even the managing partner, while the more financial management or accounting functions will be the responsibility of the finance director (FD),’ she says. ‘This is because the FD will not be an equity stakeholder or partner of the firm in many cases.’ Richards explains that there has been a lot of consideration about the nature of both roles. ‘A lot of us are spending time working out what formalities should exist between COLPs and COFAs, and their firms. Should there be a formal requirement in the partnership deeds to supply assistance to them? Should there be management liability insurance?’ He also points out that because firms are used to ‘prescriptive rules’, they now ‘are not quite sure how the SRA is going to police its regulatory powers’. From an insurance perspective, NeilsonMoore sees the COLP and COFA roles as being of paramount importance for risk teams’ consideration in 2012 and says making sure that ‘the duties and obligations of the COLP and COFA are understood by the individuals in those roles’ is key. In addition, she recommends that risk teams should review their firms’ existing management liability insurance policy and ensure that the COLP and COFA are covered, and that fines and penalties are included in the coverage. Creating more of a dialogue with the SRA through the COLP may actually serve firms better – catering for clients in such a way as to keep the regulator happy is bound to carry some benefits. After all, the regulator is in place largely to protect the client’s interests. With more of a collaborative approach to regulation (ie using the ‘relationship manager’ concept), the SRA will be able to focus its attention on firms which appear to be struggling more than others with compliance. LB michael.northcott@legalease.co.uk
1) WHO WILL HAVE THE POSITION OF COMPLIANCE OFFICER FOR LEGAL PRACTICE (COLP) IN YOUR FIRM? Managing partner
5.4%
18.6%
General counsel Head of compliance
34.1%
14%
Other Still deciding
27.9%
2) WILL THE DESIGNATED COLP ACTUALLY FULFIL THIS ROLE INSTEAD OF DELEGATING? Yes 23.8%
No Other
4.8%
71.4%
3) WHO WILL HAVE THE POSITION OF COMPLIANCE OFFICER FOR FINANCE AND ADMINISTRATION (COFA) IN YOUR FIRM? 2.3% Managing partner
7.1%
Financial director
17.9%
Other Still deciding 72.7%
4) WILL THE DESIGNATED COFA ACTUALLY FULFIL THIS ROLE INSTEAD OF DELEGATING? Yes No 31.7%
4.9%
Other 63.4%
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REMOVING THE
SAFETY NET Last year the SRA announced that the assigned risks pool and the single renewal date for professional indemnity insurance would be scrapped by 2013. What does this mean for insurance premiums and competition in the market? MICHAEL NORTHCOTT
I
n last year’s survey, debate focused on abolishing the single renewal date for professional indemnity insurance (PII). As a talking point, this issue had been on the agenda for a few years, but with the Solicitors Regulation Authority (SRA) ďŹ nally having taken the decision in April 2011 to end it by October 2013, the situation looks to have come to a head. But while the decision to scrap the single u renewal date will polarise opinion, the
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u move by the SRA also to abolish the
controversial assigned risks pool (ARP) in 2013 has very few critics. The ARP has garnered criticism from more than a few corners of the legal profession, as it has been felt by some that the scheme pushes up the price of insurance for ‘insurable’ law firms. The SRA’s reasons for making changes to the ARP were twofold. The regulator’s chief executive Antony Townsend explained in a statement that: ‘The increasing size and cost of the ARP was causing understandable concerns and resentment throughout the profession as firms that could find insurance were facing rising premiums as they helped meet the payments of the ones that couldn’t. It was also having the knock-on effect of creating a situation where rising premiums meant that more firms were unable to afford cover on the open market.’ In response to the problem, the ARP is gradually being ‘managed’ out of existence: the length of time for which firms can remain
‘Insurance companies won’t necessarily make a saving themselves just because the size of the ARP is reduced.’ Roger Butterworth, Bird & Bird
IS THERE ADEQUATE COMPETITION IN THE SOLICITORS’ PI MARKET? 4.7%
Yes No Don’t know
37.2%
58.1%
DO YOU THINK YOUR FIRM’S PII IS REASONABLY PRICED? Yes
21.4%
No Don’t know
7.1%
71.4%
