MARKET
5. Chapters 5-8 identify the competition issues associated with certain professional rules and the sometimes diverging views which exist about where the public interest lies in relation to such rules. These chapters contribute to the specific aims of the Research Working Group :
• to identify restrictions, whether deriving from statute, professional rules or custom and practice, which may have the effect of preventing, limiting or distorting
competition in the different Scottish markets;
• to identify access to justice, public interest and consumer protection factors that may justify such restrictions and to evaluate whether the restrictions are proportionate to their purpose.
Background
5.1 These particular aims were designed to take forward in relation to Scotland the review agenda provided by the EC Report on Competition in Professional Services (see chapter 1). To discharge that agenda the UK national competition authority (the Office of Fair Trading), the Scottish Executive and the Scottish legal professional bodies needed to ensure that regulation of the Scottish market for legal services was compatible with both European and domestic competition law.
5.2 The approach advised by the Commission was that a proportionality test should be applied in scrutiny of professional regulations. The test advocated by the Commission was that professional rules had to be (a) objectively necessary to attain a clearly articulated and legitimate public interest objective and (b) the mechanism least restrictive of competition to achieve that objective. The Commission believed that rules which satisfied these requirements served the interests of users and professionals alike. The Commission invited regulatory authorities in the member states and professional bodies to review existing rules, taking into account:
• whether those rules were necessary for the public interest; • whether they were proportionate; and
• whether they were justified.
5.3 The EC Treaty contained competition provisions (Articles 81 and 82) which had been applied in UK law by the Competition Act 1998. The 1998 Act provided that agreements between undertakings, decisions by associations of undertakings or concerted practices which may affect trade within the United Kingdom and have as their object or effect the prevention, restriction or distortion of competition within the UK were prohibited and void (subject to certain exceptions). Law firms were regarded as “undertakings” and the legal professional bodies as “associations of undertakings” and therefore fell within the ambit of competition law.
5.4 The 1998 Act had to be applied consistently with the principles of Community law. With effect from May 2004 Articles 81 and 82 of the EC Treaty had applied direct in EU member states and the Commission was pressing competition bodies in member states to ensure their governments applied the Articles uniformly throughout their state. Member states were required to take competition principles into account when approving professional rules made by professional bodies in addition to the public interest considerations which the bodies might have had in mind in promoting such rules.
5.5 These chapters have been based on discussions within the Research Working Group. Comments from the Group on points of detail have been assimilated, but more substantial commentary, such as that from the Law Society of Scotland, the Faculty of Advocates and the Office of Fair Trading is clearly attributed. Economic analysis has been provided by Professor Frank Stephen of the University of Manchester (formerly of the University of Strathclyde).
A LAW SOCIETY OF SCOTLAND
(a) Restriction on practice as a principal
5.6 One of the professional rules of the Law Society of Scotland47 restricted solicitors from practising as a principal in a law firm unless they had been employed as a solicitor for a cumulative period of three years. This rule might be challenged as having an anti- competitive effect by imposing an unnecessary restraint on able, newly qualified solicitors who might wish to practise as a principal without first having acquired three years experience.
Rationale for the restriction
5.7 The Law Society of Scotland believed that the rule was justified on the basis of previous experience of what could go wrong if newly admitted solicitors were permitted to act as principals of law firms immediately. There was evidence that such solicitors were not always able to provide an adequate service to their clients, which included proper risk management and compliance with the Society’s practice rules. The Society’s note at annex B explains the public interest which the rule was designed to protect more fully.
5.8 The Group found no evidence that the rule was unnecessarily restrictive, taking account of the public interest considerations identified and the flexibility which the Society’s power of waiver provided to deal with exceptional cases.
(b) Restriction on receiving a payment for referring a client
5.9 The rules of the Law Society of Scotland did not permit solicitors to pay commission/referral fees to third parties (such as estate agents or mortgage providers) for the introduction of business48.
47 Rule 3(1) of the Solicitors (Scotland) (Restriction on Practice) Practice Rules 2001. 48 Rule 4 of the Solicitors (Scotland) Practice Rules 1991.
Rationale for the restriction
5.10 The Law Society of Scotland believed it was prejudicial to the independence of the profession for solicitors to pay for referred business, as doing so might lay them open to charges of pursuing their own financial interests in advance of the best interests of their clients. The Society considered that clients should be free to choose their own agent rather than have their work commoditised and sold on to solicitors who were prepared to pay for it. The Society maintained that referral fees did not increase competition as solicitors required to compete against one another for all work. The Society noted that solicitors currently involved in referral schemes where no referral fee was payable already had an incentive to maintain a high standard of service so as to get repeat custom. Where referral fees were involved, the Society believed that the company referring would judge which solicitor to refer the business to by the amount it would receive by way of fee.
5.11 If that rule were to be relaxed to allow payment of referral fees, the Society believed there would be considerable pressure on some solicitors to pay a fee for the referrals, and that in certain areas referrals would be awarded to whoever was prepared to pay the highest fee, not necessarily to the firm giving the best service. The Society did not believe that disclosure to the individual client that a firm had paid for the referral was a protection for the client.
