Financial Services — SQE1 FLK1 Legal Services

A firm acts for a company buying business premises. As part of the transaction the solicitor recommends a particular buildings insurance policy, completes the proposal form and puts the cover in place. The insurer pays the firm £500 for the introduction. The firm keeps the £500 and says nothing about it to the client, who is billed only for the conveyancing. Everything else about the firm's position is in order.

What has the firm done? Committed a criminal offence. Not a conduct breach, not a technicality. A criminal offence, punishable by up to two years' imprisonment. This is Financial Services, the third topic in Legal Services, and it is the one area where getting the paperwork wrong can put a solicitor in the dock. Keep that £500 in mind.

Here is the route. The prohibition first, and what it costs you to breach it. Then the three-element test that tells you whether an activity is regulated at all. Then the exemption most firms live under, and its four conditions. Then the other exclusion, article 67, which covers mortgages but never insurance. And last, promotions and the practical obligations.

Start with the rule everything hangs on. Section 19 of the Financial Services and Markets Act 2000 contains the general prohibition. No person may carry on a regulated activity in the United Kingdom unless they are an authorised person or an exempt person. Breach it and you commit an offence under s.23, punishable by up to two years' imprisonment and an unlimited fine. Ignorance is not a defence.

There is a second consequence that people forget. Under s.26, an agreement made in the course of carrying on a regulated activity in contravention of the general prohibition is unenforceable against the other party. A firm that advised a client on a corporate bond and billed her £2,000 for it, separately from her boundary dispute, could not recover the fee. She simply refused to pay, and she was entitled to.

Two regulators sit behind all this. The Prudential Regulation Authority, part of the Bank of England, takes banks, building societies, insurers and major investment firms. The Financial Conduct Authority is the conduct regulator for every financial services firm, and the prudential regulator for everyone the other body does not supervise. As a solicitor you deal with the FCA, and it is the FCA that oversees the exempt professional firms regime.

So what makes an activity regulated? Three elements, and you need all three. A specified activity. Carried on in relation to a specified investment. Carried on by way of business. Both lists come from the Regulated Activities Order 2001. Miss any one of the three and the regime never bites at all.

Specified investments first, and five categories matter in practice. Securities: shares, debentures, and government securities, which are gilts. Contracts of insurance: general, life, and pure protection, which covers death, illness or disability with no investment element. Collective investment schemes: unit trusts and open-ended investment companies. Deposits: money with a bank or building society on terms that it will be repaid. And rights under pension schemes.

Note what is not on that list. A client asks you to review her finances after a divorce. You tell her that her buy-to-let flat has become a poor use of her capital and that she should sell it. Regulated? No. Direct interests in land are not specified investments, however much the advice sounds like investment advice.

Now the activities, and there are six to hold. Dealing as principal, on your own account. Dealing as agent, buying or selling on someone else's behalf. Arranging deals in investments. Managing investments, which means exercising discretion over another person's assets. Advising on investments. And insurance distribution.

Two of those are easy to confuse. You deal as agent when you settle the price on the client's instructions and sign the stock transfer form under his authority. You execute the sale yourself. You arrange when the client signs the transfer himself and your work is the agreement, completion and the forms.

And arranging is the one that catches solicitors. It is broadly defined. Drafting a share purchase agreement and preparing the stock transfer forms is arranging. Instructing a stockbroker to sell an estate's portfolio is arranging. There is also a wider category still, making arrangements with a view to transactions in investments. Ask yourself constantly: am I making arrangements that help bring about a transaction in a specified investment?

Try one. A solicitor's elderly neighbour asks for help selling a small holding of quoted shares she has inherited. Over a weekend the solicitor telephones a stockbroker, completes the forms and posts them. She charges nothing, opens no file, the neighbour has never been a client, and she has never done anything like it before. Regulated? No.

Two elements are there. Arranging is a specified activity and shares are specified investments. The third is missing. By way of business imports a degree of regularity and a commercial purpose, and a single unpaid favour outside her practice has neither. No regulated activity, so authorisation and exemption never arise.

Advising on investments is where the exam lives. It means advising a person, as investor, on the merits of buying, selling, subscribing for or underwriting a particular investment. The word doing the work is particular. Tell a client she should think about a pension and that is generic, and not regulated. Tell her she should buy shares in a named company and it is.

