Axiom Ince Report – Howden’s View

At 9:30am on 29 October, the Legal Services Board (“LSB”) finally published its long-awaited independent review^[1] (“Report”) of the Solicitors Regulation Authority’s (“SRA”) actions leading up to its intervention of Axiom Ince Ltd (“Axiom”).

This Report, first promised by this Spring^[2], was initially delayed apparently in order not to interfere with the July General Election^[3]. Then, after a further four months of radio silence and, despite ever-increasing demands for its publication from the legal profession, it was finally released during the October half-term holiday and the day before Labour’s first budget in 14 years (a good day to bury bad news, some might say).

It’s fair to say that it was worth waiting for. The report sets out a catalogue of errors and missed opportunities by the SRA in the months leading up to its full intervention into Axiom. It also suggests that a delay by the SRA in intervening into the firm resulted in almost £36 million being depleted from the firm’s client account which might otherwise have been preserved^[4], a sum which the legal profession has effectively had to replace, with contributions to the SRA Compensation Fund having increased by 270% for this year’s annual practising certificate renewal exercise.

At the same time as publishing the report, the LSB issued a press release confirming it had taken the unprecedented step of initiating enforcement action against the SRA. This has been done with the aim of requiring the SRA to make changes to better achieve its regulatory objectives, which it concluded the SRA had failed to do so in this case, with the effect that “…the SRA’s actions and omissions have in [the LSB’s] view adversely impacted on confidence and trust in the regulation of legal services…”^[5]

As soon as the Report was released, the SRA issued its response to it^[6], essentially rejecting its conclusions. It pointed out that other bodies, including external accountants and auditors who were involved with Axiom, also failed to pick up the suspected fraud (it is being deemed “suspected fraud” at this stage as no criminal convictions have yet taken place). It also states: “…In particular, it is by no means clear that a different approach would have uncovered the issue sooner. With hindsight, the report has highlighted things that we could – rather than just should – have done. But in our view, it is unrealistic to expect regulation to prevent all harms…” It would appear that hindsight is, indeed, a wonderful thing. 

We review the Report below in more detail, setting out its conclusions and recommendations. We also set out below what we consider its potential implications may be for Howden’s clients and the legal profession in general.

The Report

The LSB commissioned Carson McDowell LLP (an independent law firm based in Northern Ireland and, as such, not regulated by the SRA) to undertake a review of the SRA’s actions leading up to the intervention into Axiom. Its findings are summarised at paragraph 9 of the Report, which states:

(a) The SRA did not act adequately, effectively and efficiently;

(b) The SRA did not take all the steps it could or should have taken; and

(c) The SRA’s actions and omissions in this matter necessitates change in its procedures to mitigate the possibility of a similar situation arising again.

The Report sets out a number of key factors which led it to make the above conclusions, set out below.

The SRA’s investigation of Axiom in October 2022

The SRA carried out an investigation into Axiom in 2022, after the firm had self-reported concerns about a former employee of the firm, who was suspected of professional misconduct. The SRA looked into the firm’s bank accounts as part of this investigation, but the Forensic Investigation Officer failed to follow the SRA’s standard procedure to check off each account balance against relevant bank statements and to obtain a confirmation bank letter. This failure was also not picked up in the SRA’s internal Managerial Review process.

The Report notes that it has subsequently been identified by the SRA that alleged misappropriations from Axiom’s client account had been taking place from as early as 2019, so these errors and the 2022 inspection generally represented a “missed opportunity” to identify the alleged wrongdoing at that stage.  

The SRA’s risk assessment of Axiom as an accumulator firm

The Report highlights that there is no evidence that the SRA gave any consideration to the risk posed by accumulator firms (firms whose business model is to acquire other firms as a means of expansion) until it prepared a briefing note dated January 2023 on the topic. However, by this point in time, there had already been three large-scale interventions into such firms: Kingly Solicitors Ltd in 2020, Pure Legal Ltd in 2021 and the Metamorph Group in 2022.

Even when Axiom had been identified as one of eight accumulator firms identified by this analysis, the SRA “…failed to take any proactive steps, such as increased monitoring or an investigation of the firm, in light of that information…”^[7]

Following the preparation of the briefing note, the SRA carried out a risk assessment of Axiom in March 2023 which assessed the firm as medium risk. However, this assessment was inadequate, as it did not constitute a wide-ranging assessment of the risks associated with the firm. Remarkably, it appears that no red flags were raised by the fact that just one person (PM) was the Managing Director, COLP, COFA, Beneficial Owner, Officer and Manager, MLCO and MLRO for Axiom^[8]which, by this point, was quite a significantly-sized firm.

