90819 REPORT ON THE OBSERVANCE OF STANDARDS AND CODES (ROSC) Corporate governance country assessment Kenya December 2007 Executive Summary Good corporate governance ensures that companies use their resources more efficiently, protects minority shareholders, leads to better decision making, and improves relations with workers, creditors, and other stakeholders. It is an important prerequisite for attracting the patient capital needed for sustained long-term economic growth. This report provides an assessment of Kenya’s corporate governance policy framework. It highlights recent improvements in corporate governance regulation, makes policy recommendations, and provides investors with a benchmark against which to measure corporate governance in Kenya. Achievements Broad based reform has been rewarded with a boom in financial markets. Market capitalizations have grown rapidly and hundreds of thousands have become shareholders for the first time. Corporate Governance Guidelines have been issued and supported by private sector initiatives, including widespread director training. Kenya has made great strides introducing international standards in accounting and auditing. Revived privatization and other reforms have improved the corporate governance of state owned enterprises. Key Obstacles The Companies Act is outdated and has important gaps. There are concerns about the governance of the Capital Markets Authority, and the high turnover of its professional staff. Many investors are suspicious of the Nairobi Stock Exchange and its member brokers. Potential conflicts of interest involving company insiders and financial intermediaries remain problematic. Standards for auditing and accounting do not have a strong legal foundation. Both the private sector and the State need to take additional steps to improve the governance of companies they control. Next Steps Legislative changes should include a new Company Act and a stronger legal framework for accounting and auditing. Institutionally, the CMA should be given greater independence, and plans for the NSE to demutualize should proceed. The report identifies a number of specific changes to curtail potentially abusive market practices, strengthen shareholder rights, improve disclosure of indirect ownership, and improve both private and state sector company oversight. Acknowledgements This assessment of corporate governance in Kenya reflecting the situation as of December 2007 was completed in June 2008 by David Robinett and Deborah Eskinazi with Alexander Berg of the World Bank Corporate Governance and Capital Markets Advisory, as part of the Reports on Observance of Standards and Codes Program. The report was based on a template / questionnaire completed by Karugor Gatamah and the Center for Corporate Governance. The assessment reflects technical discussions with the Ministry of Finance, Central Bank of Kenya, Capital Markets Authority, Nairobi Stock Exchange, Retirement Benefit Authority, Institute of Certified Public Accountants of Kenya, Central Depository System, Registration of Accountants Board, Federation For Kenya Employers, DFID, DANIDA and representatives of companies, banks, and market participants. Colin Bruce, Michal Fuchs, Moses Wasike, Davorka Rzehak, Roman Zyla, and Sebastian Molineus provided useful advice and comments. The ROSC assessment for Kenya was cleared for publication by ______ on ____. Table of Contents Market profile .......................................................................................................................................1 Key findings .........................................................................................................................................3 Investor protection ..............................................................................................................................3 Disclosure ..........................................................................................................................................4 Company oversight and the board .....................................................................................................5 Enforcement .......................................................................................................................................6 Recommendations ..............................................................................................................................7 Summary of Observance of OECD Corporate Governance Principles ........................................11 Corporate Governance Landscape ..................................................................................................13 Principle - By - Principle Review of Corporate Governance .........................................................16 Section I: Ensuring The Basis For An Effective Corporate Governance Framework .......................16 Section II: The Rights of Shareholders and Key Ownership Functions............................................18 Section III: The Equitable treatment of Shareholders ......................................................................24 Section IV: The Role of Stakeholders in Corporate Governance .....................................................26 Section V: Disclosure and Transparency .........................................................................................27 Section VI: The Responsibilities of the Board ..................................................................................31 TERMS/ACRONYMS AIMS: Alternative Investment Market System CA: Companies Act CBK: Central Bank of Kenya CCG: Centre for Corporate Governance CDA: Central Depository Agents CDSC: Central Depository and Settlement Corporation Limited CEO: Chief executive officer CMA: Capital Markets Authority CSR: Corporate Social Responsibility Cumulative voting: Cumulative voting allows minority shareholders to cast all their votes for one candidate. Suppose that a publicly traded company has two shareholders, one holding 80 percent of the votes and another with 20 percent. Five directors need to be elected. Without a cumulative voting rule, each shareholder must vote separately for each director. The majority shareholder will get all five seats, as s/he will always outvote the minority shareholder by 80:20. Cumulative voting would allow the minority shareholder to cast all his/her votes (five times 20 percent) for one board member, thereby allowing his/her chosen candidate to win that seat. EGM: Exceptional General Meeting ESOP: Employee Stock Ownership Program FiRe: Financial Reporting Award GMS: General meeting of shareholders GDP: Gross Domestic Product ICPAK: Institute of Certified Public Accountants of Kenya IFRS: International Financial Reporting Standards IOSCO: International Organization of Securities Commissions ISA: International Standards on Auditing JSC: Joint Stock Company KASNEB: Kenya Accountants and Secretaries National Examination Board LR: Listing Rules MIMS: Main Investment Market System NSE: Nairobi Stock Exchange Pre-emptive rights: Pre-emptive rights give existing shareholders a chance to purchase shares of a new issue before it is offered to others. These rights protect shareholders from dilution of value and control when new shares are issued. Proportional representation: Proportional representation gives shareholders with a certain fixed percentage of shares the right to appoint a board member. PS: Permanent Secretary Pyramid Structures: Pyramid structures are structures of holdings and sub holdings by which ownership and control are built up in layers. They enable certain shareholders to maintain control through multiple layers of ownership, while at the same time they share the investment and the risk with other shareholders at each intermediate ownership tier. RAB: Registration of Accountants Board RBA: Retirement Benefits Authority RPT: Related party transaction. Shareholder agreement: An agreement between shareholders on the administration of the company, shareholder