5.12 The Law Society of Scotland had prohibited solicitors from sharing commission since 1964. In response to media reports that solicitor firms in England and Wales were offering doctors payments for referring patients, the Law Society of Scotland issued a news release on 2 September 2004 confirming that solicitors in Scotland continued to be banned from paying other people for introducing clients. The Society’s view was that intermediaries created an economic activity which was entirely unnecessary, potentially prejudicial to the independence of the adviser and which would ultimately be paid for by the consumer.
Competition issues
5.13 In its report on Competition in Professions49 the OFT expressed concern that a restriction on referral fees in England and Wales might be hampering inter alia the development of an online market place that could bring clients and solicitors together (eg payment to an intermediary firm that ‘introduced’ clients and suppliers over the internet) and the ability of solicitors to compete with non-legally qualified practitioners.
5.14 The OFT considered that:
• a blanket prohibition on the payment of referral fees was unlikely to be necessary to guarantee solicitor independence, which could generally be protected by transparency rules requiring that the client be fully informed of any referral fee paid;
• referral fee arrangements could enhance competition, as solicitors had to compete against each other to obtain such referral work;
49 See page 14
• solicitors who were involved in referral fee schemes would have an incentive to maintain a high standard of service so as to get repeat custom from referred clients as well as the referrer. The reputation of both firms was dependent on both providing a quality service to build their reputation and to gain repeat custom; and • A prohibition on referral arrangements would therefore have the effect of reducing
competition amongst solicitors to the detriment of clients, who were less likely to obtain the quality and price of legal services that best met their needs.
5.15 The OFT noted that consumers generally found it difficult to access information about professional services. A prohibition on referral fee arrangements increased clients’ search and transaction costs. Referrers might develop a better understanding about professional services than clients and therefore be in a better position than clients to identify solicitors who provided legal services of a high quality for relative good value. On that basis a referral fee arrangement was likely to minimise the effects of information asymmetry in the legal services market between lawyers and clients, and a prohibition on referral fees would prevent such benefit. Further, referral websites could significantly reduce search costs50, thereby enabling clients to find the quality and price of legal services that best met their needs.
5.16 As referrers developed a good understanding about legal services and thereby developed bargaining power, they were likely to be able to negotiate for high quality services for relative good value. The OFT considered that the effect of a prohibition on referral fees might therefore be to impede the development of better services and lower fees, thereby potentially limiting competition amongst solicitors. Referral services would provide an additional choice by which a client could choose a solicitor. A prohibition on referral fees might also have the effect of restricting clients’ freedom to access a solicitor indirectly i.e. through a referral arrangement.
5.17 The OFT concluded that referral fee arrangements could act as a competitive tool for new firms entering the market, where such arrangements were not common practice in the market.
Conclusion
5.18 The Law Society of Scotland considered that more research required to be done before a firm conclusion could be reached. As referral fees were banned in Scotland, the only practicable form for such research would be to consider experience of the impact of referral fees in similar jurisdictions where they were permitted.
5.19 In England and Wales the Law Society debated the removal of the restriction on several occasions in 2003 and resolved in December 2003 that it would be in the public interest to allow referral fees, provided that such payments were disclosed to clients51. The
50 Statement for the Federal Trade Commission’s workshop on “Possible Anticompetitive Efforts to Restrict Competition on the Internet Auto Panel”, Professor Fiona Scott Morton, Yale School of Management.
51 A postal ballot of members of the Law Society of England and Wales was held following adoption of a resolution in favour of re-instating the ban at the Society’s AGM on 15 July 2004. There was a 17% response rate for 120,000 ballots issued; 73% of those solicitors who did respond were in favour of the resolution deploring the Council’s decision to sanction referral fees. The President of the English Law Society observed however that when the Council made or changed rules, it had to make decisions on the basis of the public interest and for that reason the Council could not be bound on regulatory issues by any ballot of members.
Law Society of England and Wales undertook a review of the impact of the changes it made in 2004 to the professional conduct rules on referrals, which included a survey of the experiences and attitudes of clients. At its Council meeting in July 2005, the Law Society of England and Wales decided that it would not for the time being reintroduce a prohibition on referral fees, but would instead issue enhanced guidance to the profession. The Society’s Council decided to refer the issue of the reintroduction of the ban to the Law Society’s new Regulation Board.
5.20 The Scottish position should be reviewed when clearer evidence became available of experience in England and Wales.
(c) Professional indemnity insurance
5.21 The Law Society of Scotland maintained a Master Policy to provide indemnity for all Scottish solicitors. The arrangement was governed by rules which required solicitors to purchase professional indemnity insurance through the Master Policy52.
Competition issues
5.22 The OFT believed that it had reasonable grounds to suspect that a restriction on competition might arise from the inability of Scottish solicitors to choose their own provider for professional indemnity insurance and perhaps to seek professional indemnity insurance on better terms than were offered by the Master Policy. The OFT wished to assess whether the decision by the Law Society of Scotland to require all solicitors in Scotland to obtain their professional indemnity insurance through the Master Policy might be an unnecessary restriction on competition between solicitors in Scotland.