In fact, members of the Authorisation Team at the SRA had been raising concerns about accumulator firms internally since at least 2014 and asking for systems to be changed to enable greater visibility between law firms and therefore help to identify accumulator firms, but such requests had not been implemented^[9]. Further, when a member of the Authorisation Team prepared the briefing note upon request from the SRA’s in-house Legal Team, it was considered too negative by senior staff members at the SRA, who expressed disappointment that the person in question had voiced their concerns directly with the Legal Team and asked for the briefing note to be redrafted to be “…more positive…”^[10].

The SRA’s oversight of Axiom’s acquisitions of Ince Gordon Dadds LLP and Plexus Legal LLP.

The Report highlights that these acquisitions by Axiom in April and July 2023 respectively were unusual because, in each case: (1) it was the takeover of a much larger firm; (2) carrying out different areas of work; and (3) which had been in serious financial difficulties. However, the SRA’s focus in each case was ensuring that client files and monies held by the firms were successfully transferred to Axiom, but no real consideration was given to the firm that was receiving those files and how client interests and funds would be safeguarded^[11]. Further, the SRA has since concluded that the funds used by Axiom to purchase both firms were allegedly misappropriated from Axiom’s client account^[12].

The SRA’s intervention into the practices of Pragnesh Modhwadia, Shyam Mistry and Idnan Liaqat

The SRA intervened into the practice of three directors (PM, SM & IL) on 11 August 2023. This decision was taken at a multidisciplinary meeting on 4 August 2023. Surprisingly, the SRA was unable to provide Carson McDowell with a formal record of this meeting, with the result that Carson McDowell found it difficult to discern the bases on which this decision was made^[13].

What did become clear from interviews with people present at that meeting was that concerns were raised about the potential magnitude in respect of both resources and cost of an intervention into the whole firm, such that the decision to undertake a “partial intervention” only was taken. This is despite the fact that the SRA’s investigations at that point had already indicated that there would be an anticipated shortfall in the client account of approximately £60 million^[14].

However, the SRA’s handling of this “partial intervention” was inadequate because the SRA failed to communicate directly with the remaining directors of Axiom, and failed to make it clear that, as the funds in the client account were “tainted” by the alleged fraud, they must be ringfenced and no further payments should be made out of client account. The result of this is that, by the time of the full intervention into the firm on 3 October 2023, the client account had been depleted by almost a further £36 million.

The SRA was even put on notice by the remaining directors of Axiom on 21 August 2023 that they were not going to open a new client account because this was “impractical”^[15].

Whilst the Report concludes that no misappropriation of funds took place during this period, some clients of the firm have been prejudiced further in comparison to others. For example, those clients who have not been able to recover their funds held in the client account will have to look to recover their losses from either Axiom’s professional indemnity insurers or the SRA Compensation Fund.

However, only individuals and small corporate entities (with turnovers of less than £2 million) are able to make claims against the SRA Compensation Fund so, if Axiom’s insurers are able to decline any claims received from larger corporate clients, they may be left with no other redress. The SRA determined that more than a quarter of payments made out of client account during the “partial intervention” time period (11 August – 3 October) related to corporate clients.  

The SRA’s approach to regulation of Solicitors’ Accounts

The Report concludes that the SRA’s approach to ensuring compliance with accounts rules is “light touch” and “inadequate”^[16]. Whilst the SRA requires firms to obtain an annual accountant’s report, they only have to provide copies to the SRA if the report is qualified (i.e. if it reports any breaches of the SRA Accounts Rules). Also, the SRA does not currently check whether firms have in fact obtained an accountant’s report, providing the opportunity for breaches of accounts rules to go undetected for longer.

The SRA’s approach to accumulator firms and the acquisition of law firms

The Report concludes that the SRA needs to change its current policy of not undertaking any due diligence on an authorised firm which intends to purchase another authorised firm, as this does not take into account sufficiently the risk of clients’ files and client money being transferred between firms. It should also consider a range of other factors, including the size of the firm being required, the type of work carried out by that firm, any financial issues affecting the firm and the general “fit” of the proposed acquisition. 

The SRA’s approach to interventions

The Report acknowledges that an intervention into a law firm is a “nuclear option” and causes considerable disruption and has significant consequences for clients. However, the SRA currently has limited options other than an intervention that it can take to protect client funds, such as a less-invasive supervisory tool to allow it to monitor client accounts.

However, the Report also points out that “…it is within the SRA’s gift…” to assess any further regulatory tools it requires and to seek approval for any necessary changes / amendments to its current powers under existing legislation^[17].

