The Senior Managers and Certification Regime (SMR) came into force on 7 March 2016[1]. Its purpose is to improve standards by embedding a culture of individual responsibility and accountability within UK banks, building societies, credit unions and PRA-designated investment firms.
Under the SMR, there are a total of 17 Senior Management Functions (SMFs)[2] and 30 “Prescribed Responsibilities” which must be assigned to individuals who hold SMFs and have been pre-approved by regulators. Areas of responsibility within a firm must be identified and allocated to a specified senior executive via a “Statement of Responsibility”. Any gaps in senior manager responsibilities must be plugged by allocating responsibility for the relevant function to an existing SMF or to an executive holding the position of SMF 18 (“Other Overall Responsibility Function”). Responsibilities should not be shared between more junior staff. All Senior Managers must take reasonable steps to ensure that (a) the business of the firm for which they are responsible is controlled effectively and complies with regulatory requirements (the “Duty of Responsibility”[3]), and (b) any delegation of responsibilities is to an appropriate person and properly overseen. They must also disclose any information of which the FCA or PRA would reasonably expect notice. They will be personally liable for any misconduct within their allocated area(s).
A Senior Manager must have overall responsibility for each and every area of a firm, including the legal function. The SMR does not contain any specific requirement that the General Counsel be designated a Senior Manager. However, the FCA’s position is that whoever has overall responsibility for management of the legal function (which may, in reality, be the General Counsel) must be appointed as an SMF18 if they are not already captured under another SMF (such as the Head of Compliance). Despite this guidance, questions remained regarding the proper application of the SMR to the legal function. In January 2016, the FCA published a statement recognising the concerns of the legal profession and the lack of clarity on this point. It confirmed that, pending completion of a consultation process, firms that had decided in good faith about whether or not SMR approval is required for the person in charge of the legal function, on the basis of existing rules and other communications, would not be required to change their approach.
Subsequently, on 28 September 2016, the FCA published Discussion Paper DP16/4 “Overall responsibility and the legal function”. The FCA discusses the relative benefits and risks of including the legal function within the SMR and invites an “open debate” on the topic, being at pains to make clear that it had ‘has not reached any conclusions on the arguments’, which are set out below:
| Arguments against | Arguments for |
| The legal function is not an SMR function. The FCA Handbook[4] requires a firm to ensure that one or more Senior Managers have overall responsibilities for each of its ‘activities’, ‘business areas’ and ‘management functions’. However, the fundamental role of an internal legal function is advisory in nature. As such, the legal function does not satisfy the FCA definition and the SMR should not apply to it. | The legal function is an SMR function. In the FCA’s view, the words ‘activity, business area or management function’ covers everything that a firm does, including internally-facing functions, such as legal. The FCA agrees that ‘management’ does not cover the provision of legal advice[5]. However, it is the management of the legal function and not the provision of legal advice that brings the head of the legal function into the SMR. |
| The independence of the legal function could be compromised. Personnel in the legal function could end up being incentivised to protect their own interests rather than provide impartial and independent advice and act in the best interests of their client, resulting in a conflict of interest. | The independence of the legal function would not be compromised. The focus of the SMR is on the responsibility for effectively managing the legal function, rather than the advice provided by the legal function. |
| Legal privilege could be undermined. Requiring the legal function to be headed by a Senior Manager will mean that the advice that the legal function provides could be disclosed and scrutinised by regulators (if a firm chooses to waive legal privilege).
Rule 4 of the Senior Manager Conduct Rules requires a Senior Manager to disclose any information of which the FCA or PRA would reasonably expect notice. This could cut across the principle of legal professional privilege.
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Legal privilege would not be undermined. The SMR does not and cannot remove legal privilege. FSMA[6] protects legal privilege by providing that the FCA cannot require the disclosure of ‘protected items’ – a definition which is materially identical to the definition of items subject to legal professional privilege in Section 10 of the Police and Criminal Evidence Act 1984. The FCA Handbook also recognises[7] that the right to preserve legal professional privilege may be a good reason not to cooperate with a regulator’s request for information.
Privileged material would not need to be disclosed in order to demonstrate reasonable steps in managing the legal function. |
| Practical difficulty in complying with the SMR. It will be difficult for any legal function SMF to prove the ‘reasonable steps’ s/he took in order to comply with the ‘duty of responsibility’ to which all Senior Managers are subject. This may require the waiver of legal privilege as to the advice given by the individual. However, the privilege in the legal advice is the firm’s (not the individual’s) to waive.
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The SMR is flexible in allocating ‘overall responsibility’. The SMR does not contain any requirement that the role of the General Counsel be designated a Senior Manager within the SMR. Rather, it just requires that whoever has overall responsibility for management of the legal function holds the position of SMF18, if they are not already captured under another management function. As such, firms have the flexibility to designate the most suitable person to have overall responsibility (which may not be the General Counsel). |
| Overlap and possible conflict with other regulations. If the head of the legal function is a lawyer, then they will also be regulated by another body (e.g. by the Solicitors Regulation Authority (SRA)) which already impose ethical and conduct obligations on lawyers. | No conflict with other regulation. The approaches taken by the FCA and the regulators for the legal profession are consistent (a comparison is provided in Annex 1 of the FCA’s discussion paper). |
| Insufficient benefits. Including the head of the legal function in the Certification Regime and applying Conduct Rules delivers most of the benefits of including them within the SMR without compromising their independence.
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Benefits are real. Failings in the legal function can impact the wider business. Risks can stem from the management of the function (for example, as a result of inadequate training or weak process) as opposed to advice provided by the function (which the FCA is not seeking to regulate). As such, it is fundamentally important to enforce complete coverage under the SMR. |
The comment period closes on 9 January 2017. The outcome of the exercise will be of interest and relevance to all regulated firms as the government has signalled its intention to expand the SMR to include the whole of financial services during the course of 2018.
Whilst the FCA invites an open dialogue, reading between the lines of the discussion paper, one is left with the feeling that any attempt to convince the regulator that the head of a legal function does not need to be subject to the SMR will be, at best, a rear-guard action. Irrespective of the final outcome, the Certification Regime – the accountability structure designed for those just below the level of Senior Manager – already captures all ‘Material Risk Takers’, a definition which specifically includes the head of the function responsible for legal affairs.[8] Whilst such individuals do not require pre-approval by regulators, they will have to be certified by the firm as being fit and proper for their roles on an ongoing basis. In addition, all employees within the legal function (except for ancillary staff, such as personal assistants) are subject to the Conduct Rules. As such, they will be obliged to adhere to the FCA Individual Conduct Rules and so must:
- Act with integrity;
- Act with due skill, care and diligence;
- Be open and cooperative with the FCA, the PRA and other regulators;
- Pay due regard to the interests of customers and treat them fairly; and
- Observe property standards of market conduct.
There is no suggestion that the industry regards these requirements as objectionable. Neither should it. In truth, there is nothing to fear but fear itself. Provided that it bites only on the management of, rather than the advice provided by, a legal function then the introduction of the SMR should be no more than business as usual.
[2] See FCA Handbook, SUP10C.4 to 10C.8
[3] For more information on the Duty of Responsibility, see FCA consultation paper CP16/26, 28 September 2016
[4] See FCA Handbook, SYSC 4.7.8R and section 59ZA of FSMA 2000
[5] See section 59ZA of FSMA
[6] See section 413
[7] See COCON 4.1.12G
[8] Article 3 (9) of Commission Delegated Regulation (EU) No 604/2014
