Financial services and regulation - How the framework applie...

Learning Outcomes

This article outlines how the financial services regulatory framework applies to solicitors’ firms, focusing on the FSMA general prohibition and the RAO tests for specified investments and activities; practical RAO exclusions and the s 327 DPB exemption, including their limits for insurance distribution and credit‑related work; the FPO 2005 rules on controlled financial promotions by exempt professional firms; incorporation of the SRA Principles and transparency around referrals, commissions, conflicts, and regulatory status; client money management under the SRA Accounts Rules, including interest, reconciliations, residual balances, and the prohibition on misuse of the client account; firm‑wide compliance structures and governance (COLP/COFA, MLCO/MLRO, risk‑based policies, AML controls, training, record‑keeping, complaint handling, and reporting); and enforcement mechanisms and sanctions with appropriate remedial action where failures are identified.

SQE1 Syllabus

For SQE1, you are required to understand how the financial services regulatory framework applies to solicitors’ firms, with a focus on the following syllabus points:

• the scope and application of the Financial Services and Markets Act 2000 (FSMA) to legal practice
• the general prohibition in s 19 FSMA and the RAO framework for “specified investments” and “specified activities”
• the distinction between regulated activities and exempt professional activities (s 327 FSMA DPB exemption)
• the roles of the SRA and FCA in regulating financial services work by solicitors
• the SRA Principles and their relevance to financial services compliance
• the requirements for client money management under the SRA Accounts Rules
• the Financial Promotion Order 2005 and communications by exempt professional firms
• practical compliance structures and risk management expected in solicitors’ firms

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the difference between a regulated activity and an exempt regulated activity for a solicitors' firm?
2. Which regulator is responsible for authorising most financial services activities in England and Wales?
3. What are the main compliance steps a solicitors' firm should take to avoid breaching the FSMA when providing financial services?
4. Name two SRA Principles that are especially relevant when handling client money in the context of financial services.

Introduction

Solicitors’ firms in England and Wales often operate at the interface of legal services and regulated financial activities. This involvement may be direct—offering advice on investments, arranging insurance, or collecting client money connected to regulated products—or indirect, by referring clients to third-party financial intermediaries, arranging credit agreements, or participating in complex transactions such as mergers and acquisitions. The regulatory structure applicable to such activities is multi-layered: solicitors are subject to both the general financial regulatory regime governed by the Financial Services and Markets Act 2000 (FSMA) and sectoral rules such as the Regulated Activities Order (RAO), as well as professional standards set by the Solicitors Regulation Authority (SRA).

To operate in this environment, it is essential to understand when a particular transaction or communication falls within FSMA’s general prohibition, when professional exclusions and designated professional body (DPB) exemptions apply, and how key elements of the SRA Principles, the SRA Code of Conduct, and Accounts Rules interlock with statutory regulation. Breaching these requirements can lead not only to criminal liability and regulatory sanction but also to reputational damage and loss of client trust.

Key Term: Financial Conduct Authority (FCA)
The FCA is the principal statutory regulator of financial services in the UK, responsible for authorising and supervising firms conducting regulated activities, enforcing the general prohibition in s 19 FSMA, and possessing powers to initiate both civil and criminal proceedings against unauthorised business.

Key Term: Solicitors Regulation Authority (SRA)
The SRA governs solicitors and law firms in England and Wales, issuing foundational ethical Principles, Codes of Conduct, Accounts Rules, and managing professional discipline. Its regulatory control continues whether solicitors work in law firms, as sole practitioners, or in alternative business structures.

Key Term: SRA Principles
These are core ethical duties that underpin all aspects of solicitors’ practice, covering honesty, integrity, public trust, independence, equality and diversity, and the best interests of each client. In case of conflict, the wider public interest Principles prevail.

Key Term: Financial Services and Markets Act 2000 (FSMA)
The principal UK legislation regulating financial services, establishing, among other things, the general prohibition on unauthorised regulated activity, the DPB regime, the FCA’s enforcement jurisdiction, and the framework for exemptions.