The same line runs through deposits. A solicitor pays a widow her £150,000 legacy and she asks what to do with it. He says interest rates are favourable and she should put the whole sum in the two-year fixed-rate bond offered by a named building society. He calls it the best home for it. That is advice on the merits of a particular investment, because deposits are specified investments.

Contrast pure information. Listing a client's three quoted shareholdings in a schedule of assets and stating what each is worth from that morning's closing prices is not advice on anything. The investment is there and the business element is there. The specified activity is not. Hold on to a first-time buyer and his solicitor. They come back at the quick check.

Insurance distribution deserves its own moment, because it is the activity solicitors carry on most and notice least. It covers advising on, proposing, or assisting with contracts of insurance. Where is the line? Two conveyancers show it.

The first hands the buyer a printed sheet with three local brokers on it. Any of them should be able to help, and he is free to use anyone. She recommends nothing, contacts nobody, and the firm will receive nothing. The buyer telephones a broker himself. No specified activity at all.

The second says she will sort out the insurance. She telephones a broker, takes three quotations, chooses the policy she thinks best, completes the proposal form and asks the insurer to put cover on risk. That is insurance distribution from start to finish.

Which brings us to the exemption, because most firms are not FCA-authorised. Part 20 of the Act is the main route. The SRA acts as the designated professional body, and a firm that qualifies is an exempt professional firm. The conditions are in s.327. There are four of them, and all four must be satisfied. Fail one and you were never exempt at all.

One. The regulated activity must arise out of, or be complementary to, the provision of a particular professional service to a particular client. Incidental to the legal work. Two. The firm must not receive remuneration from a third party that it would not have received but for the activity. Three. The firm must account to the client for any commission or other financial benefit from a third party. Four. The activity must not be one excluded by a direction of the designated professional body.

Condition one does most of the work. Arrange the buildings insurance as part of a house purchase and it is incidental to the conveyancing. Set up a division that advertises motor and household insurance on the open market, staffed by people who are not solicitors, and it is not. Its customers have never instructed the firm and never will. That is a financial services business in its own right, and it needs authorisation, however scrupulously the commission is passed on.

And now the £500. Recommending the policy, completing the proposal and putting the cover on risk is insurance distribution. The insurer pays £500 for the introduction. The firm keeps it and tells the client nothing. Condition three fails, so the exemption never applied to the insurance work, so the firm carried on a regulated activity while neither authorised nor exempt. That is the s.23 offence, and there is no period of grace in which to fix it.

Accounting does not mean refusing the money. Take a firm that arranges title indemnity insurance and is offered £180. Before the policy is taken out it writes to the client with the exact amount. It explains that the firm may keep nothing from a third party unless she agrees. And it asks whether she wants the money credited against her bill, or would rather the firm kept it. She replies in writing that the firm should keep it. Condition satisfied.

Condition four has teeth too. If the SRA directs that firms may no longer carry on a description of insurance distribution under the exemption, the exemption falls away the moment the direction takes effect. It goes for matters already in progress just as it goes for new instructions. There is no transitional protection for work you have already started.

The SRA's scope rules split regulated activities in two. Non-mainstream activities are the ones an exempt firm may carry on. Mainstream activities need FCA authorisation. Holding a client's portfolio and buying and selling within it as the firm thinks best, without going back to the client each time, is managing investments. Offered as a service in its own right, it is mainstream. No firm can do it under the exemption, however long-standing the clients.

But the firm can still manage investments in the limited fiduciary situations the rules allow. A solicitor who is one of two trustees, deciding with her co-trustee which holdings to sell and reinvest, is exercising discretion over another's assets. That is managing investments, and the exemption can cover it if the four conditions are met.

Part 20 is not the only route out. Article 67 of the Regulated Activities Order excludes an activity carried on in the course of a profession. It must reasonably be regarded as a necessary part of the other professional services provided, and must not be separately remunerated. Complete the mortgage formalities for the lender your client has already chosen, on a single conveyancing fee with no commission, and article 67 excludes the arranging altogether. You need neither authorisation nor the exemption.

There are two ways to lose it. Quote a separate mortgage administration fee of £250, itemised on the bill alongside the £1,400 conveyancing fee, and the work is separately remunerated, so the third limb fails. And advising the buyer which of two competing mortgage products to take is not a necessary part of the conveyance, because the purchase completes whichever she picks.