agreements typically cover rights of first refusal and other restrictions on share transfers, approval of related-party transactions, and director nominations. SOE: State owned enterprise Squeeze-out right: The squeeze-out right (sometimes called a “freeze-out”) is the right of a majority shareholder in a company to compel the minority shareholders to sell their shares to him. The sell-out right is the mirror image of the squeeze-out right: a minority shareholder may compel the majority shareholder to purchase his shares. Withdrawal rights: Withdrawal rights (referred to in some jurisdictions as the “oppressed minority,” “appraisal” or “buy-out” remedy) give shareholders the right to have the company buy their shares upon the occurrence of certain fundamental changes in the company. Corporate Governance Assessment Kenya Country assessment: Kenya This ROSC assessment of corporate governance in Kenya benchmarks law and practice against the OECD Principles of Corporate Governance and covers public interest entities (including public limited companies, financial institutions, and parastatal companies) with special focus on the companies listed on the Nairobi Stock Exchange (NSE)1. Over the last five years, broad based reform has been rewarded with strong economic performance and a boom in financial markets. Market capitalizations have grown rapidly and hundreds of thousands have become shareholders for the first time. Corporate Governance Guidelines issued by the Capital Markets Authority have been supported by private sector initiatives, including widespread director training, improving governance across listed companies. Kenya has a strong accounting and auditing culture and has made great strides introducing international standards in these areas. Revived privatization, performance contracts, and other reforms have improved the corporate governance of state owned enterprises, which still play a major role in the economy. However, major challenges remain. The Companies Act is outdated and has significant gaps. The Capital Markets Authority lacks independence and faces high turnover of professional staff. Many investors are suspicious of the NSE and its member brokers. Potential conflicts of interest involving company insiders and financial intermediaries remain problematic. Standards for auditing and accounting do not have a strong legal foundation. In addition, the state needs to take additional steps to improve the governance of companies under its ownership. Market profile Kenya has one of the Kenya has the 4th largest equity market in sub-Saharan Africa after South Africa, largest equity markets Nigeria, and Zimbabwe and is the third largest in relative terms (at approximately in Sub-Saharan 50 percent of GDP in 2006). As of December 2007, the NSE had a market Africa capitalization of 851.4 billion Kshs (US $ 13.4 billion). 54 companies have shares listed on the NSE. The market has grown The market experienced rapid growth in value and volume in 2006 before slowing rapidly over the last more recently. Market capitalization increased over 50 percent and turnover more five years, adding than doubled in 2007, the continuation of a bull market that began in 2002. hundreds of Market capitalization has increased 600 percent over the last five years. 2007 also thousands of new saw two new listings on the NSE, after four new listings in 2006. These new shareholders listings have contributed to one of the most dramatic developments of the last few years: the explosive growth in the number of shareholders, from under 100,000 to an estimated 750,000. 1 The assessment was conducted in September 2007, before the December elections, but its findings and recommendations remain fully relevant. December 2007 Page 1 Corporate Governance Assessment Kenya 54 companies are The NSE is Kenya’s only stock exchange. It has three segments: the Main listed on the NSE’s Investment Market System (MIMS), the Alternative Investment Market (AIMS), two tiers and the Fixed Income Securities Market System for bonds and similar securities. 46 companies are listed on the MIMS and 8 on AIMS. All companies must meet listing rules, there is no “over the counter” market. The NSE 20-Share Index stood at 5246 in December 2007, a 20 percent increase over the previous year. Pension funds and While there has been rapid growth in individual participation, companies and foreign investors play institutional investors still hold most of the market. These include insurance a big role in the companies, employer sponsored pension plans (i.e. occupational schemes), the market National Social Security Fund, and foreign companies and institutional investors. The State also remains a key player. At the end of 2006 domestic individuals held 19.4 percent of the market, domestic institutional investors 45 percent, and foreign investors 32 percent. Some companies have Most companies have a known controlling shareholder—an individual, family, hundreds of foreign company, or the state of Kenya—and thousands or tens of thousands of thousands of small shareholders. The largest have hundreds of thousands. Thanks to the growth shareholders in Employee Stock Ownership Programs (ESOPs), many companies also have a large number of employee shareholders. State ownership The state remains a significant shareholder, with major stakes in a number of remains significant large listed companies, including the two power companies (KenGen and Kenya Power & Lighting), major banks and financial companies (Kenya Commercial Bank, National Bank of Kenya, ICDC Investment), the national air carrier (Kenya Airways), and industrial and processing companies (Mumias Sugar, East African Portland Cement). It has recently accelerated its privatization efforts, and the IPOs on the NSE have acted as catalysts for the market. The IPO for KenGen brought in hundreds of thousands of new investors. Planned privatizations include additional tranches of KenGen, as well as selling shares in the National Bank of Kenya and Safaricom. Telcom is to be sold to a strategic investor. Kenya’s corporate Kenya is a common law country, and much of its corporate legal framework is governance based on decades-old UK legislation. Key laws include the Companies Act framework is strongly (Chapter 486 of the Laws of Kenya) and the Capital Markets Act (Cap 485A). influenced by its The Capital Market Authority (CMA) is the principal supervisor of securities common law legal markets and listed companies. A draft Company Bill was issued in 2006, and heritage there have been plans to amend other legislation. The CMA has also issued a number of important regulations2. Corporate Listed companies are required to “comply or explain” with the Guidelines on Governance Corporate Governance issued by the CMA. The Guidelines focus primarily on the Guidelines issued by board, and touch on the internal audit and internal controls, disclosure, and the CMA have helped shareholder rights. Some Guidelines have been introduced in the Listing Rules. increase market The Guidelines build upon Principles for Corporate Governance in Kenya, issued awareness in 1999 by the Kenya Centre for Corporate Governance. The Kenyan Principles have also been the basis for a number of company level codes of governance. The Central Bank of Kenya (CBK) has issued separate corporate governance guidelines for banks. 