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When is it time to corporatize your family business

At one of my recent corporate governance classes, a participant wondered out loud why large retailers that were family owned were not regulated by the government. His question arose after we had undertaken a case study on what is now becoming an unfortunately familiar situation of mammoth retailers collapsing with significant supplier payments outstanding. The knock on effect of such a collapse is always fraught with dire economic effects on the supply chain of both processed and unprocessed goods, the manufacturers and growers of the same, their cash flows and overall financial stability thereafter especially where such a mammoth retailer has turnover in the billions of Kenya shillings.

Truth is, you can’t expect the government to register your company, give you the license to operate a business and then regulate the management of the millions of companies and sole proprietorships that fuel Kenya’s economy. It would require hundreds of thousands of civil servants to do that. Where the government does step in is when a business decides to seek capital from the public in the form of equity or debt, at which point approval of such an issue will be required from the Capital Markets Authority whose role is to ensure that the public is well informed about the issuer not only at the point of issuing the equity or debt instrument, but for the years following such issue by requiring publication of the financials of the issuer and tracking of their financial performance.

A recent report issued by the Retail Trade Association of Kenya (RETRAK), titled Kenya Retail Industry Outlook Survey 2020, was quite illuminating. RETRAK boasts of a membership of up to 600 businesses made up of supermarkets, restaurants and specialty stores such as mobile phone shops, clothes and furniture shops amongst others. The report provides the outcomes of a survey undertaken by members in June 2020 where 28% of the respondents said that the greatest barrier to trade was weak corporate governance structures especially in family owned businesses.

You know the drill: an entrepreneur starts a business with one branch, the business grows based on customer popularity, more branches are opened and family members are recruited (or forced) into the business primarily out of trust rather than professional qualifications and before you can say Bob’s your uncle, the business has multiple branches and the family owners are stretched to capacity and, in some cases, to their level of incompetence. Spouses and adult children are now running an enterprise with hundreds of employees, multiple suppliers, complex supply chains and even more complex financing structures. More often than not, the founder is unwilling to bring in outside professionals to run the business as that would entail letting out “family secrets”. The result is that family tensions spill over into the business and the rest is history.

A good start would be to design job descriptions for the various roles in the business. From the chief executive officer, chief finance officer, supply chain manager etc, which would then help the founder and the role holder to have clarity on what their specific functions are and, perhaps, allow them to see where there are individual skills gaps that need to be addressed. Doing this in tandem with a well designed organization chart allows role holders to see their reporting structure which helps avoid tensions that accrue when one family member feels undermined where decisions are made without their input. Setting up regular business meetings outside of the family’s dining table and in a more formal office set up, with an agenda and a performance dashboard on the various work functions is also a good way to infuse some professionalism into the business as well as awareness and accountability on what the various role holders are doing.

And for the love of God and country, it would be advisable to avoid the jua kali route of writing the job description yourself and bringing in a human resource professional (of which there are several available) to do this task as it allows independence and the right amount of challenge in ensuring the job description is one that is benchmarked with what is out in the market. While this is not a panacea to weak governance it is a good start to helping the business prepare for the professionalization of key organizational roles critical to the organization as it begins to scale and make an impact on the wider (and often unsuspecting) economy.

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Twitter: @carolmusyoka


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Does Age Really Matter

Robert Winship Woodruff was born in 1889 and at the age of 33 years became the CEO of the Coca Cola Company in 1923. According to a Harvard Business School (HBS) case study by Lorsch, Khurana and Sanchez titled the Board of Directors at The Coca Cola Company, it was Woodruff who began shaping the fledgling soft drink enterprise and its franchise system into what was to become the world’s most widely recognized brand.

Like any visionary entrepreneur, Woodruff set about his business as the new CEO with a ruthless focus on market share growth and standardization of the product. However, in order to undertake this gargantuan task, Woodruff needed to have full control of the board. On his board were representatives from the company’s main sugar suppliers as well as the company’s leading advertising agency. The HBS paper outlined Woodruff’s leadership style: “His board meetings were brief; he didn’t want to hear from anybody. They were there to serve his agenda. From Woodruff’s perspective, there was no one to sweet talk because all of the owners of large institutional chunks of Coca Cola stock were under Woodruff’s thumb. Woodruff not only controlled the board of Coca Cola, but in effect he really controlled the boards of the institutions that controlled the Coca Cola stock.”