Key Term: Regulated Activities Order (RAO) 2001
SI 2001/544, this Orders designates specific investments and activities (“specified activities”) which, when carried out “by way of business” in the UK, become “regulated activities” under FSMA unless an exclusion or exemption applies.

Key Term: general prohibition (s 19 FSMA)
It is an offence to carry on a regulated activity in the United Kingdom unless authorised by the FCA or covered by a specific exemption. The prohibition extends to holding out, without entitlement, as being authorised.

Key Term: Financial Promotion Order (FPO) 2005
This secondary legislation restricts “financial promotions”—that is, invitations or inducements to engage in investment activity—by unauthorised persons or firms, subject to a detailed structure of exemptions and requirements for approved content.

The Financial Services Regulatory Structure

Solicitors’ firms operate in a “dual regulatory” environment. The core financial services framework is set out in FSMA and its secondary legislation, but solicitors are also subject to the SRA Standards and Regulations. In England and Wales, most financial services work (such as creating, administering, or advising on investments, arranging insurance, or managing investments) is regulated by the FCA. However, through the “designated professional body” (DPB) regime (notably the s 327 FSMA exemption), solicitors’ firms may carry on certain regulated activities as an “exempt professional firm”—but only where strict statutory and regulatory conditions are satisfied.

There is a clear demarcation in the roles of the FCA and SRA. The FCA’s powers relate generally to financial services authorisation, supervision, and enforcement. The SRA’s responsibilities include ensuring compliance with the SRA Principles, Codes of Conduct, client money protection, and other standards for the protection of clients and the integrity of legal services. Where firms rely on the DPB exemption, the SRA monitors compliance and may impose requirements, issue guidance, conduct investigations, and refer serious cases to the Solicitors Disciplinary Tribunal (SDT).

In practice, solicitors’ firms must consider:

• Which activities are regulated under FSMA
• The practical application of exemptions and exclusions
• The separate (but overlapping) obligations under the SRA regulatory regime, including safeguarding client interests and assets, addressing conflicts, and handling fees and commissions lawfully.

Regulated Activities and Exemptions

Calling an activity “regulated” is not a matter of form, but of statutory substance. Under FSMA and the RAO, the question “is this a regulated activity?” is answered by applying a four-part test:

• Is the activity carried out by way of business?
• Does it involve a “specified investment”?
• Does it comprise a “specified activity”?
• Is there a relevant regulatory exclusion or exemption?

A “yes” answer to the first three and a “no” to the fourth makes the activity “regulated” and subject to the general prohibition.

Key Term: regulated activity
Any activity listed as a “specified activity” in the RAO which is conducted in relation to a “specified investment” and is carried out by way of business; it requires FCA authorisation unless covered by an applicable exclusion or exemption.

Key Term: exempt regulated activity
A regulated activity undertaken by a professional firm—such as a law firm or solicitor—without FCA authorisation, under s 327 FSMA “DPB exemption”, provided all regulatory and professional conditions are satisfied.

Specified investments under the RAO include:

• Shares and stock
• Rights under contracts of insurance (including life, title indemnity, and after-the-event policies)
• Bonds and other instruments of indebtedness
• Regulated mortgage contracts

Specified activities include:

• Advising on investments
• Arranging deals in investments
• Dealing as agent or principal in investments
• Managing, safeguarding, and administering investments

The designated professional body exemption (s 327 FSMA)

The s 327 exemption enables certain professional firms (including solicitors’ firms regulated by the SRA) to perform limited regulated activities where the work is ancillary to the core legal service, and all statutory and conduct conditions are adhered to.