2 In 2008-2009 the CMA, with the Financial and Legal Sector Technical Assistance Program, will conduct a comprehensive review of the capital market framework. December 2007 Page 2 Corporate Governance Assessment Kenya Key findings The following sections highlight the principle-by-principle assessment of Kenya’s compliance with the OECD Principles of Corporate Governance. Investor protection Basic shareholder Basic shareholder rights are in place in Kenya. Registration is secure and being rights are protected dematerialized through the Central Securities Depository. Shareholders can demand a variety of information from the company and have a clear right to participate in the general meeting of shareholders (GMS) either in person or in proxy, and to nominate, vote for, and remove board members. Changes to the company’s articles, increasing authorized capital, payment of dividends, and major transactions all require shareholder approval. Related party However shareholders also face limits to their rights. They cannot vote in the transactions do not GMS electronically or by post. Shareholders have pre-emptive rights to new share have to be approved issues, but these can be waived with the approval of the GMS and the CMA. by shareholders Perhaps a greater problem is related party transactions (RPTs) that company insiders could use to extract value from the company. Most RPTs do not have to be disclosed before they take place, and do not have to be approved by shareholders. Insider trading and Many investors are concerned that brokers and other industry insiders engage in market manipulation improper conduct and abuse their position. This includes trading on inside are perceived to be information, improper trading with shares in investor accountants, and market widespread manipulation. Recently, a major brokerage that had engaged in improper practices entered insolvency with substantial obligations to investors3. At the time of this report, there have been no prosecutions for insider trading. Funds do not disclose Recent growth in equity markets has increased the importance of new classes of voting or voting intermediaries: fund managers, investment bankers, and research analyst. These policy intermediaries currently face limited regulation regarding conflicts of interest. Fund managers are not required to disclose their voting, or voting policy, in the GMS for companies in which they invest. Having and disclosing a voting policy can make funds more effective advocates for good corporate governance. Taking control of a There are one or two friendly mergers and acquisitions of listed companies each company requires year. To date, there has been one attempted hostile takeover of a listed company, making a tender offer and that has not been resolved. The most significant control changes have and CMA approval involved ongoing privatization through the stock exchange, which have brought hundreds of thousands of new investors into the market. Regulations issued by the CMA govern takeovers. The regulations are designed to limit conflicts of interest during changes in control and require would-be acquirers to make public tender offers to other shareholders. Offers are to include an independent opinion of their value to other shareholders. In practice these rules create a high threshold for changes in control, but do not always prevent the exercise of control through undisclosed relationships and holdings. 3 Investor claims where satisfied when the NSE seat of Frances Thuo and Partners was auctioned off. December 2007 Page 3 Corporate Governance Assessment Kenya Disclosure Listed companies Listed companies in Kenya are required to produce quarterly and semiannual issue quarterly, financial statements as well as audited annual reports4. Annual reports are semiannual, and normally mailed to shareholders, and contain full financial statements, a annual financial chairman’s or management report, a directors’ report, and statements on corporate statements governance and corporate social responsibility. Many company websites also have this and additional information. Great progress has Financial statements are to be prepared according to International Financial been made in Reporting Standards (IFRS) and audited with International Standards on Auditing implementing (IAS). To facilitate both sets of standards, the Institute of Certified Public international Accountants (ICPAK) engages in annual training for its members. Together with standards of the CMA and NSE, it has also established the Financial Reporting Award (FiRe) accounting and that reviews the annual reports of participating companies and gives awards to the auditing statements that most comply with IFRS. In 2006, 80 companies, including most listed companies, submitted reports. Overall, compliance with IFRS is high relative to many emerging market economies. The legal basis for ICPAK is the de facto stander setter, and their authority is generally respected. accounting and However there is no explicit legal basis for ICPAK to set accounting or auditing auditing standards is standards. (Regulations require listed companies and banks to comply with IFRS not explicit and ISA). Legally, the CA provides requirements for company accountants that are in conflict with IFRS, as does some sector specific legislation, such as the Insurance Act. Reviews of audit Until recently, there was little effort to verify audit quality. ICPAK has begun to quality have been review audits prepared by smaller firms, and is looking for international partners recently introduced to review the audits of listed companies prepared by big four affiliates. Auditors also face potential conflicts of interest. Many audit firms provide tax as well as auditing services to the same client, and in some case will help their clients prepare the accounts they audit. Different bodies ICPAK shares responsibility for regulating the profession with the Kenya administer the Accountants and Secretaries National Examination Board (KASNEB), which accounting exam, act administers the qualifying exam for accountants and auditors; and the as the SRO for the Registration of Accountants Board (RAB). Neither body provides independent profession, and oversight of the profession. Nor does the CMA, which has limited legal authority provide the right to and few resources to do so. At the same time, sharing authority with KASNEB practice and the RAB circumscribe some of ICPAKs authority as a self-regulatory body. Indirect ownership Listed companies are required to report material events to the CMA and NSE, and and control are these announcements can be viewed on the NSE website. Related party sometimes opaque transactions are not explicitly required to be part of this disclosure, and are normally only disclosed in the annual report, after they have taken place. Annual reports also list the top ten direct shareholders. Indirect, ie beneficial, ownership is only required to be disclosed in the prospectus for listing and during changes in control. Custodian accounts and holdings through related parties are both used to conceal control, and the means through which a small number of listed companies 4 Listed companies are also required to submit interim and annual audited accounts to the CMA. December 2007 Page 4 Corporate Governance Assessment Kenya are controlled is unclear. Whistleblowers do not Whistleblowers—employees who reveal improper conduct by their employers— have adequate can be a critical source of corporate information. Unfortunately whistleblowers in protection private companies in Kenya have little legal protection. In practice, few employees dare to reveal misconduct by their employers. Company oversight and the board Companies have one Kenya has a one-tier board system. Companies must have a board with at least tier boards and two members, plus a company secretary. Listed companies normally have 9-12 normally have 9 to 12 directors. The board is responsible for overseeing and directing the company, directors including the choice of secretary and managing director, and has substantial freedom under the law to exercise or delegate that power as it sees fit. The CMA Guidelines recommend that the board define the company’s strategy, oversee management and performance, identify principle risks and opportunities, develop remuneration and staff policy, and review internal controls and compliance. Director duties are The fiduciary duties of directors are rooted in English common law, and are not based on precedent explicit in the CA. These include duties to act in the interest of the company and and not explicit in the show the same care regarding the company as