In 1955, at the age of 66 years, Woodruff retired as CEO but created the powerful Finance Committee of the board which he chaired. As chairman, he controlled the budget of the company and held a veto over all decisions of the company’s CEOs. The chief financial officers of the company were required to report directly to him, rather than the CEO, and he would approve any expenses above $5,000. He eventually retired from the finance committee in 1981 and retired from the board in 1984 at the age of 95, when the company was in the safe pair of hands of Roberto Goizueta, who by this time was the chairman and CEO. One of Goizueta’s first tasks was to create a maximum retirement age of 71 for directors of the Coca Cola board, which he described to someone as looking very close to a geriatric ward. According to the HBS paper, Goizueta felt that “Directors over 71 had to retire not just to save embarrassment on Wall Street, but because of the very real threat of legal liability in the event the company’s directors were shown to be incapable of hearing and understanding the matters they were voting on.”

Now the truth is that modern medicine and lifestyle changes have ensured that a person at the age of 70 is still in a good mental and physical state to perform the rigours of board membership. This was considered in the revamped Companies Act 2015 where the age limit of 70 for directors of companies was removed. Previously, under the 1948 Companies Act, a director of a company who had reached the age of 70 was required to be approved at every subsequent annual general meeting to continue to serve on the board. The Capital Markets Authority in the same year 2015, issued the Code of Corporate Governance Practices for Issuers of Securities to the Public (the Code) which was quite a thorough update of governance laws for Kenya. In what was a clear example of the left hand not knowing what the right hand was doing, the Code maintained the age limit for directors of issuers, by recommending an age limit of 70 years for board members which limit had been removed in the Companies Act 2015. However, according to the Code, shareholders at an annual general meeting may vote to retain a board member who has attained the age of 70. The recommendation in the Code is more loosely worded than the old Companies Act which required re-election at every AGM by special notice, following attainment of 70 years. The loose wording of the Code can be interpreted to mean that once shareholders approve of the director’s continued service after the age of 70, he or she does not need to keep coming back every year for subsequent approval. And the director can serve and serve and serve, just like Woodruff, to the grand old age of 94.

But before you panic, there are checks and balances that boards of listed companies put in place to ensure this doesn’t happen. Defined terms for directors which provide for a set number of years ensures that the director’s capacity to serve again can be interrogated when that term ends. In addition, maximum number of terms is a standard board protocol. The difficult part though, is when said director is a key shareholder such that director terms of service do not apply to them. At that point, all Woodruff-esque bets are off!

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Twitter: @carolmusyoka

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CMA throws down the gauntlet

The 1969 Wild West movie Butch Cassidy and the Sundance Kid, provides classic entertainment as two endearing villains (and one inevitable female lover sidekick) perform numerous robberies, evade the rigorous arm of the law and eventually expire in an ignominious Bolivian conclusion. On Wednesday last week, the Capital Markets Authority published a press release of significant import to the East African corporate governance landscape. “The Board of the Capital Markets Authority (CMA) has taken administrative action against the NBK Board members and former senior managers who served at the bank as at December 31st 2015 for the alleged misrepresentation of financial statements and embezzlement of funds at NBK. The Authority has also recommended to the Office of the Director of Public Prosecutions, the prosecution of some of the senior managers and further criminal investigations of additional individuals.”

A number of erstwhile senior executives was named and shamed, including the former Managing Director, former Chief Finance Officer, former Chief Credit Officer, former head of Treasury, former Director of Corporate and Institutional Banking and one former Relationship Manager in Business Banking. Pretty much half of the bank’s C-Suite was fingered in the financial scandal. The CMA action came as a result of whistle blower information which led the regulator to conduct an inquiry into the affairs of the Bank that led to the commencement of the published enforcement proceedings.