For the s 327 exemption to be valid:

• Regulated activity must be “incidental” to the legal services on a matter-by-matter (specific) basis and by reference to the firm's overall business (general) profile. If the regulated activity becomes the focus or is a central marketing feature of the business, the DPB exemption is likely lost.
• Any commission or “pecuniary or other advantage” from a third party must be fully accounted for to the client and not retained by the firm unless explicit, fully informed client consent is given.
• Only activities specifically permitted by the SRA’s Scope Rules may be undertaken; “mainstream” financial services or insurance business is not permitted under the DPB regime.
• The activity must not be subject to FCA or Treasury restriction, nor can the firm engage in other regulated activities outside the DPB permissions.
• All relevant SRA Conduct of Business and professional conduct rules must be satisfied, alongside appropriate standards for advice, documentation, disclosure, and ongoing management of regulated activity.

Key Term: Designated Professional Body (DPB) exemption
The DPB exemption under s 327 FSMA authorises solicitors' firms to conduct specified regulated activities as incidental, without FCA authorisation, strictly in alignment with SRA oversight and professional obligations.

The “incidental” requirements are strictly construed. For example, in a conveyancing matter, arranging defective title insurance for a client would generally be an “incidental” activity. However, if a conveyancing firm’s business is predominantly built around arranging such insurance for a wide client base, the activity may be deemed non-incidental.

Breaching the terms or exceeding the bounds of the DPB exemption may result in unauthorised practice, constituting a criminal offence under s 23 FSMA.

RAO exclusions commonly used by solicitors

The RAO provides several exclusions that remove otherwise-regulated activities from the FSMA regime, subject to precise conditions and critical limitations, especially in relation to insurance or credit activities. The key practical exclusions for solicitors include:

• Introducing: Where the firm solely introduces a client to an FCA-authorised third party for advice or arrangement, and has no continuing role. This exclusion cannot be used when the transaction involves insurance contracts.
• Authorised third person (ATP) exclusion: The transaction is entered on the advice of an FCA-authorised person. The solicitors’ ongoing role does not attract FCA authorisation, provided all commission or other benefits are accounted for and not retained absent explicit client agreement. Again, insurance contracts are generally excluded from the application of this exclusion.
• Execution-only client: The client is not seeking, and is not given, advice on the merits of the transaction by the solicitor (or has sought advice and been referred to an FCA-authorised person instead). The role here is limited to arrangement. This exclusion is unavailable where the transaction is connected to insurance contracts or the solicitor receives undisclosed commission.
• Trustees/personal representatives: Where a solicitor undertakes specified activities as a trustee or personal representative, or advises fellow trustees and beneficiaries, within the constraints set out in RAO. The exclusion is not available if separate remuneration from the trust or estate is received, nor does it generally apply to insurance mediation or distribution.
• Professional/necessary: Applies where the regulated activity is a necessary part of carrying out the solicitor’s profession, and is not separately remunerated or marketed, nor consists of insurance distribution activities.
• Takeover/body corporate (50% test): Solicitors may advise or arrange transactions relating to the acquisition or disposal of 50% or more voting shares (or day-to-day control) in a body corporate. The exclusion does not apply where insurance contracts form part of the arrangement.

Each exclusion applies only to the specific "specified activity" and context it covers, with multiple exclusions potentially available in a single matter depending on facts.

Credit-related activities and insurance distribution activities are subject to further constraints and specialist regimes under the RAO. For credit, excluding FCA authorisation is possible for time-to-pay fee arrangements if repayments do not exceed 12, last no more than 12 months, and no interest or extra charges apply. Otherwise, such arrangements may either require s 327 DPB compliance or direct FCA authorisation.

Insurance distribution activities—such as arranging, proposing, or assisting with insurance contracts or claims—are generally not covered by the standard RAO exclusions, making reliance on the s 327 DPB exemption essential for most insurance-related transactions by solicitors (e.g., arranging title indemnity insurance or after-the-event litigation policies).

Key Term: controlled financial promotion
An invitation or inducement to engage in investment activity communicated by an unauthorised person, restricted by the Financial Promotion Order 2005 and subject to detailed exemptions and approval requirements.

Worked Example 1.1

A client asks a solicitor to advise on the purchase of shares in a private company. The solicitor gives specific advice about which shares to buy. The firm is not FCA authorised but is regulated by the SRA.