they would in their own personal law affairs. In practice, shareholders or the company may bring suits against directors for violating their duties, though such suits are not frequent. Some companies provide liability insurance for their directors. Most directors are Most Kenyan companies have boards composed primarily of non-executive non-executives, but directors, including a non-executive chairman. The CMA Guidelines recommend are not always that one third of board members be independent. The Guidelines also recommend independent that the board should “fairly reflect the company’s shareholding structure” and “should also provide…for representation of…minority shareholders”. In addition they note that director appointment should be “sensitive to gender representation, national outlook, and should not be perceived to represent single or narrow community interest”. In practice many boards have some woman members, and some have representatives of minority shareholders. However these board members can only be elected with the tacit support of the largest shareholders. There are a number Directors are to disclose potential conflicts of interest to the board. Model articles of provisions on in the CA require them to recuse themselves if conflicted. But this is not directors and mandatory for all companies. The CMA Guidelines notes that the board should conflicts of interest, manage conflicts of interest and that all related party transactions should be vetted but most are by an audit committee of independent and non-executive directors. voluntary Similarly, the Guidelines also give the board responsibility to oversee compliance with the company code of conduct. However they say little on what the contents of this code should be, and do not explicitly mention ethics. Director training is The Center for Corporate Governance has provided training to thousands of board extensive members in Kenya and other East African countries. A number of market participants commended the work of the Center in this area, and almost all noted that directors in their companies had received training, either through the Center for some other source. SOEs have made a Recipients of director training include most board members in parastatals, also number of reforms to known as state owned enterprises (SOEs). This is one of many steps SOEs have improve performance taken to improve their corporate governance. Others include a significant increase and corporate in private sector participation on SOEs boards, the introduction of performance December 2007 Page 5 Corporate Governance Assessment Kenya governance contracts, and ongoing privatization and listing of SOEs on the NSE. Awareness of In Kenya, corporate social responsibility is an explicit goal of many listed Corporate Social companies. This includes legal compliance and reduced “demand” for corruption, Responsibility is high policies involving employees like AIDS policies, and various efforts to help local communities. Enforcement The CMA has broad The Capital Market Authority (CMA) has authority over issuers, the NSE, the ranging powers to depository, brokers and dealers, investment banks, fund managers and investment oversee market advisors, and the credit rating agency. They approve new licenses, listings, participants and issue takeovers and other transactions; engage in ongoing market surveillance; and new regulations undertake regular inspections. They can investigate complaints, and can refer cases to the Attorney General and issue reprimands and fines for non-compliance with regulations, but do not engage directly in prosecution. The CMA has authority to issue new regulations, and has issued requirements for securities market intermediaries, listing on the stock exchange, and takeovers and changes in control. The CMA also issued the Corporate Governance Guidelines that apply to all listed companies. The CMA’s status as The CMA has the status of a state corporation, and falls under the authority of the a state corporation is Ministry of Finance. This status presents serious governance challenges for the not consistent with CMA. Being a state corporation limits the top salaries that the CMA can pay to its good practice staff and contributes to a high rate of turnover and professional staff moving to the private sector. The CMA’s board includes Ministry representatives that are not always specialists in capital market issues. While the CMA is considered to have a fair amount autonomy in practice, its subordinate status does limit its legal independence, and is considered contrary to good international practice. The CMA has not been able to comply with IOSCO Principles because of its current governance structure. Recent scandals and perceptions of abuse in the markets have also raised questions about the CMA’s willingness to aggressively pursue wrongdoing by brokers and corporate insiders. The CMA has been attempting to increase the effectiveness of its enforcement of market abuses, but still faces criticism. The NSE is seen as an The NSE is a self-regulatory organization owned by its broker-members. old boys club However its self-regulatory activities are limited, with oversight effectively seeded to the CMA. For example, the CMA sets the listing rules, and determines which companies are allwed to list, and required to delist. The NSE is perceived as an “old boys club” run for the benefit of its members, and to the detriment of investors. Current plans to transform the NSE into a listed company could reduce the influence of brokers and may improve the reputation of the market. Kenya’s courts have In addition to being able to take complaints to the CMA, investors can also file experienced wide suits in court under specific provisions of the CA and under common law ranging reforms in principles based on precedents set in Kenya and the UK. In recent years Kenya recent years has experienced wide-ranging judicial and legal reform to reduce corrupt practices and improve performance; and the cost and time to use the courts in Kenya is better than in many other African countries. However they still remain a relatively expensive alternative, and there have been a limited number of relevant court decisions in recent years. December 2007 Page 6 Corporate Governance Assessment Kenya Recommendations Kenya has undertaken important reforms in recent years. However, fully tapping the potential of capital markets and professionalizing boards and management will require that reform continues. Good corporate governance ensures that companies use their resources more efficiently and leads to better relations with employees, creditors, and other stakeholders. It is an important prerequisite for attracting the patient capital needed for sustained long-term economic growth. Strengthen Key Laws and Institutions Introduce a new A new Companies Act should be finalized and passed into law. It should draw on company act experience from the recent revision of the UK common law and clarify the developed with broad relative powers and responsibilities of shareholders, the board, and other based consultation corporate bodies while still maintaining adequate flexibility. The law should be finalized as part of a broad consultative process that serves both to incorporate relevant experience and to raise the awareness of Kenya’s many investors on the new law and the importance of good corporate governance. Develop a clear The CMA should have the independence and accountability consistent with strategy to restructure IOSCO membership and compliance with the IOSCO Principles. This will require the governance of the a change in legal status and either removing its state corporation status or altering CMA in order to give it. CMA should move to a fully professional board, which is not subject to the it greater control or intrusive oversight by the Ministry of Finance. The issue of the independence while capacity of the CMA also needs to be urgently addressed. It should be able to pay preserving competitive salaries