02 November 2016


In March this year the PRA and the FCA introduced the Senior Managers Regime (SMR) in relation to banks and PRA regulated investment firms. The SMR is expected to be extended to all UK authorised firms during 2018. On 28 September, the FCA published its long awaited paper on overall responsibility and the legal function (PDF). This followed the FCA’s announcement earlier in the year that it would consult on the pros and cons of capturing individuals with overall responsibility for the legal function within the SMR.

Currently, a Senior Manager must have overall responsibility for each area of the firm's business, ensuring complete coverage. This includes the management of the legal function and may mean appointing the head of the function as an “SMF18” (other overall responsibility function) if responsibility for management of the legal function is not already covered by another senior management function in the firm (for example, Head of Compliance).

Why has the FCA published the consultation?

The FCA paper states that many firms felt that it had not been clear that a Senior Manager must be appointed for overall responsibility of the legal function; others considered it inappropriate for the SMR to apply to the legal function at all; and firms were concerned that the regime requires the General Counsel (GC) (in some firms the head of the legal function might be the “Legal Director” or “Head of Legal” but we refer to the “GC” here for convenience) to be captured as a Senior Manager in their role in providing legal advice to the firm. Firms were concerned that the inclusion of the legal function within the SMR could lead to adverse implications for culture within relevant firms and for the in-house legal profession, and that it would compromise the independence of the legal function and their ability to offer legally privileged and impartial advice.

What are the arguments for and against including the head of the legal function in the SMR?

The FCA paper states that the FCA wishes 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 paper sets out in Chapter 3, arguments for and against including the head of the legal function in the SMR, but it does not reach any conclusions on these arguments.

The arguments for excluding the head of the legal function from the SMR:

  • The legal function is an advisory role and is not recognised by stakeholders as an ‘activity, business area or management function’ and therefore the SMR does not apply
  • Although there is no specific requirement for a GC to be allocated overall responsibility for the legal function, in practice many firms are likely to feel the GC is best placed in this regard. This may cause a number of issues as follows:
    • Legal professional privilege (which protects the confidentiality of communications between client and lawyer) may be prejudiced
    • Independence of the legal function – this might be compromised
    • Overlap with other regulations – lawyers are already regulated by the SRA or the Bar Standards Board – so there is a potential for overlapping or conflicting regulation with the relevant legal sector regulators
    • Insufficient benefits of including the head of the legal function in the SMR; the GC is already included in the Certification Regime and the Conduct Rules under the SMCR, which delivers most of the benefits of including them within the SMR without compromising their independence
    • Additional issues – e.g. pre-approval by the regulator of a Senior Manager’s appointment will be required (this might impact the hiring/retention of senior lawyers)

The arguments to keep the head of the legal function in the SMR:

  • The legal function is an ‘activity, business area or management function’ as this description is intended to be non-exclusive and covers everything the firm does including internal-facing functions (clearly this conflicts directly with the first bullet point above)
  • Failings in the legal function can impact the wider business
  • The focus and purpose of the regime is on the responsibility for managing the legal function (rather than the advice that they provide)
  • It is possible that the concerns around legal privilege arose as a response to the presumption of responsibility, rather than the duty of responsibility. However, the presumption of responsibility (which placed the burden on the Senior Manager to show that they had taken such steps as a person in their position could reasonably be expected to take to stop the firm’s contravention of a relevant requirement occurring or continuing) was replaced with the duty of responsibility (which places the burden on the regulators rather than the Senior Manager - to prove whether or not reasonable steps have been taken)
  • Arguments that the proposals do not in fact prejudice privilege or compromise independence
  • Flexibility to allocate ‘overall responsibility’ for the legal function – this need not be allocated to the GC (this could be allocated to another Senior Manager)
  • Arguments that there is in fact no conflict with other regulation that applies to lawyers

What does the legal profession think?

