Normalising and embedding good corporate governance in law firms

August 1st, 2023
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Good corporate governance is an important element of good corporate citizenship. No entity, including law firms, operate in a vacuum, but within and with the society that it serves. All organisations, irrespective of their objectives, serve society by providing goods and/or services. Legal practitioners also serve society by providing legal services in a variety of areas; ranging from representation in respect of litigation matters, criminal matters, civil matters, deceased estate matters, Road Accident Fund matters, matrimonial matters, commercial matters, etcetera. All legal services provided by legal practitioners in law firms are either provided to an individual, a group of individuals, or businesses or entities.

Various scholars provide definitions or explanations of good corporate governance, but at the centre of good corporate governance is ‘transparency’. Transparency is not an easy notion to be understood and/or implemented as some entities claiming transparency still do not disclose certain elements of their operations that they believe may impact them negatively. Transparency requires that everything is put out there and not hidden from stakeholders as it may backfire once it unfolds. Stakeholders require to have a full view of the entity that they are vested in, good or bad, so that they can make informed decisions around the entity.

King IV (the current King Code on Corporate Governance) is applicable to all entities within South Africa, irrespective of size or form, although not compulsory, sets out guidelines by providing principles and recommended practices to be followed; and requires that the entity ‘apply and explain’ its application of the Code. The previous version of the King Code, King III, was based on the premise of ‘apply or explain’. King IV, therefore, enforces transparency and not just a tick-box exercise to say something was done, but requires that organisations also explain how it was done. While the Legal Practitioners Fidelity Fund (LPFF) encourages legal practitioners to apply the King Code in running their law firms, the King Code is not legislation and does not supersede legislation, but there is a lot of benefits for the law firms that apply the principles and recommended practices, especially in the long run. Several principles that are in King IV are incorporated in the Companies Act 71 of 2008. However, should a conflict exist between the provisions of the Act and the King Code, the law prevails.

The King Code introduced concepts such as ethical and effective leadership, an organisation being an integral part of society, sustainable development, corporate citizenship, and stakeholder inclusivity assists in the day-to-day running of entities and ensure long-term sustainability and viability of the entity (PwC ‘A summary of the King IV Report on Corporate Governance for South Africa, 2016’ (www.pwc.co.za, accessed 26-6-2023)). King IV defines ‘corporate governance’ as the ‘exercise of ethical and effective leadership by the governing body towards the achievement of the following governance outcomes:

  • ethical culture;
  • good performance;
  • effective control; [and]
  • legitimacy.’

Considering these governance outcomes, one may immediately identify that the presence of those outcomes is more likely to bring about transparency and long-term sustainability of the entity. This article does not seek to discuss the principles and/or recommended practices of the King Code, nor does it seek to discuss the concepts of corporate governance, but rather seeks to unpack the governance outcomes as may be applicable to law firms. The ensuing discussion of the governance outcomes is not limited to what is discussed in this article, but provides guidance.

Ethical culture

An ethical culture that is rotten with fraud and corruption cannot lead to long-term sustainability of an entity, irrespective of its offerings and current market share. When talking about corporate governance, one is often reminded of the saying ‘tone at the top’. The tone at the top is crucial for an organisation’s long-term sustainability. For law firms, that tone at the top requires that the directors/partners/sole practitioners leading the law firm should set a tone that ensures that there is a good ethical culture within their firm. A desirable ethical culture cannot be set in an environment where the directors/partners/sole practitioners ignore the law and the rules governing the law firm, and do not move beyond compliance to act ethically in all respects. Good corporate governance exists in an environment where the ethical culture forces people to put their own selfish interests aside and act ethically in the best interests of the entity. The best interests of a law firm, includes the interests of the users of the legal services of that firm, the society that it serves.

Sections 86 and 87 of Legal Practice Act 28 of 2014 outline the types of trust accounts that the law firm may operate for purposes of depositing money held on behalf of another person, the clients of the firm, and the requirement to keep proper accounting records. More often than not, the absence of proper accounting records in a law practice is as a result of a poor ethical culture or leads to a poor ethical culture. This is because when employees of the law firm realise that the leadership does not concern itself with regulatory requirements and, therefore, does not regard the keeping of proper accounting records as important, they use that gap to act unethically and may misrepresent the accounting records.

While the LPFF recognises and acknowledges that not all legal practitioners are necessarily conversant with accounting principles and practices, they can still try to at least understand what is contained in the accounting records, as they remain responsible and accountable for what happens within the law firm, irrespective of who acted unethically. Leadership in the practice should, therefore, not reduce corporate governance to just talking about it, but should act it, and embed it in the law firm. Every staff member should be conversant with the code of ethics within the law firm, and the penalties imposed, or actions taken should they act against that code. For example, they should call for accounting records, including their supporting documents, on an ad hoc basis and interrogate them, requiring explanations where necessary. This will ensure that the ethical culture, especially around entrusted clients’ money, remains intact and above board as staff will fear being caught acting unethically. However, leadership that has a tendency of asking staff to make unlawful payments using entrusted money and covering up for that, open a gap for staff to emulate that practice without the leadership knowing, for their own benefit. This is because staff can get used to preparing accounting records that are flawed with fraud and develop a skill to also hide their own fraud. When this practice becomes the culture in the law firm, it becomes difficult, if not impossible, for leadership to identify fraud perpetrated by staff against the law firm.