5.23 The OFT also considered whether the Master Policy might be reducing the capacity for solicitors with a good claims record to benefit from the competitive advantage inherent in a lower premium for professional indemnity insurance.
5.24 Lastly, the OFT considered an allegation made by some users of legal services that Scottish solicitors had a mutual interest in avoiding claims on the Master Policy and might therefore refuse to advise a client who required assistance in acting against another solicitor.
(i) Choice of insurance provider
5.25 The OFT compared the requirement for all Scottish solicitors to obtain their professional indemnity insurance cover under the Master Policy with arrangements in other jurisdictions, such as England and Wales where solicitors could choose their insurer from a list maintained by the Law Society of England and Wales.
5.26 It was not clear however that the apparent benefits of the arrangements in England and Wales, in terms of greater freedom to solicitors to seek insurance directly from an approved pool of insurers, could similarly be achieved in the context of the much smaller solicitor profession in Scotland. In the course of its investigation the OFT had not received representations from any Scottish law firm alleging that their ability to compete was
52 The Solicitors (Scotland) Professional Indemnity Insurance Rules 1995, made under section 44 of the Solicitors (Scotland) Act 1980.
restricted by the current arrangements. The OFT concluded that it was unlikely that there was strong and compelling evidence that the decision by the Law Society of Scotland to maintain in force the Master Policy arrangements had the effect of preventing, restricting or distorting competition.
(ii) Impact of good claims records on premiums
5.27 Having considered the Master Policy guidelines and premium documentation, the OFT was satisfied that under the arrangements then in place the premiums set for professional indemnity insurance did take account of the relative levels of risk associated with different sized law firms, and the level of expertise provided by the number of partners within the firm. It appeared to the OFT that bigger practices paid more in premiums; and those practices with a high ratio of partners to non-partners paid less than practices with very few partners (and therefore more limited supervision or expertise). Most importantly, a discount or penalty was included in the calculation of premium depending on the practice’s claims record. Thus firms with a good claims history were eligible to receive a premium discount, whereas firms with a poor claims history would pay a higher premium.
5.28 The OFT noted from the information provided that the Law Society of Scotland had in the past regularly reviewed and increased the impact of a firm’s claims record on the level of premium payable under the Master Policy. The Society had also expressed an intention to continue reviewing that in the future. The OFT encouraged the Society to continue to do so to ensure that the claims record of a solicitors’ firm was adequately reflected when premiums were set under the Master Policy.
(iii) Alleged refusals by solicitors to provide services
5.29 The OFT considered lastly whether the alleged mutual interest of Scottish solicitors in avoiding claims on the Master Policy might be resulting in a refusal to supply services where the client required assistance in acting against another solicitor.
5.30 While the OFT was aware of instances of complainants reporting difficulty in finding a solicitor to represent them, the OFT did not have sufficient evidence to establish that an alleged mutual interest of Scottish solicitors in avoiding claims under the Master Policy was a significant factor in a solicitor’s decision not to represent a client. In the absence of such evidence the OFT considered that any difficulties experienced by legal services clients in obtaining representation ought to be considered as an access to justice, and not a competition, issue.
Conclusion
5.31 The OFT noted that the Law Society of Scotland had reviewed on a number of occasions the appropriateness of its arrangements for professional indemnity insurance and encouraged it to continue to conduct such reviews regularly with a view to ensuring that the arrangements in place were those that minimised restriction to competition while ensuring that solicitors had adequate professional indemnity insurance. Having reviewed the extensive information provided by the Law Society of Scotland, the OFT announced on 11 February 2005 that it had decided to close its investigation.
(d) Legal professional privilege
5.32 Lawyers could not be compelled in court to disclose legal advice which they had given to their clients. The Code of Conduct for Solicitors holding Practising Certificates issued by the Law Society of Scotland provided that the observance of client confidentiality was a fundamental duty of solicitors (rule 4). That principle was recognised by the courts as being essential to the administration of justice and to the relationship of trust which had to exist between solicitor and client. Legal professional privilege was a privilege which belonged to the client, rather than to the solicitor or advocate, and affected advice as well as litigation.
5.33 A similar privilege did not however apply to other professions, who complained that there was not a level playing field. In the White Paper “The Future of Legal Services : Putting Consumers First” published in October 2005 the UK Government indicated that it did not at that stage propose to extend legal professional privilege to include communications between a particular client and non-lawyer members of a firm providing legal and other services to the consumer (see chapter 6).
Competition issues
5.34 Where the subject of exchanges between clients and their legal advisers was advice that could equally be provided by a member of another profession, the OFT believed that there was a case on efficiency and competition grounds for either a reduction in the scope of privilege of legal advisers or a limited extension of privilege to others in order to remove the distortion of competition that favoured the lawyer. An example was tax advice where accountants felt themselves at a disadvantage to lawyers.
Conclusion
5.35 The issue of whether privilege should be extended to others than lawyers was beyond the scope of the report. The balance of opinion within the Group was that the competition argument for getting rid of legal professional privilege did not seem particularly strong. Following consultation in England and Wales, the Department for Constitutional Affairs decided for its part that there should be no alteration to the scope of legal professional