in the pool has been halved from 12 months to six months, and the ARP fund manager has been ‘actively pursuing [unpaid premiums] on behalf of the insurers’, to combat the issue of ARP firms not paying the premiums they do owe. Firms which remain in the ARP for longer than six months will be forced to close down. The cost of funding the ARP had risen to around 15% of total PII premiums across the profession in England and Wales, according to SRA figures. Roger Butterworth, general counsel and risk management partner at Bird & Bird, says that the ARP was an issue which could have worsened. ‘The scare of ARP had to do with what it would cost if it continued to expand,’ he says. However, in the last 12 months, the size of the ARP has been reduced to about 10% of its original size, dropping from around 500 law firms to fewer than 50. ‘But insurance companies won’t necessarily make a saving themselves just because the size of the pool is reduced,’ adds Butterworth. Many heads of risk and compliance share Butterworth’s view. Tony Cherry, chair of DAC Beachcroft’s internal committee for governance and risk, says: ‘There are too many
factors affecting the premium to identify one cause of any variation. Any law firm should have a good dialogue with its insurer about pricing.’ Similarly Andrew Clark, general counsel for Allen & Overy, does not predict a notable change in the premium thanks to the reduction in the size of the ARP. ‘To the extent that there will be a saving, I don’t expect it to be material,’ he says. ‘Firms like ours pay high prices for high-quality PI insurance. I think what we’ll see over the next couple of years is more players coming into the market. Obviously we hope that will bring more competition into the pricing.’ The sudden drop in the number of firms in the ARP is ‘something of a mystery’, according to Sandra Neilson-Moore, European practice leader for solicitors’ professional indemnity at Marsh. ‘In my opinion, there are no specific measures brought in by the SRA that had a direct effect on the number of firms entering the ARP,’ she says. ‘The SRA’s measures are more designed to keep firms from languishing in the ARP, while entering the ARP has to do with the perception of the commercial insurers of a given firm’s insurability.’
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1) WHAT IS THE ANNUAL COST IN POUNDS STERLING FOR EACH £1M OF INSURANCE PURCHASED, WITHIN THE FIRST £10M OF THE FIRM’S COVERAGE? £200,000
£150,000
£100,000
£50,000 £0 Top 20 firms
Firms 21-50
Firms 51-100
All firms
2) WHAT IS THE ANNUAL COST IN POUNDS STERLING FOR EACH £1M OF INSURANCE PURCHASED, IN RESPECT OF THE TOTAL LIMITS OF THE FIRM’S COVERAGE? £12,000 £10,000 £8,000 £6,000
‘The closure of the ARP may cause more insurers to come into the market as qualified insurers, and that could drive down prices.’ Bill Richards, LG
£4,000 £2,000 £0 Top 20 firms
Firms 21-50
Firms 51-100
All firms
3) AVERAGE TOTAL INSURANCE COVER FOR THE TOP 150 UK FIRMS £350m £300m £250m £200m £150m £100m £50m £0 Top 20 firms
Firms 21-50
Firms 51-100
Firms 100+
All firms
Our survey broached the important issue of what the industry perceives to be the appropriate level of competition, and just how reasonable firms find the pricing of insurance to be. 71% of respondents said that they found PII generally to be reasonably priced, but just 58% of respondents agreed that there was adequate competition in the PII market. NeilsonMoore points out that: ‘There is not as much competition in this area as there is in other areas of insurance, but that is because it is a specialised market. There is actually a reasonable amount of competition for the “right” firms.’ She does add, however, that there is ‘hardly a surfeit of competition’. In addition, Neilson-Moore argues that the abolition of the ARP and the single renewal date will not affect premiums. ‘It may result in more insurers entering the market and thus bring more competition into play. That may affect premiums u favourably for some individual firms,
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u but I do not believe it will have a material
