DP16/4: How will the FCA apply SMF 18 (Other Overall Responsibilities) to the Legal Function ?

• Global

• Consulting
• Financial services - Senior Managers and Certification Regime

12-10-2016

Introduction

The FCA’s rules require that a senior manager must have overall responsibility for every activity, business area or management function in a relevant firm and this includes the legal function. Consequently, whoever has overall responsibility for management of the legal function needs to be captured as an SMF18 (if they are not already designated to hold another SMF.) In this regard, the FCA is emphasising that the focus of the SMF is not on the provision of legal advice but on the effective management of the legal function.

The new Discussion Paper

DP16/4 is expressed to be a response to concerns raised by the industry about the implications of bringing the head of the legal function within the SMR. These concerns include the risk of compromising the independence of the legal function and its ability to offer legally privileged and impartial advice.

The purpose of DP16/4 is therefore to clarify how and why the legal function is currently captured under the SMR and to consider whether it should continue to be so. It is the FCA’s professed intention to balance the independence of the legal function and its ability to offer legally privileged and impartial advice with the principles and expectations of the SMR.

The FCA has clarified that all employees within the legal function (except ancillary staff such as personal assistants) are subject to the FCA’s Conduct Rules. Further, the Certification Regime captures “Material Risk Takers” (as defined under the remuneration rules of CRD IV, which specifically includes the head of the function responsible for legal affairs.) Consequently, the head of the legal function will be subject to the Certification Regime, irrespective of whether they are designated a senior manager.

Whether to include the head of legal function within the SMR or not?

In chapter 3 of DP 16/4, the FCA discusses the arguments for and against having the head of the legal function as an SMF. These are, in summary, as follows:

Against

0. The legal function is not an “activity, business area or management function” per SYSC 4.7.8R. Consequently, this rule does not apply to the legal function. Further, the role of head of legal is an advisory function and not one that involves management of the authorised person’s affairs. Consequently, the legal function cannot be designated as an SMF under section 59ZA of FSMA.
    
0. Designating the firm’s General Counsel as an SMF would impair their and the legal function’s ability to provide impartial and independent advice to the business.
    
0. Including the head of legal function in the SMR may prejudice legal professional privilege because, if the role falls within the regime, the SMF may need to disclose material to the regulators which might otherwise be privileged in order to defend himself by demonstrating that he had taken reasonable steps to avoid a contravention occurring or continuing. The fact that such privilege would be the firm’s to waive (not the individual’s) could potentially impede the SMF’s ability to defend himself from regulatory enforcement proceedings, which would be unfair.
    
0. Senior Manager Conduct Rule 4 requires an SMF to disclose any information of which the FCA or PRA would reasonably expect notice. This could potentially cut across the principle of legal professional privilege and create a conflict of interest, if the head of legal function were an SMF, because it could put his personal regulatory obligation to disclose material to the regulators in conflict with his duty to act in the best interests of his client and to ensure that the firm’s right to privilege (i.e. to withhold disclosure of such material) is appropriately exercised. This threat to legal professional privilege threatens to compromise the independence of the advice provided by the legal function and could lead to members of the legal function being incentivised to protect their own interests ahead of their professional duties to their client.
     
0. 5. Lawyers are already subject to regulation, in particular by the Solicitors Regulation Authority and the Bar Standards Board (and equivalent bodies in Scotland, Northern Ireland and overseas.) As such there is the potential for overlapping and conflicting regulation with the relevant legal sector regulators.

For

0. In the FCA’s view, the words “activity, business area or management function” per SYSC 4.7.8R include everything that a firm does, including the activities of the legal function. The FCA also considers that having overall responsibility for management of the legal function is likely to fall within section 59ZA of FSMA.
    
0. Systemic failings in the management of the legal function could create risks that could in turn impact the wider business of a relevant firm. The risks of concern to the FCA relate, inter alia, to inadequate training, weak processes or poor resource management. These are management concerns which are distinct from the quality and accuracy of legal advice provided by the function, which the FCA says it is not seeking to regulate.
    
0. Since the focus and purpose of the SMCR is on the responsibility for managing the legal function (rather than the advice that it provides), there is an argument that privileged material would not need to be disclosed in order to demonstrate reasonable steps in managing the function. The FCA considers that it can effectively supervise the legal function without having access to legally privileged material.
    
0. The FCA considers that the replacement of the presumption of responsibility with the duty of responsibility mitigates the concerns about possible unfairness to senior managers arising from the risk of firms exercising privilege over material relevant to the SMF’s defence to a regulatory enforcement action because the burden of proof in respect of an action for breaching the duty of responsibility will now be on the regulators, not on the senior manager. 
    
0. The FCA does not agree that there is any concern about possible conflicts arising from overlapping regulation from counterpart regulators for the legal profession (such as the SRA). The FCA notes in this regard that there are many other professionals working in financial services who are regulated both by the FCA and other professional bodies and that these overlapping rules are regularly complimentary and do not create any difficulties. The FCA expects that it will be the same with the rules of the regulators for the legal profession.

Conclusion

In summary, it seems likely that the FCA will not accept the objections that have previously been raised by the legal profession to including the head of the legal function within the SMR. Consequently, we can probably expect a Consultation Paper in the New Year proposing minor changes to the FCA’s existing rules in respect of the SM&CR, clarifying the requirement that the head of legal function needs to be a senior manager and that the relevant SMF will be SMF18, unless the individual responsible for the legal function has already been designated as another SMF.

It is notable that the FCA’s proposal to include the head of legal function within the SMR directly contradicts the view of The Law Society of England & Wales which has expressly raised (i) the risk of conflicts of interest arising between in-house lawyers and their employers and (ii) the risk of eroding legal professional privilege as a consequence of this development. Read the Law Society press release.

The closing date for feedback in response to DP16/4 is 9 January 2017. If the FCA decides to take forward any proposals, it will issue a consultation paper in due course.