Failure to consider regulatory issues at an early stage when mulling a merger can result in fundamental SRA Principles and Rules relating to confidentiality and conflicts of interest being infringed, leading to potential SRA investigations and disciplinary sanctions.
In this article, first published by The Law Society Gazette, regulatory and professional discipline Partner, Andrew Pavlovic, and non-contentious partnership law Partner, Zulon Begum, consider the three regulatory issues that firms need to be aware of.
Rule 6.3 of the Code of Conduct for Solicitors/Firms requires that the affairs of current and former clients are kept confidential unless disclosure is required or permitted by law or the client consents.
However, a key driver in any merger is likely to be whether there is a synergy between the clients of the firms, providing an opportunity to increase market share in a particular practice area and ‘cross-sell’ other ancillary or relevant services. It follows that understanding who the other firm’s clients are is fundamental when considering whether a merger is likely to be successful.
Furthermore, as part of any due diligence, firms will require details of the other firm’s clients to establish whether there are any conflicts of interest (see below), and may wish to review a sample of files to establish whether the firm’s file-opening procedures and conduct of files is in accordance with the relevant regulatory requirements, and that work in progress is secure.
A failure to have regard to the obligation to maintain confidentiality in the course of a merger can have severe regulatory consequences for both firms. In 2018 the SRA fined parties involved in a merger £80,000 for numerous breaches of confidentiality during the due diligence process. One party was fined for disclosing unredacted confidential information and documents from over 7,000 client matters to other firms. The receiving party was also fined for reviewing the information provided in the knowledge that the information they had received was confidential and ought not to have been disclosed.
The SRA has sought to provide assistance to firms negotiating mergers in its recently published guidance on confidentiality. This guidance reiterates that firms should consider:
- What information needs to be disclosed and what information can be safely provided as it is already in the public domain;
- Whether certain types of information (such as financial information) can be provided in a generic way without recourse to client-specific information; and
- Whether a firm’s terms of engagement with clients should include paragraphs permitting the disclosure of certain generic information (such as the name of the client and the type of work undertaken) for the sole purposes of merger discussions.
The SRA’s position remains that client information cannot be provided to another party without the client’s consent. In mergers involving large firms, obtaining consent from all relevant clients is likely to be time-consuming and burdensome and could potentially unsettle client relationships.
In reality, many firms will already have a shared understanding of the other’s client base. For example, Clyde & Co and BLM, who recently announced their merger, are both heavily insurance-focused and may already be aware whether they are on various insurers’ panels. Nevertheless, the need to keep affairs of clients confidential is a critical issue which must be considered early.
2. Conflicts of interest
Firms will also need to ensure that a merger does not result in the firm acting for one or more clients in relation to the same or related matters, or in circumstances where the combined firm, following the merger, holds information in relation to a matter which is adverse to a current client.
Client conflicts are an inevitable feature of mergers and need to be handled carefully to avoid damaging significant client relationships. Both firms will need to determine how to deal with such conflicts in accordance with their professional duties and, where conflicts cannot be managed through consent or information barriers, the combined firm may be required to cease acting for certain clients.
Firms that find themselves acting in a conflict-of-interest scenario, even where that conflict arises inadvertently, can expect to be investigated by the SRA and sanctioned by either the SRA or the SDT. Some of the largest fines issued by the tribunal have related to firms acting in conflict situations, which infringe both the relevant conflict rules in the relevant Codes of Conduct, in addition to the relevant SRA Principles requiring firms to act with independence and in the best interest of clients.
3. Regulatory risk
Finally, firms will want to merge with a firm that has a clean bill of health from a regulatory perspective and does not have any weaknesses in its policies and practices that make it vulnerable to investigations and/or findings of misconduct in future.
This goes beyond ascertaining whether the firm is the subject of any regulatory investigations or client complaints and should extend to reviewing policies on issues such as anti-money laundering, bullying and harassment. Engagement letters should be reviewed (subject to client consent) to ensure that these contain all information required from a regulatory perspective. From an accounting perspective, vulnerabilities may arise where the client account has been used as a bank account or where there is a failure to return monies to clients promptly at the conclusion of a matter.
Regulatory issues can sometimes come to light as a result of merger discussions and negotiations when firms are conducting due diligence, leading firms to self-report the matters identified to the SRA. The identification of such issues is not necessarily a bar to merging, but the potential reputational impact of SRA investigations should be considered by both parties.
This article was first published by The Law Society Gazette.
If you are a partnership or LLP and are considering a merger and would like to find out about how we can support you through the process, or if you have any other queries arising from this article, please contact our regulatory and professional discipline specialist, Andrew Pavlovic, or non-contentious partnership law specialist, Zulon Begum.
Andrew Pavlovic is recognised by Legal 500 UK 2023 as a ‘Next Generation Partner’ in the field of professional discipline, and has substantial regulatory experience, having previously acted for the Solicitors Regulation Authority over several years in complex disciplinary proceedings and subsequent appeals.