Good performance

A law firm that ensures a good ethical culture is rewarded with good overall performance. Good performance can be seen in the ability of the legal practitioners of the law firm to attract and retain its clients, and in its financial performance. Word of mouth will go a long way in marketing the capabilities of a law firm that acts ethically. However, the opposite is also true, word of mouth will destroy a law firm that acts unethically even if the legal practitioner and staff can provide the required standard of legal services. It does not require all clients of a law firm to have a bad experience with the firm, but it takes just one client to spread the news about their bad experience, which can lead to existing and potential clients holding a negative view about the law firm and taking their business elsewhere. Every client of the law firm should, therefore, be treated with honesty and respect, in order for the performance of the law firm to yield good results over the long term. For good performance to be achieved by a law firm requires that leadership and staff at the firm maintain integrity, doing right even when the client does not know what is happening.

Effective control

While law firms employ people based on their skills and capabilities, there should be effective controls in place because some capable and skilled persons may not necessarily possess the required ethical qualities. Controls are only effective if they address an identified risk that threatens the achievement of objectives. This, therefore, requires of legal practitioners leading the law firm, to ensure that they perform risk assessments in their practices. A risk assessment involves understanding the objectives of the law firm, identifying risks that may threaten their achievement, prioritising the risks, and putting controls in place. For controls to be effective, they should consistently address the identified risk by either curtailing the likelihood of the risk occurring or the impact of the risk on the objectives should the risk materialise, or both. For law firms, one of the risks that they may face is theft or the misappropriation of trust funds. This risk calls for controls around the –

  • receipting of trust funds;
  • recording of trust funds;
  • maintenance of accounting records to determine the trust position at any given point;
  • review of trust accounting records to ensure that they are proper and accurate in all respects; and
  • ultimately presenting the records for auditing or inspection.

Leadership at a law firm should, therefore, ensure that they control adherence to policies and procedures, and be consistent in dealing with non-adherence thereto for effective control to have meaning.

Legitimacy

Legitimacy speaks to authenticity, and the quality of being believable or trustworthy. If the LPFF continues to consider the law firm and the accounting records produced by it, as an example, the test by the auditors will be on their legitimacy. Once the auditors discover that the accounting records are fabricated in anyway, this observation gets reported to the regulatory authorities, the Legal Practice Council (LPC). Such reporting may lead to investigation of the law firm by the LPC, which if found to have produced illegitimate accounting records will have dire consequences for the law firm as the legal practitioners will be subjected to disciplinary action, which may result in suspension and/or strike off for the legal practitioner concerned. These outcomes will require the appointment of a curator bonis who will oversee the trust account of the law firm and inform the clients of the firm what transpired, which will negatively impact the law firm further, as potential clients of the firm will not want to be associated with the law firm and will take their business elsewhere. Accounting records that cannot be trusted lead to the law firm, as a whole, not being trusted by its stakeholders, and therefore, it is seen as acting illegitimately. No client wants to be associated with an illegitimate law firm, whether in fact or by perception. Legal practitioners should, therefore, protect not only their actual performance, but also how they are perceived by the society that they serve and their stakeholders.

Conclusion

In conclusion, applying the principles and recommended practices of King IV, though not legislation, will benefit law firms and contribute positively to its long-term sustainability and viability. Legal practitioners should not be in pursuit of immediate self-gratification when running law firms but should rather focus on the society that they serve and they will be rewarded with long term sustainability of their practices. A law firm that carefully applies the principles and recommended practices stands a better chance of withstanding tough economic times. Transparency is easily achieved in an environment where the ethical culture is good, performance is good, there is effective control, and records produced are legitimate and can be trusted and relied upon by stakeholders.

As a legal practitioner, one should always see themselves as part of the corporate citizenship and be responsible towards the society that one serves, and the reward will be fulfilling. Short-cuts will lead to shortened existence, avoid the temptation and do it right.

Simthandile Kholelwa Myemane BCom Dip Advanced Business Management (UJ) Cert Forensic and Investigative Auditing (Unisa) Certified Control Self Assessor (Institute of Internal Auditors) Cert in Management and Investigation of Cyber and Electronic Crimes Cert in Fraud Risk Management Cert in Law for Commercial Forensic Practitioners Cert in Investigation of Financial Crimes Cert in Investigation and Detection of Money Laundering Cert in Economic Crime Schemes (Enterprises University of Pretoria) Post Graduate Diploma in Risk Management (MANCOSA) is the Practitioner Support Manager at the Legal Practitioners’ Fidelity Fund in Centurion.

This article was first published in De Rebus in 2023 (Aug) DR 4.

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