And there is one thing article 67 will never cover. Insurance distribution. Because of the Insurance Distribution Directive override, a solicitor who arranges or advises on insurance must rely on Part 20 or be authorised. That is why, inside one conveyancing retainer, the mortgage formalities and the buildings insurance are treated completely differently.

Then a restriction that sits alongside the general prohibition rather than inside it. Section 21. You must not, in the course of business, communicate an invitation or inducement to engage in investment activity. Not unless you are authorised, the content has been approved by an authorised person, or an exemption applies. The exemptions are in the Financial Promotion Order 2005.

So a firm that emails its client base a newsletter urging them into a named venture capital fund, with a link to subscribe, has made a financial promotion. Part 20 lets a firm carry on regulated activities incidental to its legal work. It does not let it promote investments. And since 7 February 2024 an authorised person may only approve a promotion for an unauthorised person if it has passed the FCA gateway introduced in 2023.

Last, the obligations that come with relying on the exemption. Status disclosure. Tell the client in writing, before the activity is carried out, that the firm is not authorised by the FCA and is regulated by the SRA. And that complaints and redress arrangements may differ from those against an authorised firm. A client care letter about costs and your own complaints procedure does not do it.

Keep records. And when the client's needs go beyond the exemption, refer them to an authorised firm. Be careful even there. A simple introduction is usually fine. Actively facilitating the transaction may itself be arranging.

A word on how SQE1 tests this. There are no cases to learn here, and you will not be asked to recite a section number. You get a scenario, five answers, and one instruction. Pick the best. So learn the tests and work them in order.

If you keep only three, keep these. The three elements of a regulated activity: specified activity, specified investment, by way of business. The four conditions in s.327, which stand or fall together. And article 67, which quietly solves the mortgage problem and never touches insurance.

Four traps. One: arranging is broader than it feels. Introducing a client to a stockbroker, drafting documents that facilitate a share purchase, preparing the transfer paperwork. None of that feels like financial services, and all of it can be arranging deals in investments.

Two: generic against particular. Telling a client to think about life cover is not regulated. Telling her to take that policy from that insurer is. The examiners build questions around this line, so read what was actually said.

Three: commission is not a paperwork problem. Keep a payment from a product provider without accounting to the client and you do not merely breach a rule. You fall outside the exemption entirely, which means you were carrying on a regulated activity unlawfully, which is criminal.

Four, and this is the mirror image. Status disclosure is a conduct requirement, not one of the four statutory conditions. Forget it and you have a conduct failure. But if the four conditions in s.327 are met, the exemption still holds and no offence has been committed.

Quick check, and here is that first-time buyer. A solicitor acts for a man buying his first home with a mortgage. Early on she tells him he must have buildings insurance in place by exchange. She adds that he may want cover that would repay the mortgage if he died.

He asks which policy to take. She tells him the buildings policy offered by his lender is the best value on the market and that he should take that one. Which of her two statements, if either, is a regulated activity?

Three answers. One: both, because contracts of insurance are specified investments. Two: neither, because both were made in a conveyancing retainer for a single fee. Three: the second only, because advising on the merits of a particular policy is a specified activity. Pause here if you want a moment.

The answer is three. Telling him the lender's policy is the best value and that he should take it is advice on the merits of one identified contract of insurance. That is advising on investments, and insurance distribution. The first statement is different in kind. Saying cover must be in place by exchange states what the transaction requires. Suggesting he think about cover generally names no particular contract.

Why the other two fail. Option one stops at the specified investment: the advice must go to the merits of a particular one. Option two confuses the exemption with the question. The retainer may make Part 20 available, but it does not stop the statement being regulated.

Five things to take away. One: run the three elements every time. Specified activity, specified investment, by way of business. Lose any one and there is nothing to worry about. Two: advice is only regulated if it is about a particular investment, and land is not a specified investment.

Three: the four conditions in s.327 stand or fall together. Incidental to the legal work, no unaccounted third-party payment, account for commission, and not excluded by a direction. Four: article 67 covers the mortgage formalities on a single fee, and never covers insurance.

Five: our firm with the £500. It did the insurance work competently. It kept an introduction fee and said nothing, and that alone turned a conveyancing file into a criminal offence. Disclose it, account for it, or do not take it. Next time, Funding Options for Legal Services.

Practise this topic with exam-style questions at sqe1prep.co.uk. This episode is for education and exam revision only, not legal advice, and we are not affiliated with or endorsed by the SRA or Kaplan.