to top staff, and retain enough revenue to do so. accountability Bolster investor At the same time, the CMA must do more to restore confidence in itself and the confidence in the NSE marketplace. The planned demutualization of the NSE should go forward. Demutualization should coincide with greater vigilance by the CMA in policing misconduct by brokers. Strengthened legislation on market manipulation and other forms of misconduct should also be considered. Rules on broker access to accounts should be strengthened: shareholders must always have separate accounts, and penalties for unauthorized trading should be substantial. Licensing requirement in capital market regulations should be reviewed and made more comprehensive. Better Protect Investors Address potential Greater vigilance of intermediaries should also be extended to fund managers, conflicts of interest in investment bankers, and research analysts. Potential conflicts of interest must be investment banking carefully managed, and this will require improved practices by the intermediaries, and fund management increased oversight by the CMA, and possibly additional legislation or regulation strengthening the “Chinese walls” between various services provided by financial intermediaries. Require funds to Funds should also participate in the general meeting of shareholders (GMS), disclose how they vote develop voting policies for those meetings, and disclose both their policies and at the GMS how they vote. These policies should seek to further the interest of their beneficiaries, and explicitly exclude voting to satisfy management or others if it conflicts with those interests. Regulation should be considered that requires funds to develop and disclose these policies, as well as voting practices. December 2007 Page 7 Corporate Governance Assessment Kenya Disclose related party Better protecting investors will also require a more rigorous and transparent transactions, and process for related party transactions (RPTs). Any potential transaction in which a introduce rules to board member, manager, major shareholder, or their relations, has an interest, avoid their abuse should be disclosed to shareholders before they take place, together with the opinion of the audit committee on the transaction. The Listing Rules should also require RPTs that exceed a certain threshold — for example 5 percent of company assets — receive approval of the GMS. If a director is conflicted, the (new) Companies Act should also require that board member recuse himself5. Recusal for significant shareholders in the GMS should also be considered. Require disclosure of To be fully effective, a strengthened regime for RPTs will also require better indirect ownership disclosure of beneficial ownership and control. An obligation for major shareholders to disclose their direct, indirect, and controlling stakes in listed companies should be considered. This disclosure would be to the company and CMA, and require these shareholders disclose in a timely matter when they cross a key threshold (e.g. 10 percent) and make any additional transactions in the company’s shares. This disclosure should include shareholder agreements that transfer effective control. Strengthen Preemptive rights by current shareholders in the case of a new securities issue preemptive rights should be clarified. It should be clear that such rights can only be waived by a supermajority of shareholders at the GMS or with CMA approval. In the latter case the CMA should have very clear guidelines on issuing such a waiver, and should do so sparingly. The audit committee should also provide an opinion on any issue of securities, and if waiving preemptive rights is justified. The new CA should also allow for postal or electronic voting by shareholders. Ensure Greater Transparency Strengthen the legal The legal basis for accounting and auditing standards in Kenya should be basis for international reinforced by passing a new act that mandates international standards, and giving accounting and ICPAK the authority to oversee implementation of those standards. Conflicts auditing standards between the CA, other legislation, and international standards should be removed. The current division of authority between ICPAK, KASNEB, and the RAB should also be reconsidered. Limit potential Many auditors provide non-audit services to their clients. Reform should also conflicts of interest seek to limit these potential conflicts of interest, restricting the provision of audit involving auditors and non-audit services to the same client. In addition, an update of the Accounting and Auditing ROSC should be undertaken to provide a more thorough review of the profession, the disclosure framework, and more detailed recommendations in this area. Strengthen the CMA Other steps to improved disclosure should include: strengthened oversight of and Registrar in company reporting by the CMA—which has statutory authority in this area; and overseeing disclosure continuing reforms of the Registrar, which increasingly emphasize investor access and enforcing relevant provisions of the CA. Finally, whistleblowers should receive explicit legal protection from retaliation by their employer. 5 This is only required in the model articles in the CA, but can be removed by adopting different articles. December 2007 Page 8 Corporate Governance Assessment Kenya Improve the Effectiveness of Company Oversight Include duties of The new Company Act should include explicit duties and powers for the board of loyalty and care in directors in law. These can build on the language already found in the CMA the new company act Guidelines and the model articles in the current CA. They should include an explicit duty of care and a duty of loyalty to the shareholder and the company. Make greater use of Boards of listed companies should strive to have both a high number of independent directors independent directors and directors chosen by minority shareholders. The language in the Guidelines should be strengthened, requiring at least one half be independent, and encourage the nomination committee to actively solicit the views of minority shareholders and strive to have their candidates serve on the board. All companies should To ensure accountability as well as independence, the Guidelines should also have codes of ethics require that companies have codes of ethics that apply to board members. In addition, the Guidelines should require more comprehensive disclosure on directors, and the new Company Act should mandate that board member remuneration be disclosed on an individual basis and approved by shareholders. CSR efforts should be Most listed companies in Kenya have Corporate Social Reasonability (CSR) approached carefully programs. Boards and shareholders should take care to ensure that these programs benefit their intended recipients, and are not improperly influenced by the Managing Director or other individuals in the company. More innovative approaches that tap the skills and dynamism of the private sector should also be considered. Additional language in the Guidelines may be warranted to encourage greater vigilance in this area. Develop an While progress has been made in improving the oversight of SOEs, much more ownership policy for could be done in this area. The government should begin developing an explicit SOEs ownership policy for SOEs that guides SOE governance and the states role as a shareholder. To facilitate this, a diagnostic and action plan for SOE governance should also be considered. The government and relevant donors may also wish to address corporate governance in other types of entities, especially cooperatives, which play an important role in Kenya’s economy. Review bank The World Bank would be pleased to assist the central bank in reviewing the corporate governance compliance of the banking sector with the Central Bank Guidelines and other aspects of corporate governance good practice. December 2007 Page 9 Corporate Governance Assessment Kenya Summary