effect on premiums overall; ie in macro terms.’ The cost of insurance as the market currently stands is nothing really unusual. We asked firms to provide detailed figures on how much their insurance costs per £1m of their entire cover. The average across respondents from the LB100 was £8,987 per £1m. NeilsonMoore thinks this is evidence of a fair deal. ‘When you think about these statistics in terms of reward to risk for the insurers, it is a scary bet if they are collecting only £10k of premium for every £1m of risk they insure,’ she says. ‘However, what this aggregate statistic masks is the fact that some 40-60% of the PI premium spend is for the first £10m of the coverage, depending on the level of coverage purchased.’ Premiums did rise this year however, with the level of compulsory cover charged to the profession totalling £256m according to figures published by the SRA, an increase of 20% from last year’s £214m. However, the number of firms that went into the ARP fell to 32, after the regulator made eligibility rules more stringent in an effort to reduce the costs to the profession. XL Insurance Ltd took the largest share of the market at 18%. One respondent to our survey, on the question of whether the cost of PII was reasonable, said that while the cost was ‘realistic’, it still did not seem ‘reasonable, proportionate to our risks’. This response is symptomatic of the debate about whether the PII market is not sufficiently wide to encourage a proper level of competition. Heads of risk and compliance have mixed views. Craig Perry, general counsel for CMS Cameron McKenna, thinks that the market is competitive: ‘I think many large firms would probably contemplate going with a limited number of insurers – it is competitive, but because it is a narrow market, it could of course change very rapidly.’ Olswang’s new general counsel Simon Callander is pragmatic about the PII market: ‘It’s interesting to note how benign the PI market is for law firms compared with other professions. While that reflects experience to date, developments in different markets have shown that markets can change quickly.’ He adds that there are other competing factors that insurers must face: ‘The financial downturn and the eurozone crisis are issues which still leave insurers exposed [even though the ARP has become smaller]. If capital was restricted for any reason, that might well have an effect on their capacity to insure.’
‘Firms like ours pay high prices for highquality PI insurance. Over the next couple of years we’ll see more players coming into the market.’ Andrew Clark, A&O
After a consultation, the SRA announced in April 2011 that firms may only remain in the ARP for six months instead of the original 12, and that from October 2012 the ARP will be funded jointly by qualifying insurers and the profession. The SRA also explained that the ARP will be replaced in October 2013 with a system where insurers offer a three-month extended policy period to firms who cannot obtain PII for the following year, and the single renewal date will remain in place until October 2013 to help facilitate the transition. While these changes have been welcomed by many in the profession, there remains the possibility that law firms generally will not see much of a change in the actual cost of their premium. As Neilson-Moore explains: ‘When the ARP is abolished in 2013, the burden for the uninsured and uninsurable risks will fall directly on the profession, rather than vicariously through the commercial insurance premiums. The larger and City firms will still bear a disproportionate amount, but it will be through their practising certificate charges and other SRA levies.’ Seeing a reduction in the size of the premium may be some way off, but Bill Richards, head of risk and compliance at LG, says: ‘The closure of the ARP may cause more insurers to come into the market as qualified insurers, and that increase in capacity could have the effect of driving down prices.’ Richards does qualify his statement however, suggesting that because the ARP is only one element that affects the premium, we may not see any reduction in the near future. ‘Another 9/11 or Hurricane Katrina would have more of an effect on the premium. Disasters like that would have a trickle-down effect coming from the global insurance and reinsurance market,’ he says. Although PII pricing might be made more competitive gradually by the abolition of the ARP and the possible influx of extra competition, it is far from clear whether top firms will still be required to stump up for the ‘uninsurables’ in years to come. What is clear from the survey is that there remains a mix of views among firms about the PII market. Some see the reforms as having been an important development, whereas others appear to have been at ease with the status quo. Since the SRA has announced the reduction in the amount of time firms can spend in the ARP, the profession may get a taste of what effect total abolition of the system will have. LB michael.northcott@legalease.co.uk
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