The Law Society stated on its website that it is clear that legal functions should not be included in the regime because it can create conflict and erode Legal Professional Privilege (LPP). The Law Society identified three key issues that arise from the inclusion of the legal function in the SMR (which echoed some of the arguments set out in the FCA paper):

  • The potential to put the lawyer in a conflict of interest situation with their employer which could affect the lawyer's ability to provide full and frank legal advice.
  • Serious concerns about the erosion of LPP; that in some circumstances the GC may, by virtue of being included in the SMR, feel obliged to disclose legally privileged information. This could impact on the advice given and on the ability to ensure a fair trial. We can see obvious tensions between the ability of a GC to demonstrate to the regulator that he or she took 'reasonable steps' to prevent a regulatory breach and the need to maintain the privilege of legal advice given by the GC regarding that issue.
  • The regulatory burden on in-house solicitors is doubled, as they would have to comply with FCA regulation in addition to that of the Solicitors Regulation Authority.

A closer look at the impact on culture and dynamics?

The potential impact on the culture and structure of the in-house legal function – and the place of the legal function and the GC within financial firms will need to be looked at more closely. The Association for Financial Markets in Europe (AFME) and the British Bankers Association (BBA) stated earlier this year in a joint letter to the FCA that a regime (i.e. the SMR) that appears to compromise the independence of the legal function risks altering how a firm engages with the GC and the legal function – and would result in either less engagement with the GC and the legal function (and therefore less advice being taken, increasing the firm’s risk profile) or more use of external counsel. The AFME and BBA stated that the latter would entail receipt of external advice that is both privileged and outside the regulatory remit of the regulators and could be given out of context (i.e. GCs usually have a better grasp of the “full story” than external counsel), increasing the firm’s legal risk profile and risking poor decisions being made; and that legal advice which is forced out to external counsel in this way may be detrimental to the firm's control environment and risk management culture. Others say that the regime might cause some GC’s to act more "defensively” out of a perceived need for self-preservation (to mitigate a perceived personal risk) which might be put ahead of mitigating risks to the firm.

All of this should be considered in the context of the expectation by some firms that a “progressive” GC is one who is more than just a technical legal expert/legal adviser but also a “business partner” with a key role in the leadership and the (commercial) strategy of the firm. Therefore, the interplay between the GC's role as a legal adviser and the GC's role as a business executive is likely to come under increased scrutiny – and this might lead some GCs to scale back their commercial or strategic input and focus more squarely on providing legal advice – or managing the provision of legal advice.

Potential power struggles?

It is also interesting to note that one of the arguments to keep the head of the legal function in the SMR (at paragraph 3.33) is that:

“As the SMR does not mandate who should be allocated overall responsibility for the legal function, firms have the flexibility to designate the most suitable person to have overall responsibility. For example, the Chief Executive Officer or another Director may have overall responsibility for the legal function; or the legal function may be embedded in another department (e.g. Compliance or Human Resources). In this case, the SMF with overall responsibility for those departments may also be given overall responsibility for the management of the legal function.”

It will be interesting to see whether in some firms, the SMR triggers a “power struggle” of sorts between the legal department (keen to retain its independence – both structurally and in terms of giving advice) and other Senior Managers or department heads (who might want to have greater involvement in matters concerning the legal function or indeed have overall responsibility for the legal function, if they perceive that this is the best way of mitigating risk to the firm and ultimately to themselves as Senior Managers).

What is the deadline for responding to the consultation?

The role of the GC has evolved greatly over the years and perhaps the stage is now set for the next evolutionary phase. This is a great opportunity for firms and senior lawyers to help shape the future by engaging with the issues and with the FCA. The FCA invites responses to two questions by 9 January 2017:

  1. Whether respondents agree with the summary in Chapter 3 of the paper, of the key policy arguments for and against inclusion of the management of the legal function in the SMR; and whether respondents think the FCA has missed any key arguments
  2. Whether respondents believe the Senior Managers and Certification Regime (SMCR) should include a requirement to allocate overall responsibility for the management of the legal function to a Senior Manager – and why

For further information on the SMR and SMCR, please contact James Green.

Key contact

Tom Dunn

Tom Dunn Partner

  • Head of Regulated Funds and Financial Services
  • Regulated Funds
  • Financial Services

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