of Key Recommendations Recommendation How to be Introduced Priority/Status Strengthen Key Laws and Institutions Revise the Companies Act Based on current efforts Immediate Strengthen the CMA Changes in relevant legislation Immediate Demutualize NSE Based on current efforts Immediate Aggressively pursue market abuses Stepped up CMA enforcement Immediate Better Protect Investors Address conflicts of interests of funds and Greater oversight by CMA Medium-Term other intermediaries Changes in relevant legislation/regulation Encourage Institutional investor voting Private initiatives Medium-Term Changes in relevant regulation Tighten control of related party transactions Changes in listing rules/new CA Immediate Better disclose corporate control Changes in relevant legislation/regulation Medium-Term Tighten rules for preemptive rights Changes in relevant legislation/regulation Medium-Term Allow for postal and electronic voting Changes in listing rules/new CA Medium-Term Ensure Greater Transparency Strengthen legal basis for accounting and New accounting and auditing act(s) Medium-Term auditing Limit auditor conflicts of interest New accounting and auditing act(s) Medium-Term Increase regulatory oversight Greater oversight by CMA Medium-Term Continue reform of Registrar Formal protection for whistleblowers New act Long-Term Improve the Effectiveness of Company Oversight Articulate explicit director duties New CA Immediate Increase number of independent directors Changes to the Guidelines Immediate Require codes of ethics Changes to the Guidelines Immediate Disclose more on directors Changes to the Guidelines Immediate New CA Increase CSR effectiveness Private Initiatives Long-Term Changes to the Guidelines Improve SOE and cooperative governance SOE ownership policy Long-Term Donor assistance December 2007 Page 10 Corporate Governance Assessment Kenya Summary of Observance of OECD Corporate Governance Principles Principle FI BI PI NI NA I. ENSURING THE BASIS FOR AN EFFECTIVE CORPORATE GOVERNANCE FRAMEWORK IA Overall corporate governance framework X IB Legal framework enforceable /transparent X IC Clear division of regulatory responsibilities X ID Regulatory authority, integrity, resources X II. THE RIGHTS OF SHAREHOLDERS AND KEY OWNERSHIP FUNCTIONS IIA Basic shareholder rights IIA 1 Secure methods of ownership registration X IIA 2 Convey or transfer shares X IIA 3 Obtain relevant and material company information X IIA 4 Participate and vote in general shareholder meetings X IIA 5 Elect and remove board members of the board X IIA 6 Share in profits of the corporation X IIB Rights to part in fundamental decisions IIB I Amendments to statutes, or articles of incorporation X IIB 2 Authorization of additional shares X IIB 3 Extraordinary transactions, including sales of major corporate assets X IIC Shareholders GMS rights IIC 1 Sufficient and timely information at the general meeting X IIC 2 Opportunity to ask the board questions at the general meeting X IIC 3 Effective shareholder participation in key governance decisions X IIC 4 Availability to vote both in person or in absentia X IID Disproportionate control disclosure X IIE Control arrangements allowed to function IIE 1 Transparent and fair rules governing acquisition of corporate control X IIE 2 Anti-take-over devices X IIF Exercise of ownership rights facilitated IIF 1 Disclosure of corporate governance and voting policies by inst. investors X IIF 2 Disclosure of management of material conflicts of interest by inst. investors X IIG Shareholders allowed to consult each other X III. EQUITABLE TREATMENT OF SHAREHOLDERS IIIA All shareholders should be treated equally IIIA 1 Equality, fairness and disclosure of rights within and between share classes X IIIA 2 Minority protection from controlling shareholder abuse; minority redress X IIIA 3 Custodian voting by instruction from beneficial owners X IIIA 4 Obstacles to cross border voting should be eliminated X IIIA 5 Equitable treatment of all shareholders at GMs X IIIB Prohibit insider trading X IIIC Board/Mgrs. disclose interests X IV. ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE IVA Legal rights of stakeholders respected X IVB Redress for violation of rights X IVC Performance-enhancing mechanisms X IVD Access to information X IVE “Whistleblower” protection X December 2007 Page 11 Corporate Governance Assessment Kenya Principle FI BI PI NI NA IVF Creditor rights law and enforcement X V. DISCLOSURE AND TRANSPARENCY VA Disclosure standards VA 1 Financial and operating results of the company X VA 2 Company objectives X VA 3 Major share ownership and voting rights X VA 4 Remuneration policy for board and key executives X VA 5 Related party transactions X VA 6 Foreseeable risk factors X VA 7 Issues regarding employees and other stakeholders X VA 8 Governance structures and policies X VB Standards of accounting & audit X VC Independent audit annually X VD External auditors should be accountable X VE Fair & timely dissemination X VF Research conflicts of interests X VI. RESPONSIBILITIES OF THE BOARD VIA Acts with due diligence, care X VIB Treat all shareholders fairly X VIC Apply high ethical standards X VID The board should fulfill certain key functions VID 1 Board oversight of general corporate strategy and major decisions X VID 2 Monitoring effectiveness of company governance practices X VID 3 Selecting/compensating/monitoring/replacing key executives X VID 4 Aligning executive and board pay X VID 5 Transparent board nomination/election process X VID 6 Oversight of insider conflicts of interest X VID 7 Oversight of accounting and financial reporting systems X VID 8 Overseeing disclosure and communications processes X VIE Exercise objective judgment VIE 1 Independent judgment X VIE 2 Clear and transparent rules on board committees X VIE 3 Board commitment to responsibilities X VIF Access to information X Note: FI=Fully Implemented; BI=Broadly Implemented; PI=Partially Implemented; NI=Not Implemented; NA=Not Applicable December 2007 Page 12 Corporate Governance Assessment Kenya Corporate Governance Landscape CAPITAL MARKETS At the end of 2007, the Nairobi Stock Exchange (NSE) had a market capitalization of 851.4 billion Kshs (US $ 11 billion), and is the 4th largest equity market in sub-Saharan Africa, after Nigeria, South Africa, and Zimbabwe. The market experienced rapid growth in value and volume in 2006, with market capitalization increasing almost 50 percent and turnover more than doubling over the previous year. This is the continuation of a bull market that began in 2002: market capitalization has increased 600 percent over the last five years. 2006 also saw four new listings on the NSE, and 2007 two new listings. There were no new listings in the previous four years. Perhaps most significantly, there has been explosive growth in the number of shareholders over the last few years, increasing from under 100,000 to an estimated 750,000. Kenya Stock Exchange: Key Indicators (2004- 2007) 2007 2006 2005 2004 NSE Share Index 5445 5646 3973 2946 Market Capitalization (Kshs, bn) 851 792 463 306 Market Cap/GDP (%) 50% 33% 24% Number of Listed Companies 531 51 47 47 New Listings 2 4 0 0 Delistings 0 0 0 0 Turnover (Kshs, bn) 60.28 22.03 20.35 Turnover Ratio 11.6% 14.6% 9.8% 8.1% Kenya and other Emerging Markets: Selected Market Data (2006)6 Market Market Market Cap ($) Turnover Listed Market Cap Cap % of % of ratio % Compani Cap % (Billions Turnover OECD OECD of OECD Country Name es GDP $US) Ratio (%) Avg. Avg. Avg. Kenya 51 49.9 11.4 14.6 49.8 0.8 14.5 Uganda* 5 1.2 0.1 5.2 1.2 0.0 5.2 Tanzania* 6 4.2 0.5 2.1 4.2 0.0 2.1 Namibia 9 8.3 0.5 3.8 8.2 0.0 3.8 Zambia* 14 11 1.2 2.1 11 0.1 2.1 Botswana 18 37.2 3.95 2.3 37.1 0.3 2.3 Ghana 32 25 1.23 2.1 24.9 0.2 2.1 Cote d'Ivoire 40 23.7 4.2 3.3 23.6 0.3 3.3 Mauritius 41 56.7 3.6 4.4 56.5 0.2 4.4 Zimbabwe 80 … 26.5 6.2 … 1.8 6.2 Nigeria 202 28.5 32.8 13.6 28.4 2.3 13.5 Regional average 45.3 24.6 7.8 5.4 24.5 0.6 5.4 South Africa 401 280.2 715 48.8 279.3 49.5 48.6 OECD Average* 894 100.3 1,443.9 100.4 100.0 100.0 100.0 54 companies have shares listed on the NSE, 6 have bonds. Trading is concentrated in the largest companies: the top ten stocks in the market account for 71 percent of market capitalization and 46 percent of trading volume. In 2006 the NSE adopted an Automated Trading System (ATS), replacing a traditional open-outcry system. The NSE has three segments: the Main Investment Market System (MIMS), the Alternative Investment Market (AIMS), and the Fixed Income Securities Market System, the first two are for company shares, the last for corporate bonds, preferred shares, and government securities. 