The Capital Markets Authority Code of Corporate Governance Practices for Issuers of Securities to the Public 2015 is a mouthful of a name for a regulatory framework that guides listed companies and issuers of financial instruments to the public. The code mentions the word “whistleblower” three times, addressing it through guidelines and recommendations to boards to ensure that they put into place whistleblowing mechanisms and policies and disclose the same on the company website. In the course of my corporate governance work, I do note that many directors pay fleeting attention to this critical aspect of board supervision. Well the CMA cottoned onto the lackadaisical approach to whistleblowing procedures by boards of regulated companies and put its own whistleblowing mechanism in place.

Last week’s press release finished off on that very note: “Appreciating the critical role which can be played by whistleblowers in drawing attention to areas of irregular, illegal or unethical conduct, the Authority will continue to explore appropriate measures to encourage persons aware of such matters to make reports. The Authority continues to maintain an anonymous whistleblower portal, easily accessible through its website through which tip-offs and reports can be made.”

The NBK scenario is a quintessential case of multiple regulatory intervention. The bank is under the heavy regulation and supervision of the Central Bank of Kenya and was in breach of its statutory total capital to total risk weighted assets ratio by December 2015 when it posted a ratio of 14% against the statutory requirement of 14.5%. The banking supervision unit was clearly paying attention by this time as their own investigations then yielded criminal proceedings against the Chief Financial Officer, Chris Kisire and the acting Chief Financial Officer Wycliff Kivunira which were reported in the Daily Nation’s May 25th 2017 edition. The two were charged with abuse of office for fraudulent procurement practices at the bank.

By dint of this action, the CMA has provided additional support to the CBK’s banking supervision unit by investigating management’s financial malfeasance and poor board oversight over the financial statements. It also should give significant pause for reflection for directors of banks that are also listed on the Nairobi Securities Exchange (NSE) as to the multiple jurisdictional ambit that the companies they sit on endure.

The notable lesson here for directors of companies listed on the NSE, as well as those that issue financial instruments that require to be licenced by the CMA is this: If you don’t provide an independent whistle blowing system that should ideally feed into the audit committee, the regulator is already happily doing that job for you. Independent whistle blowing providers are readily available to provide this critical service. Consequently, board members have to be ready to deal with the outcomes of what might come out of this process; friendly management might end up being Butch Cassidy and the Sundance Kid(s) in disguise.

Next week I will focus on the retributions that have been made on the NBK management and directors and why this should make any sitting director of a listed company think about taking their CEO for a long, long lunch to have a courageous conversation.

[email protected]

Twitter: @carolmusyoka

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The Life and Times of Whistle Blowers

Do you remember that annoying classmate in primary school who always provided to the teacher unsolicited reports of those who were “making noise” when the teacher had stepped out of class? Or the one in boarding school who reported to the dorm master when colleagues had scaled the fence using military grade subterfuge and sneaked out of school to have a good time? In school we referred to these dystopian citizens as “snitches” or “tattle tales” but this was largely informed by the folly of youth where everyone was supposed to be bound by the Mafian oath of omerta or silence when such indiscretions were being perpetuated. However in adulthood, the role of these informers in an organization is absolutely critical in providing information about criminal activities that are being perpetuated by staff, management or, in extreme cases, the board of the organization itself.