Answer:
Advising on the merits of buying specific shares is a regulated activity. However, if the advice is incidental to legal work for that client and the firm complies with the SRA's rules (including accounting for any commission), the DPB exemption may apply. If the advice is not incidental or the firm receives undisclosed commission, FCA authorisation would be required.

Worked Example 1.2

A firm refers a client to a financial adviser and receives a referral fee, which it does not disclose to the client.

Answer:
The firm is in breach of the SRA Principles (integrity, transparency, and acting in the client's best interests) and the SRA's Conduct of Business Rules. The DPB exemption would not apply, and the firm may also be in breach of the FSMA.

Worked Example 1.3

A solicitor receives funds from a client to invest in a property transaction. The solicitor pays the money into the firm's office account and uses it to pay business expenses before the transaction is completed.

Answer:
This is a breach of the SRA Accounts Rules and the SRA Principles. Client money must be kept separate and only used for the client's matter. The solicitor and the firm may face disciplinary action.

Worked Example 1.4

A corporate lawyer introduces a client to an FCA‑authorised investment manager and later forwards messages between them to “help keep things moving”.

Answer:
The RAO “introducing” exclusion applies only if the firm merely introduces and has no ongoing role. Acting as a conduit or maintaining messages is an ongoing role and defeats the exclusion. Consider relying on the ATP exclusion if the transaction is entered into based on the authorised manager’s advice, and ensure any third‑party benefit is accounted to the client.

Worked Example 1.5

A property solicitor arranges defective title insurance for a buyer and negotiates terms with the broker.

Answer:
Arranging an insurance contract is insurance distribution. Common RAO exclusions rarely apply to insurance distribution. The firm must rely on the s 327 DPB exemption and comply with SRA Scope and Conduct of Business Rules, including accounting for any commission to the client.

Worked Example 1.6

A firm offers an interest‑free instalment plan over 10 months for fees, with no additional charges.

Answer:
This fee arrangement is likely to be an exempt agreement under the RAO if the number of repayments does not exceed 12, the term does not exceed 12 months, and no interest/charges are applied. Outside these conditions, the firm must consider the s 327 DPB exemption or FCA authorisation.

Worked Example 1.7

A solicitor advises a client on selling 60% of the voting shares in a trading company and arranges the transfer.

Answer:
Advising and arranging on buying/selling shares is regulated. The “takeover/body corporate” exclusion generally applies where 50% or more of voting shares or day‑to‑day control is acquired or disposed of, provided the transaction does not involve insurance contracts. The exclusion would remove the activities from regulation here.

Financial promotions (FPO 2005)

Section 21 FSMA prohibits unauthorised persons from communicating an invitation or inducement to engage in investment activity unless an exemption applies or an authorised person has approved the content. The Financial Promotion Order 2005 (FPO) frames what is a “controlled financial promotion.” Controlled activities for these purposes include making arrangements, deals, or promoting contracts of insurance. The FPO distinguishes between real-time and non-real-time communications, and between solicited and unsolicited approaches, each attracting different treatment and exemptions.

Some common FPO exemptions relevant to solicitors’ firms are:

• Introductions to authorised persons (art 15)
• Trustees and PRs (arts 53–54)
• Takeover of a body corporate (art 62)
• Promotions by exempt professional firms (real‑time: art 55, non‑real‑time: art 55A), each subject to strict requirements on the content, scope, and professional context
• One-off communications (arts 28/28A), provided suitably personalisation and context-specific conditions are satisfied

It is critical to appreciate that a controlled financial promotion may occur even where a transaction is not, itself, regulated under the RAO. Unauthorised financial promotions may result in criminal liability under s 21 FSMA and are subject to strict scrutiny by both the FCA and the SRA.

Key Term: controlled financial promotion
A communication that directly or indirectly invites or induces a person to engage in investment activity, as defined in the FPO 2005, and subject to requirement for authorisation or approval unless a specified exemption applies.