46 companies are listed on the MIMS and 8 on AIMS. The NSE 20-Share Index is a geometric mean of 20 company shares, in December 2007 it stood at 5246, a 20 percent increase over the previous year. OWNERSHIP Kenyan individuals own 19.4 percent, Kenyan institutional investors (including the state) 45 percent, foreign individuals less than one percent, and foreign institutional investors 31 percent of listed companies. Ownership is fairly concentrated, of the 37 largest companies (which make up 98 percent of market cap), the top ten shareholders own 70-95 percent in 23, 50-70 percent in eight, 30-50 percent in two, and 15-29 percent in two. Practically all companies have a known “controlling” shareholder. On the other hand, many companies now have thousands of small shareholders, the largest tens or hundreds of thousands. Institutional investors include over 1300 occupational pension schemes, 16 individual benefits scheme, and the National 6 Source: World Development Indicators 2006. Data for Kenya are for 2006. Regional average includes 12 African equity markets listed above but excludes South Africa. OECD average includes 24 high-income OECD countries (as defined by WDI). December 2007 Page 13 Corporate Governance Assessment Kenya Social Security Fund (NSSF). These schemes cover 15 percent of the workforce, and benefit primarily those in the formal work force. The NSSF has the largest number of members, but the occupational schemes hold 61 percent of the assets. In March 2007 the NSSF had total assets of 63 billion Kshs, 26.4 billion Kshs (42 percent) of which was invested in the shares of Kenyan listed companies. The occupational schemes had 159 billion Kshs of assets, with 45 billion (28 percent) in domestic shares. Privatization started in Kenya in 1991, with 160 of 240 SOEs privatized. These were mostly smaller enterprises, and state ownership remains in a number of listed companies, including Kengen, Portland Cement, KPC, National Bank, and Kenya Commercial Bank. A new privatization law was enacted in 2005, but has not been fully implemented. LEGAL FRAMEWORK Corporate legal framework. The Companies Act (Chapter 486 of the Laws of Kenya) provides the legal framework governing companies. It is substantially the same as the 1948 UK companies act, and there is a general feeling that it should be substantially revised or updated. A draft Company Bill was lodged in 2006, and work on a new company law is ongoing. Kenya is a common law country, and common law precedent and principles of equity are considered in court decisions on corporate matters. Company types. The Companies Act (CA) allows for limited partnerships, private companies, and public companies. Private companies may limit the transfer of shares and cannot have more then 50 members. Only public companies may list their shares. Other organizational forms include cooperatives and municipal corporations, each founded under their own act, and state corporations, which must comply with both the CA and the State Corporations Act. In 2005 there were 125,000 registered companies, almost 11,000 cooperatives, and 120 state corporations. Securities law framework. The Capital Markets Act (Cap 485A) sets out the powers and objectives of the Capital Market Authority (CMA) and provides the legal framework for the stock exchange and securities industry. It also has provisions on insider trading. These have been supplemented by a number of regulations issued by the CMA. The legal framework is considered to have some gaps and insufficient remedies, especially regarding market manipulation and misconduct by brokers, and has not kept pace with the rapid development of the market. There are plans to revise the Capital Markets Act in the near future. Listing rules. Listing rules, including the relevant fees, are set by CMA regulation and not the exchange. Companies can issue securities on the Main Investment Market System (MIMS), the Alternative Investment Market (AIMS), and the Fixed Income Securities Market System. The first two are for company shares, the last for corporate bonds, preferred shares, and government securities. Listing requirements for the MIMS include: paid up share capital of 50 millions Kshs, net assets of 100 million Kshs, and profitability in the three of the last five years. The AIMS requires paid up share capital of 20 millions Kshs, net assets of 20 million Kshs, and the company to be in existence for two years, with “good growth potential”. Additional requirements for AIMS companies include: at least 25 investors who hold at least 20 percent of the equity after listing, two independent non-executive board members, and a “clear policy on dividends”. The CMA must approve listing, not the NSE. Corporate Governance Code. Listed companies are required to “comply or explain” with the Guidelines on Corporate Governance issued by the CMA. The Guidelines focus primarily on the board, including board responsibilities, composition, and committees. They also touch on the internal audit and internal controls, disclosure, and shareholder rights. Some of the Guidelines provisions have been introduced in the Fifth Schedule of the Listing Rules: the requirement to establish an audit committee, maximum of five directorships by the same person in listed companies, cap on holding position of chairman in no more than two listed companies, disclosure in the annual report of the compliance with the guidelines, requirement for Chief Financial Officer to be a member of the Institute of Certified Public Accountants, requirement for Company secretary to be member of the Institute of Certified Public Secretaries, and requirement for the auditor of the company to be a member of the Institute of Certified Public Accountants of Kenya. In practice, companies do include corporate governance statements in their annual reports, but it is not always a comprehensive review of compliance. The Guidelines build upon Principles for Corporate Governance in Kenya, issued in 1999 by the Kenya Center for Corporate Governance. The Kenyan Principles have been the basis for a number of company level codes of governance. The Central Bank of Kenya has also issued corporate governance regulations for banks, both listed and non-listed. KEY INSTITUTIONS Securities regulator. The Capital Market Authority (CMA) is the securities market regulator. The CMA supervises all companies that issue securities, the stock exchange, depository, brokers and dealers, investment banks, fund managers and investment advisors, and the credit rating agency. The CMA has broad powers and can issue binding regulation. It can refer criminal cases to the Attorney General, but cannot prosecute cases directly. The CMA has the status of a state corporation and is overseen by the Ministry of Finance. Being a state corporation limits its ability to pay competitive salaries. Its subordination to Finance as a state corporation is not consistent with membership in the International Organization of Securities Commissions (IOSCO). Stock exchange. The Nairobi Stock Exchange (NSE) was founded in 1954 and is Kenya’s only exchange. It is a self- regulatory organization owned by its member brokers. In practice, oversight of listed companies and brokers is dominated by the CMA, and the role of the exchange is limited. The exchange has a reputation among investors of being run in the December 2007 Page 14 