Such an informer is called a whistle blower and is defined as a person who informs on a person or organization that is engaged in an illicit activity. A bank I know had a whistle blower call in to say that the branch manager was stealing from the branch. An auditor was sent over to the branch but he couldn’t find any evidence of the stealing. The whistle blower was tenacious and called again, this time saying “tell the auditor to put a camera in the backroom where the ATM is loaded with cash. He will see.” Sure enough a hidden camera was placed and the branch manager was busted in all his glory skimming money from the ATM cassettes as he ostensibly loaded them with cash.
The Capital Markets Authority (CMA) code of corporate governance practices for issuers of securities to the public 2015(we should probably reduce that mouthful to two words: “The Code”) specifically mentions whistle blowers three times. Some context around its genesis would be useful here. The Kenyan private and public sector space has a litany of cases of gross malfeasance perpetuated by senior management, very often leading to the eventual collapse of institutions for lack of cash flow. More often than not, staff knew what was going on but did not have the avenue to report such activities, as it would lead to instant dismissal, or in some extreme cases, grave personal injury. Imperial and Chase Banks are classic cases of organizations that could have done with a whistle blower policy, but they also beg the question: who do you whistle blow to, when it’s the owners or key officers of the institution perpetuating the fraud? The CMA Code tries to address this, on the premise that companies issuing securities to the public – such as shares via the Nairobi Securities Exchange (NSE) or bonds – have the basic corporate governance framework of a board of directors where the buck should stop. Section 4.2.1 provides that the board shall establish whistle-blowing mechanisms that encourage stakeholders to bring out information helpful in enforcing good corporate governance practices. Sounds a bit la-di-da right? Like some flowery language meant to incorporate current buzzwords such as “good corporate governance” and “stakeholders”.
But a second and far more robust attempt is made further down the Code under Section 5.2.5 which states that the board shall establish and put into effect a Whistleblowing Policy for the company whose aim shall be:
a) To ensure all employees feel supported in speaking up in confidence and reporting matters they suspect may involve anything improper, unethical or inappropriate; b) To encourage all improper, unethical or inappropriate behavior to be identified and challenged at all levels in the company; c) To provide clear procedures for reporting of such matters; d) To manage all disclosures in a timely, consistent and professional manner; and e) To provide assurance that all disclosures shall be taken seriously, treated as confidential and managed without fear of retaliation.

Why should you wake up and take notice if your company is not listed on the NSE? The CMA Code covers any company that has issued securities to the public. Therefore an Imperial Bank, which had issued a CMA approved bond to the public not too long before it crashed and burned, would have been expected to be applying the code within its own corporate governance framework had it lasted long enough. Section 7.1.1 (w) of the Code gets even more prescriptive by declaring that the board shall disclose the company’s Whistleblowing Policy on its annual report and website.

The CMA Code is a fairly modern and well thought out regulatory framework that encourages issuers of securities to “apply or explain” the guidelines provided therein. It will therefore require an inordinate amount of CMA supervision to ensure that issuers of securities are religiously submitting annual returns where they undertake the self-evaluation mechanism that an “apply or explain” framework presumes. If the CMA does this well, it then provides a second level of scrutiny to banks that may have inadvertently escaped the Central Bank of Kenya’s statutory hawk eyes and wish to take money from the public in a different form.

The institutions that do this well outsource the whistleblowing framework to an independent third party whose number is widely circulated within the organization. Staff members are encouraged to call that number or send an email with the assurance that the information will be handled sensibly by a non-aligned entity. The third party entity provides these reports directly to the organization’s board audit committee for directive action to be taken. It is imperative that the feedback loop on the whistleblowing falls outside of current management for obvious reasons: management might be part of the problem. Outsiders have no way of knowing what rot goes on inside an institution until the crap hits the fan. What the CMA Code has done is provide a way to protect investors and enable them to hold issuers of securities to a higher standard of transparency. However, this can only work successfully if the CMA plays its enforcement role judiciously.

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Uchumi Directors are not living happily ever after

[vc_row][vc_column width=”2/3″][vc_column_text]It’s one thing to see the law being created. It’s another to see it being applied. The outcome of the Uchumi Supermarkets Ltd (USL) enforcement action by the Board of the Capital Markets Authority (CMA) was one of the best precedents set by the regulator since John Hanning Speke discovered Lake Victoria as the source of the Nile. As a corporate governance educator, I am constantly asked for local case studies since our curriculum is replete with American and European examples, as those are more mature markets that have built up a significant jurisprudence of corporate scandals and enforcement actions thereafter. Kenya itself has a litany of white-collar scandals, but very little in the form of punishment for the perpetrators of corporate malfeasance.