SRA Principles and Financial Services Work

The SRA Principles, as set out in the SRA Standards and Regulations, apply comprehensively to all financial services work conducted by solicitors and their firms. These include the duties of honesty, integrity, independence, public trust, client best interests, and the promotion of equality, diversity and inclusion.

Application of the Principles in a financial services context requires transparency about:

• Referral arrangements and the receipt of third-party commissions or other advantages, all of which must be disclosed and (unless client consents) accounted to the client
• The regulatory limits under which solicitors operate, especially where clients may assume FCA authorisation
• Accurate description of regulatory status in client care documents and all publicity (in accordance with the SRA Code of Conduct and Transparency Rules)
• Respect for conflicts of interest (including own-interest conflicts), which may arise in connection with commission payments, complex transactional work, or collective investment activities

Failure to comply can not only lead to SRA enforcement but may constitute an offence under FSMA or result in common law claims (e.g., for an account of profits or in negligence).

Solicitors must also provide clients with clear information about costs (including the potential for fees to be paid via credit), the scope and incidental nature of any regulated activity, and the protections available (such as the SRA Compensation Fund and professional indemnity insurance).

SRA Accounts Rules and Client Money

The SRA Accounts Rules are especially significant in the context of financial services. Key features are:

• Client money must be held separate from office money, deposited promptly in designated client accounts, and not used for any other than the client’s matter
• Firms are required to maintain complete and accurate records, perform three-way reconciliations, control electronic payments, and safeguard client funds throughout a matter
• Any financial benefit (such as interest on client money, commissions or third-party advantages received) must be accounted for to the client, unless explicit informed consent is provided to the contrary, and all financial dealings must be recorded transparently
• Residual balances should be returned promptly, and active steps must be taken to trace clients if necessary; failure to comply may result in disciplinary action

In addition, the SRA prohibits the misuse of the client account as a banking facility, for example, acting as a mere conduit in transactions with no legal work or otherwise engaging in arrangements inconsistent with the proper provision of legal services.

Strict compliance reduces the risk of failing to comply with anti-money laundering laws and ensures oversight by compliance officers in the firm. Any use of client money which enables, or could present a risk of, financial crime, may make a solicitor personally criminally liable, especially where relevant anti-money laundering controls are absent.

Compliance Structures in Solicitors' Firms

In the contemporary regulatory environment, all SRA-authorised firms must adopt, implement, and periodically review clear and detailed compliance systems, incorporating:

• Firm-wide policies and procedures for identifying and analysing each financial services transaction, correctly applying the RAO tests, exclusions, and DPB exemption requirements; pro-forma checklists and decision logs are commonly used
• Process-driven controls to check if financial promotions are being made, review content for potential FPO application, and ensure sign-off or approval steps where needed
• Formal risk assessments that map the scope, volume, and type of financial services work, supported by regular internal reviews, audits, and annual reporting to the SRA and, where applicable, external Quality Scheme or Lexcel oversight
• Ongoing, mandatory staff training on identifying the distinction between legal and regulated financial services advice, recognising the boundaries of the DPB regime, complying with AML requirements, and the relevant exclusion and exemption regimes within the RAO and FPO
• Rigorous systems to record, disclose, and account for all referral fees, commissions, and third-party benefits, whether received personally or by the firm
• Comprehensive anti-money laundering structures, including appointing a Money Laundering Compliance Officer (MLCO) and Money Laundering Reporting Officer (MLRO), regular staff screening, and implementation of a risk-based approach to CDD, enhanced due diligence, and ongoing monitoring
• Governance structures requiring the appointment of a Compliance Officer for Legal Practice (COLP) and a Compliance Officer for Finance and Administration (COFA), who are jointly responsible for the overall oversight of compliance, investigation of suspicion or breach, and transparent cooperation with the SRA and other regulators

Key Term: COLP
The Compliance Officer for Legal Practice is responsible for firm-wide regulatory compliance, reporting breaches, overseeing systems of supervision, and cooperation with the SRA.

