SRA: Reports say it should be more proactive

The Solicitors Regulation Authority’s (SRA) review of the handling of Axiom Ince shows it missed an opportunity to uncover fraud a year before closing the firm.

The report by Northern Ireland law firm Carson McDowell also revealed that Axiom was on the verge of acquiring an unnamed “large medical malpractice firm” when the fraud was finally uncovered.

But poor communication from the SRA meant £36m was released from the client’s account in the weeks that followed, before the SRA closed the firm, meaning there will be more calls to its compensation fund.

The SRA believes the fraud has been going on since 2019 and the report said that during its investigation, the regulator was provided with forged documents purporting to be from State Bank of India (SBI) about customer money held by the firm.

Among the reform recommendations is the reintroduction of the requirement that all law firms submit an accountant’s report each year – we have detailed the recommendations separately.

Legal Services Council issued a press release before the review was published – in which it announced its intention to take enforcement action against the SRA – but now I read the full 75-page report.

It recorded that the SRA was called into Axiom Ince in October 2022 after the firm reported concerns about the behavior of a former employee. The SRA’s policy is for its forensic investigation officers (FIOs) to routinely check a firm’s compliance with accounting rules, even if the investigation is unrelated.

However, Carson McDowell found, the SRA “did not conduct an effective inspection of Axiom’s client account… and did not put in place an adequate procedure to confirm client account balances directly with a firm’s bank.

“It therefore missed an opportunity at that stage to identify alleged wrongdoing at the firm.”

Axiom Ince provided a detailed list of customer accounts and balances, but the FIO did not obtain written confirmation from the various banks to confirm the balances as required by SRA procedure at the time.

It later emerged that 12 SBI statements given to FIOs were forged. Procedures were tightened in response to what happened.

The next failure, according to Carson McDowell, was the SRA’s approach to the risk of “accumulating” (or consolidating) law firms.

Even though the issue was first reported internally as far back as 2014 and despite the collapse of three such firms – Kingly in 2020, Pure Legal in 2021 and Metamorph in 2022 – it was not until January 2023 that a member of the SRA’s clearances team produced an informative note about them.

This revealed that the two ways such firms’ risk was managed was a ‘watch list’ – which excluded Axiom because it did not meet the criteria the team was using – and a report discussed at monthly ‘risk operational”.

The report said the watchlist was “of very limited use” — even if Axiom had been on it, it would have made no difference — while data shared about Axiom at the meetings indicated no action was needed.

The Axiom was discussed because of the complaints the SRA received about it, rather than because it was a battery, and was deemed a “medium” risk, although there was no explanation as to how this rating was achieved.

The report added: “The SRA does not appear to have considered the unusual structure of the company in that (group chief executive Pragnesh Modhwadia) held a 100% stake in the firm and also held all compliance roles.” This was “unusual” for a firm of this size.

It later became “very clear” that, apart from Mr Modhwadia, “there was little understanding of how the business worked” between the other directors – for example, the managing partner “indicated he had no connection with the firm’s banks”.

The takeovers of Ince Gordon Dadds (IGD) in April 2023 and then Plexus Legal in July exposed weaknesses in the SRA’s processes, Carson McDowell continued.

In November 2022, the SRA received “credible information” that raised concerns about whether IGD was fit and proper to hold customer money. A forensic investigation revealed that the firm had “significant financial stability issues”.

There were weekly and then daily meetings between SRA and IGD as the firm prepared for a pre-pack sale, with Axiom emerging as the frontrunner to buy it.

“The SRA had no procedure in place to assess the risks of the acquisition of law firms in cases where a firm is being acquired by another firm or body that is already authorized… It appears that, in accordance with its procedure, the SRA has given limited consideration to whether this proposed transaction is appropriate.”

The SRA did not carry out any wider risk assessment, despite the fact that IGD was much larger than Axiom and in financial difficulty, as well as operating in an area of ​​law, shipping, that Axiom did not.

There was no evidence that the SRA considered the risks associated with Axiom being a battery firm.

“Had the SRA carried out due diligence, including a review of Axiom’s accounts, this could have helped to reveal the alleged misappropriation of funds from the client’s account.”

