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Independent Directors under Attack

2024 has started with a governance bang! This is led by the change in governance rules gazetted by the Capital Markets Authority (CMA) in October 2023 and awaiting approval by Parliament. The Capital Markets (Public Offers, Listings And Disclosures) Regulations 2023 is an updated governance guide that has redefined the tenure of an independent director from nine years to six years. With no statement issued following the gazettement we, the hoi polloi, are only left with an ignorance vacuum within which to interpret the thinking of the regulators. Under the previous CMA regulations, an independent director was defined as a director who does not have a material or pecuniary relationship with the company, one who is compensated through sitting fees or allowances and one who does not own shares in the company. Furthermore, if nine years had passed since date of first appointment, that independence was deemed to have ended. This definition to begin with already had some questionable rationale as the ownership of shares should have been refined to provide for materiality.

If one owns a hundred shares in a company whose total listed shares is a ten million, is this really an ownership that sways one’s independence? At less than 0.01% how can such a drop in the ocean affect one’s judgement especially since such ownership cannot materially affect the decision making at the board? But I digress. The proposed regulations awaiting parliamentary ratification now define an independent director in pretty much the same terms as above described, except that now an executive director is expressly stated as not being independent and a time frame of six years now encapsulates the independence.

So I went hunting around other jurisdictions to see whether this was a global trend or whether Kenyans have decided to forge their own path. The South Africans, who in 1994 established the private sector led but widely respected King Code of Corporate Governance, are now utilizing version 4 of the same issued in 2016. They have taken a ‘substance over form’ approach to corporate governance, asking organizations to apply and explain by stating their intentions as they apply the rule. King IV provides that a non-executive director may continue to serve in an independent capacity for longer than nine years if, upon an annual board assessment, it is concluded that the director continues to exercise objective judgement, has no interests, relationships or associations which a reasonable third party observer considers as capable of causing bias or influence. The South Africans are saying “Hey, self-regulate as a board and every year use the standard of a reasonable third party to determine the long-in-the-tooth director’s objectiveness.”

The Australian Stock Exchange Corporate Governance Principles issued in February 2019 provide that “A listed entity and its security holders are likely to be well served by having a mix of directors, some with a longer tenure with a deep understanding of the entity and its business and some with a shorter tenure with fresh ideas and perspective. It also recognizes that the chair of the board will frequently fall into the former category.” The authors of this document are clearly board room practitioners rather than theorists. They go ahead to add, “The mere fact that a director has served on a board for a substantial period does not mean that the director has become too close to management  or a substantial holder to be considered independent. However, the board should regularly assess whether that might be the case for any director who has served in that position for more than 10 years.”

So just like the South Africans, our Australian Commonwealth brothers see the need for the board to undertake the self-assessment on independence. Finally, the United Kingdom has issued a new Corporate Governance Code 2024 which will come into effect in January 2025. Section 2, Provision 10 basically says that the board should clearly explain why a director who has been in role for more than 9 years should continue to be considered independent. Just like the South Africans and our Australian Commonwealth brothers, the United Kingdom views boards as mature enough to decide if those that walk amongst them can be viewed as independent. Further, they are required to explain why.

This is a fairly modern approach to corporate regulation. Substance over form. Explain your intentions and hope that they stand up to public scrutiny. The historical approach to regulation is paternalistic: “Daddy said do this and don’t question Daddy because he said so!” So the corporate children of Kenya await further direction on this, while facing the grave danger that valuable institutional knowledge is being given short shrift.

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Twitter/X: @carolmusyoka

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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.

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