What next?

One might have expected a period of reflection by the SRA but, as mentioned above, it published its response to the Report immediately upon its release, rejecting its conclusions. It was keen to point out that the Report acknowledges “…the excellent work by the SRA in uncovering and investigating the alleged fraud…^[18]”, this being one of very few positive comments about the SRA in the Report. It also claims that many of the conclusions of the Report are with the benefit of hindsight.

There have been many calls throughout the legal profession and beyond for senior leaders at the SRA to consider their positions and step down, which is not surprising given the effect this whole saga has had on the profession and consumer confidence in the legal sector, but so far it appears that this is not going to happen.

The SRA then turned in its response to the issue of consumer protection generally, pointing out that it launched its Consumer Protection Review at the start of 2023. One topic it is apparently keen to focus on is how to better protect clients’ money, and it raises the potential “more radical” solution of stopping law firms holding clients’ money.

With notable exceptions, law firms have been successfully holding client money for hundreds of years; certainly far longer than the seventeen years the SRA has existed anyway. It is vital to the proper and efficient functioning of a number of areas of practice, such as conveyancing and trust and probate administration, as well as being a modest source of income for firms. To prevent all law firms from holding client money would cause huge disruption and expense across the legal profession and we suggest that the SRA may first want to get its own house in order and review its own processes and procedures as recommended by the Report before considering taking such a drastic step.

The chronology to the Report also contains some interesting information. Firstly, it confirms that the SRA had to be served with two Notices under s.55 of the Legal Services Act requiring it to provide information and documents. Also, Carson McDowell had to go back to the SRA at least twice after its initial request to ask for further information / documentation, as much of what had been provided was corrupted, password protected or significantly redacted. This process took from 12 February to 3 May 2024, which explains a large portion of the delay in completion of the report from the original Spring 2024 date. Would the SRA have tolerated a firm under investigation by it acting in a similar manner?

Also, despite the LSB announcing in its press release dated 29 May 2024 that the Report was being delayed so as not to interfere with the upcoming General Election, it appears that the first draft of the report was not in fact sent to the LSB until 9 July 2024, five days after the election in fact took place.

270% increase to Compensation Fund Levy

The SRA recently announced at its annual Compliance Conference that the Axiom Ince issues were “history for us” and urged the profession to move on as it had apparently already done so^[19]. Given that the profession has just undertaken its annual practising certificate renewal exercise, which included payment of an increased contribution to the SRA Compensation Fund of 270%, we query whether the profession has or should move on as requested just yet. 

Had the Report been released before the LSB approved the SRA’s request to increase the Compensation Fund levy on 27 September 2024, we suspect there would likely have been much more of a backlash to this decision than was the case at the time, particularly given that the Report concludes that almost £36M of Axiom’s client account deficit was as a result of the SRA’s actions between the partial intervention into the three directors on 9 August 2023 and the full intervention into the firm on 3 October. Should the LSB have released the Report first and then given the profession time to digest it before making this decision, particularly considering there is still no confirmation as to whether or not insurers are going to be meeting the claims made against Axiom?

SRA Consumer Protection Consultation

Howden responded to the SRA’s consultation paper entitled: “Protecting the public: our consumer protection review”, which came out in February this year. In our response we made the following observations:

• PII arrangements had not been brought into the scope of the discussion, yet they are directly relevant to the issue of client protection;
• the discussion paper was premature as it was without the benefit of a full understanding regarding the background to the Axiom scenario;
• whilst the Compensation Fund was constantly referenced in the consultation paper as the source for reimbursement of Axiom Ince’s client account shortfall, there had been no indication to date that any claims were not going to be met by Axiom’s insurers; and
• recent decisions regarding the aggregation provisions in the MTCs could cause instability in the solicitors’ PII market, particularly if insurers end up footing the bill for the lion’s share of claims against Axiom. As such, the MTCs needed to form part of this consultation.

The SRA has just launched a consultation on the outcome of its consumer protection review^[20]. The consultation is to be split into three sections: (1) The model of solicitors holding client money; (2) Protecting the client money that solicitors hold; and (3) Delivering and paying for a sustainable compensation fund. The consultation will remain open for responses until 21 February 2025.

Howden will be responding to this consultation and will continue to advocate for and support our clients and the legal profession generally with dealing with any regulatory changes which the SRA may seek to implement as a result of this consultation. We also urge you to respond to the consultation yourselves, particularly given that the SRA seems to be seriously considering stopping law firms from holding client money. This, in our view, would be a disastrous outcome for the profession. You should not be punished because of the failings of your regulator.  Howden has your back.