Plexus was also in financial difficulties and in regular contact with the SRA, but again the regulator did not consider the risks of the acquisition, despite the same risk factors, even though it was coming so soon after IGD – indeed, the FIO in charge of Plexus was apparently unaware of that deal.

These events demonstrated “the limitations of the SRA’s processes to bring together information from different teams to enable it to take a holistic view of risk”.

Carson McDowell said: “The SRA, across the organisation, had information which, taken together, should have clearly signaled a potential risk to customers and consumers.”

However, a member of the forensic investigation team was concerned about the integration of Axiom Ince and IGD, and in May 2023 requested that a new case be opened. This led to a “precautionary” visit to the firm, although not until the end of July.

At this meeting, Mr Modhwadia was challenged about the company’s growth but “met SRA staff … that he was in control of the business and there was nothing to indicate that there was anything wrong with the operation of the company”.

However, an FIO was “unsettled” by aspects of the company following the interview and it was their “diligent investigative work” that disabled the fraud.

It revealed that an SBI letter that had been provided by leading law firm Pinsent Masons on behalf of Axiom after the firm’s accounts verification meeting with the SBI was forged.

While Axiom claimed to hold £57 million in customer deposit accounts with SBI as of 30 June 2023, SBI said it held no customer accounts for Axiom; rather, he had office accounts containing around £20m. This meant £57m of customer money was missing.

The report added: “It appears that the firm has been in financial difficulties for some time, possibly restarting in early 2019.”

Furthermore, while Mr Modhwadia said he financed the various purchases with family money and that Axiom’s total loan was £1.5m, including an office overdraft of £850,000, SBI confirmed that Axiom had borrowed £18m.

“Based on the SRA’s findings, it appears that false statements and correspondence were used to misrepresent Axiom’s bank position and, in addition, matters such as residual balances were used to mask the company’s financial activities,” said Carson McDowell.

“It took the strong skills of the FI team to uncover the true financial position of the firm and the extent of the alleged fraud.”

This led to the decision to intervene in the individual practices of Mr Modhwadia and two other directors, but not the entire firm, as it appears that the suspected violations were not more widespread. The report said it was unclear to what extent the difficulty of closing a firm of this size was a factor in the decision.

Carson McDowell accepted it was a difficult decision – given that disrupting the firm’s closure could upset customers – and said it was “reasonable” for the SRA to initially carry out a “partial” intervention.

But this had a “higher degree of risk” because the SRA could not be sure that no one else was involved.

The report continued: “In order to protect customer funds, it was vital that customer account funds that were ‘tainted’ by the alleged fraud were closed. The SRA’s investigations indicated that the last date of any alleged misappropriation of funds was 27 July 2023. Therefore, any money in the customer’s account on 27 July 2023 was “tainted” and no further transactions should have been made to or from the customer . account.”

The problem was that this did not happen, with the SRA itself admitting that its communication with Axiom’s remaining directors was “less than clear”.

They believed it was business as usual and as a result the £44m of customer money held at the time of the partial intervention was legitimately reduced to £8m by 3 October when the SRA closed the entire practice.

Axiom’s other partners told the SRA on August 21 that they were unable to open a new customer account, and the report said they should then have recognized the risk of payments being made from affected customer funds.

Carson McDowell said: “Some customers were able to complete their transactions using the money in the customer’s account, but due to the significant deficit in the account, insufficient funds remained for other customers of the company.

“Some customers may have recovered all the money they put into their Axiom customer account, while other customers may not have received anything back from their Axiom customer account and will instead have to look to- and recover funds from either the SRA Compensation Fund or Axiom’s Professional Indemnity Insurers.”

Corporate customers are not eligible to recover from the compensation fund – and more than a quarter of customer account payments during the partial intervention were to corporate customers.

The report concluded: “We have concluded that the SRA did not act appropriately, effectively and efficiently, nor did it take all the steps it could or should have taken, and that the SRA’s actions and omissions in this matter requires modification of its procedures. mitigates the possibility of a similar situation occurring again…

“Our review found that there are areas of the SRA’s regulatory regime that should and can be changed.

“While we recognize that the SRA has the advantage of many hard-working and knowledgeable staff across the organisation, we believe that the organization as a whole could and should take a more proactive approach to protecting the public interest and identifying wider risks. on the legal market.”