Key Term: COFA
The Compliance Officer for Finance and Administration is responsible for the integrity of financial controls and safeguarding of client money, undertakes responsibility under the SRA Accounts Rules, and maintains reporting obligations.

Key Term: SRA Accounts Rules
These rules mandate strict segregation of client money, systems for monitoring and reconciliation, accounting for all benefits, and compliance with all relevant reporting and audit requirements.

Firms should ensure that all communications (internal and external) which may amount to financial promotions are appropriately reviewed, and template disclaimers or risk warnings are used, in line with both FPO and SRA requirements. Websites, marketing materials, letters, and reports should all be checked for compliance, particularly where regulated activities may be triggered.

Exam Warning

Failing to distinguish between regulated and exempt (incidental) activities, or providing regulated financial advice which exceeds the scope of the DPB exemption, can trigger criminal sanctions under FSMA—and simultaneous disciplinary action by the SRA. Even apparently routine communications may be caught as controlled financial promotions under s 21 FSMA. Always check and record whether an activity is within RAO scope, whether exclusions or s 327 DPB exemption conditions are satisfied, and if FPO restrictions on communications apply.

Enforcement and Consequences

Enforcement of financial services compliance in solicitors’ firms is shared between the SRA, the FCA, and, where necessary, the criminal courts. The main enforcement mechanisms and their consequences are:

• SRA powers: Investigation, written warnings, administrative fines, imposition of conditions on practising certificates, suspension or revocation of authorisation, and referral of serious breaches to the Solicitors Disciplinary Tribunal (SDT).
• SDT sanctions: Wide range of disciplinary outcomes including reprimand, financial penalties without upper limit, suspension, striking off the roll, and cost orders; outcomes are publicly reported and may be appealed to the High Court.
• FCA/FSMA powers: Civil or criminal prosecution for unauthorised regulated activities, “holding out” without entitlement, breach of s 21 (financial promotion), and breach of other FSMA requirements. Conviction under s 19 can lead to a custodial sentence or unlimited fine; courts may also order restitution.
• Broader liabilities: Potential for professional negligence claims, breach of trust, liability for money laundering under the Proceeds of Crime Act 2002, and severely damaging reputational impact upon both firm and individual practitioners.

Any identified breach or failure should lead to prompt remedial action by the firm, documented internal investigation, cooperation with regulators, and adoption or reinforcement of improved controls and training systems for the future.

Key Point Checklist

This article has covered the following key knowledge points:

• The general prohibition under s 19 FSMA prohibits solicitors’ firms from carrying on regulated activities unless authorised or exempt.
• The RAO defines “specified investments” and “specified activities”; RAO exclusions, used properly, can remove activities from regulation.
• The s 327 DPB exemption allows certain regulated activities if they are incidental to legal services and SRA rules are followed, including accounting for any commission.
• Insurance distribution and credit‑related activities require particular care; exclusions rarely apply to insurance distribution.
• Financial promotions are restricted by the FPO 2005; exempt professional communications must meet the detailed conditions or be approved by an authorised person.
• The SRA Principles and Accounts Rules apply to all financial services work in solicitors’ firms, including obligations regarding transparency, conflicts, and client money.
• Firms must have compliance structures, including COLP/COFA and AML officers, formal risk assessments, policies, robust staff training and record-keeping, and timely reporting.
• Breaches can result in SRA controls, SDT sanctions, FSMA criminal liability, and reputational harm.

Key Terms and Concepts

• Financial Conduct Authority (FCA)
• Solicitors Regulation Authority (SRA)
• SRA Principles
• Financial Services and Markets Act 2000 (FSMA)
• Regulated Activities Order (RAO) 2001
• general prohibition (s 19 FSMA)
• Financial Promotion Order (FPO) 2005
• regulated activity
• exempt regulated activity
• Designated Professional Body (DPB) exemption
• SRA Accounts Rules
• COLP
• COFA
• controlled financial promotion