Last month's N2 deadline of 1 December 2001 – when the Financial Services Authority (FSA) at long last became sole regulator of all financial services activity in the UK – meant different things to different members of the legal fraternity. But nowhere was it more nervously anticipated than among the small number of firms that have fully embraced investment services.
Of the 250 firms that were regulated by the Law Society to do discrete investment business (DIB firms), around 180 have decided to take the plunge and opt for life under the FSA. In the long run-up to N2, there was much agonising from such firms as to whether they should stay in the game and bear the additional costs of extra regulation, or hive off their investment practices into self-contained units, or even give up financial services altogether.
The Solicitors for Independent Financial Advice (Sifa) represents 225 firms engaged in this line of work. “Sifa members have stood solid,” claims managing director Ian Muirhead. “We've had only a couple of indications so far that firms are wobbling and wondering about getting out.”
The 44 members of the Association of Solicitor Investment Managers (Asim) that handle securities business can expect much closer FSA scrutiny than the typical Sifa firm, which mainly deals in packaged products. The doom and gloom that was prevalent among many solicitor investment managers over the past 18 months has largely gone, according to Asim chief executive Heather Martin. She believes those firms that have recently split off their investment divisions have done it for “commercial reasons”, and not because they were at all apprehensive about the FSA.
“People are still nervous,” she concedes. “Compliance may be expensive, but the costs of non-compliance are even more expensive.” Certainly, dealing with the FSA could cost many firms dear post-N2, and Martin reckons that as many as a third of her member firms have taken on extra staff to deal with the new regulatory issues.
“Compliance may be expensive, but the costs of non-compliance are even more expensive”
Heather Martin, Asim
According to Muirhead, compliance under the Law Society used to be a matter of “filling in pieces of paper”, with firms having to run parallel client and compliance files. However, he believes that the FSA “hasn't got the patience, the time or the inclination” to scrutinise a firm's files.
“As far as the FSA's concerned, it's a question of the substance of solicitors' advice that's important. It's not concerned with people filling in paper after the event,” Muirhead explains. “The proof of the pudding is in the advice that's given to the client, and that's all the FSA needs to see.”
Consequently, lawyers can no longer treat compliance as a separate issue from advice. “Compliance is part and parcel of every piece of advice that's given,” Muirhead adds.
With this in mind, Sifa has developed its own software in the form of a CD-Rom (called Fincenta) to help its members negotiate the new regulatory minefield.
According to Martin, the vast majority of her members decided to keep their investment businesses in-house, despite the anxiety initially felt when the new regime was being consulted upon. “The FSA has genuinely listened and a lot of the problems have been ironed out,” she says. The main stumbling block was the capital adequacy rules, which require firms to hold a sum equivalent to the firm's turnover during a 13-week period as evidence of solvency. It is not difficult to see how much of a turn-off such provisions would be to, for example, a City firm whose investment business might represent as little as two per cent of its turnover. However, the FSA granted law firms an exception from this rule.
Not everyone was dreading the new regime. For example, West Midlands firm Armstrong Neal, which claimed to be the first firm to specialise solely in financial services and tax when it was set up in 1999, views N2 positively. Solicitor Malcolm Graham believes it is a time for entrepreneurial firms “to go out and generate more work” as 70-odd DIB firms drop out of the scene.
“There's an opportunity to go out there and really attack the market,” he says. “But one of the things solicitors have to wake up to is that they're no longer in competition with solicitors, but with business as a whole.” Thesis Asset Management, which is wholly owned by the partners of South East firm Thomas Eggar Church Adams, claims to have acquired the investment management portfolios of three smaller solicitor investment managers in the past year.
Sifa has come up with a solution for some firms that want to remain involved – a chain of solicitor-owned Solicitors' Financial Centres (SFCs), which are based upon the Solicitor Property Centres in Scotland. According to Muirhead, firms need the “critical mass” to take on the new regime and to set up the administrative systems required.
“If you're operating with a single financial adviser in-house, you're on a hiding to nothing, because the economics will become non-viable,” he warns, saying that they can either “beef up” their own departments or join forces with other firms and form an SFC. Such a venture is a franchise operation that enables solicitors to jointly own financial services units to which participating firms can refer their clients.
So far there are three centres, based in Teesside, Exeter and Wokingham, Berkshire, which went live to tie in with N2. “In all cases, they have exclusive territory and they're given the right to farm the legal community in that defined area and offer them the opportunity to get involved,” explains Muirhead. He envisages that there could be as many as 50 such centres opening over the next five years.
In the end a very small – but very notable – collection of firms have hived off their investment businesses in preparation for the FSA. Cripps Harries Hall in the South East separated out its wealth management services on N2 day. The firm had £375m of funds under management and now trades as Cripps Portfolio. In the run-up to the deadline, Cambridge firm Hewitson Becke + Shaw joined forces with Ipswich-based Birketts to launch Affinity Investment Management, while Maidstone-based Brachers set up Ashcourt Asset Management 18 months ago.
Simon Lough, a director at Cripps Portfolio, reckons that its recent demerger was inevitable, notwithstanding N2. “It was a move we'd have had to have made at some point,” he says. “Ideally, we'd have wanted to wait a year or two.” He believes that one of the main problems for law firms that employ investment managers is how best to incentivise them when non-solicitors cannot become partners. At Cripps, every member of staff in the new entity has been rewarded with equity.
Lough is also expecting compliance costs to shoot up. Two years ago, Cripps had one person working on regulatory issues part-time; now the firm has three full-time staff.
“The paperwork involved in, for example, opening a portfolio for a client has undoubtedly increased enormously, which is raising the costs of doing business, which means you have to charge more for your services or you have to deal with larger and larger clients,” he says. “But we'd also have to say that much of the regulation has a lot of merit; but the cost of compliance is still a concern.”
John Morton, chief executive of Ashcourt and a former Asim chair, has no regrets about hiving off. “We've managed to take the pain and the agony of the new regulations in two steps,” he says, adding that when Ashcourt was established it fell under the remit of the Investment Management Regulatory Organisation (Imro), which was taken over by the FSA last month. “Such a lot of the new regulation is, as far as fund managers are concerned, modelled around Imro, and we've managed to spread the burden,” he says.
Both Morton and Lough enthusiastically believe that there is a value in retaining strong connections with the legal profession. According to Lough, the synergy between lawyers and financial advisers was the reason for Cripps Portfolio keeping the firm's name, which required a special Law Society waiver.
Morton believes that it provides clients with reassurance. “It gives the clients the comfort of the importance of client care as opposed to the stockbroker end of the industry, where there occasionally can be accusations of churning clients' portfolios,” he concludes.