The CMA has undoubtedly set the tone for board directors and key officers of listed and non-listed public companies in this town which tone is as clear as the waters in a baptismal font as evidenced by the allegorical language used. “The Chairman and the directors will be required to “disgorge” their director allowances.” A dictionary meaning of disgorge is to “yield or give up funds, especially funds that have been dishonestly acquired.” Another definition of the same word is “to eject food from the throat or mouth.” And therein lies the allegory, the hidden meaning. Directors who allow malfeasance to occur on their watch and are remunerated during such time are feeding from the wrong trough and will be asked to regurgitate those emoluments swiftly, unashamedly and unequivocally.

The former chairperson and two former non-executive directors of USL were disqualified from holding office as directors or key officers of a publicly listed company, a company that has issued securities, or a company that is licensed or approved by the CMA for a period of two years. They were also asked to return the director allowances paid to them for the financial years 2014 and 2015. Finally, they were instructed that if ever a listed company saw it fit to appoint them to a board after they had atoned for their sins and sat in director purgatory for two years, they would be required to attend corporate governance training before being eligible for appointment.

The former chief executive officer and the former finance manager were also disqualified from holding office as a directors or key officers of companies that are regulated by the CMA. The regulator will also be filing a complaint at the Institute of Certified Public Accountants regarding the professional conduct of the two who are registered Certified Public Accountants.

In retrospect, what the named Uchumi directors and officers have gotten is a rap on the knuckles. They dodged a bullet provided by the current and newly operationalized Companies Act 2015 that allows a shareholder to bring a derivative action against a director for negligence, default, breach of duty or breach of trust. And the regulatory outcome would set enough of a precedence to warrant a shareholder to pursue this course of action in our highly litigious country. The new Companies Act 2015 has given a lot of teeth to stakeholders – including the company itself – to seek retribution for malfeasance or wrong doing on the part of the very parties supposed to maintain the best interests of the company. In light of the fact that a law cannot be applied retrospectively, and the fact that these breaches happened before 2015, the main worry for the named directors is how to mpesa those funds back to base and, for the officers, what color tie to wear to the disciplinary hearing at ICPAK.

The CMA itself issued a new corporate governance code in 2015 (CMA Code), and relied on its fairly modern tenets, that codified director fiduciary duties, in its conclusions about the creative accounting undertaken by the officers of Uchumi and overseen by the non executive directors. Quoting the CMA press release on the Uchumi decision: “The inquiry further established that in some instances the USL branch expansion program was undertaken without due regard to the Board’s fiduciary duty of care due to the absence of a proper risk management framework being in place. It was also established that in some instances, USL pre-financed landlords in addition to making payment of respective commitment fees, but nevertheless the branches were never opened or funds recovered.”

Under Chapter 6 of the CMA Code titled Accountability, Risk Management and Internal Control, boards of directors are required to put in place adequate structures to enable the generation of true and fair financial statements. The Code explains that the rigours of risk management by the board should seek to provide interventions that optimize the balance between risk and reward in the company. In layman’s language: Figure out what could possibly go wrong in the company whose board you sit on and ensure you put in place processes that recognize that risk and, where possible, mitigations for such an eventuality. Furthermore all times ensure the financial statements reflect- rather than conceal – those risks. In the Uchumi case, paying developers of buildings where you intended to open new branches in advance and not putting into place protection measures in case your advance funds were mis-directed to personal Christmas slush funds, was a big mistake. Those pre-payments that were not being recovered should have been provided for or written off entirely.

In light of all the recent corporate scandals, and our seeming inefficiency in prosecuting white-collar thugs dressed in oversized Bangkok knock off suits, the CMA enforcement action is a breath of fresh air. While the directors have all gotten off fairly lightly with a mild disgorgement, it is the social pariah status that will be the most effective deterrent for board directors in this market. I’m not sure that there is a self respecting board in this town, whether in the public or private sector that wants a “director formerly known as the Uchumi guy” serving on its board anytime soon.

[email protected]
Twitter: @carolmusyoka[/vc_column_text][/vc_column][vc_column width=”1/3″][/vc_column][/vc_row]