Corporate Governance Assessment Kenya interest of its broker members, a reputation compounded by the misconduct of some brokers. Demuatlization is planned for the exchange, largely to reduce the influence of its current owners. Central securities depository. After years of planning, the Central Depository & Settlement Corporation Limited (CDSC) commenced operation of the central depository system in November 2004. The CDSC is owned by the NSE (20 percent), brokers (18 percent), and, in anticipation of greater regional cooperation, the governments of Uganda and Tanzania (5 percent). Currently all shares traded on the NSE must be “immobilized” through the CDSC, where the evidence of share ownership is the electronic record, and the shareholders receipt. Currently the CDSC has about 800,000 accounts. However securities are not fully “dematerialized”: many shares not traded in the last few years are still held in certificate form. The central depository system was developed by Millennium Information Technologies Limited of Colombo, Sri Lanka. Financial sector regulators. The Central Bank of Kenya (CBK) is responsible for supervising and regulating depository institutions (banks). Kenya had a period of significant governance problems in banks (especially in the early 1990s) mainly related to insider lending. In 2006 the CBK reviewed its prudential guidelines and issued new corporate governance requirements for banks to align their governance with international best practice. Pensions in Kenya are regulated by the Retirement Benefits Authority, and insurance companies by the Insurance Regulatory Authority. Company Registrar. The Registrar of Companies is empowered to collect basic information from both listed and non-listed companies and enforce certain provisions of the CA. Until recently, the Registrar’s files were badly organized and its enforcement actions limited. Recent efforts have made some improvements, but the institution does not play the role envisioned in the law. Shareholder rights groups. The Kenyan Center for Corporate Governance (CCG) established a Shareholder Association, but it is currently not functioning. There are some company level groups, but no other shareholder associations at the national level. Accountancy bodies. The Institute of Certified Public Accountants of Kenya (ICPAK) is the primary self-regulatory body for accountants and auditors. It is the de facto standard setter, provides ongoing training for its members, investigates complaints against, and applies sanctions. A separate body, the Kenyan Accountants and Secretaries National Examination Board, administers the certification exams for would be accountants and auditors (as well as company secretaries); and the Registration of Accountants Board licenses practicing members of the profession. Legal changes have been proposed that would confirm ICPAK role as a standard setter under the law, and may merge their functions with one of the other bodies. Institute of Directors. The Center for Corporate Governance (CCG) was established in 1999. It has trained thousands of directors in Kenya and neighboring countries, including hundreds of directors in state owned enterprises. CCG’s Principle of Corporate Governance would influence the Guidelines issued by the CMA and a number of company level codes of corporate governance. It has also issued Guidelines on governance in SOEs, cooperatives, and banks and been involved in a number of initiatives to raise the awareness of corporate governance in both Kenya and across Africa. Ownership of state-owned enterprises. The Permanent Secretary (PS) of Finance acts as the shareholder ex officio in state owned enterprises (SOEs). In this role he is supported by the Investments unit in the Treasury, which reviews SOE accounts, receives dividends, on-lends to SOEs (i.e. lends funds from the World Bank and others for particular projects), has been involved in privatization, and whose employees often act as substitutes for the PS, who is supposed to serve on the boards of all SOEs where the state has at least 50 percent of ownership. SOE oversight is shared with the administrative ministry assigned to each SOE, and the presidents office, which oversees the performance contracting system that for SOEs. December 2007 Page 15 Corporate Governance Assessment Kenya Principle - By - Principle Review of Corporate Governance This section assesses compliance with each of the OECD Principles of Corporate Governance. Please see Methodology for Assessing the Implementation of the OECD Principles on Corporate Governance for full details.7 SECTION I: ENSURING THE BASIS FOR AN EFFECTIVE CORPORATE GOVERNANCE FRAMEWORK The corporate governance framework should promote transparent and efficient markets, be consistent with the rule of law and clearly articulate the division of responsibilities among different supervisory, regulatory and enforcement authorities. Principle IA: The corporate governance framework should be developed with a view to its impact on overall economic performance, market integrity and the incentives it creates for market participants and the promotion of transparent and efficient markets. Assessment: Partially Implemented Kenya is a common law country and has been heavily influenced by British law and legal tradition. Critical laws, including the Companies Act, are based on dated UK equivalents. The Capital Market Authority (CMA), ICPAK—the professional body for accountants and auditors, and the private sector have taken steps to compensate for this dated legal structure through regulations, guidelines, training programs, and other efforts. However critical gaps remain in the current legal framework. The CMA, with the Financial and Legal Sector Technical Assistance Program will conduct a comprehensive review of the capital market framework. Overall capital market transparency. Kenya has a strong “auditing and accounting culture”, and listed companies do provide substantial information to the public. However, market participants expressed concern that some of the NSEs broker-members engage in market manipulation and insider trading, and there is a feeling that what is happening in the market is not entirely transparent. Regulatory consultation process. New laws are drafted by working groups including various stakeholders, and then presented to the public as “bills” before being adopted—or rejected—by parliament. The CMA posts proposed regulations, rules, and guidelines for 30 days for public comment on its website, sometimes arranges consultative seminars with stakeholders, and has established a private sector advisory committee to comment on draft regulation. Principle IB: The legal and regulatory requirements that affect corporate governance practices in a jurisdiction should be consistent with the rule of law, transparent and enforceable. Assessment: Broadly Implemented Legal clarity. The government has committed to streamlining and clarifying the legal framework. A long standing Law Reform Commission under the Attorney General seeks to simplify and modernize the law, and a Kenya Law Reform Commission Bill has been drafted to strengthen the commission. The President has also launched a Rapid Results Initiative to streamline regulation and improve public services. The Companies Act (CA) is based on the 1948 UK act, and it is agreed that it needs updating. It does not describe board member duties (which are based on common law precedent), it includes outdated requirements for company accounts, and does not provide an adequate basis for subsequent securities legislation and regulation. A draft Company Bill was presented in 2006, and work continues on a new act. The setting of accounting and auditing standards also lacks a strong legal basis, and a new Accounting Act is also being developed. 7 Principles are Fully Implemented if the OECD Principle is fully implemented in all material respects with respect to all of the applicable Essential Criteria. Where the Essential Criteria refer to standards (i.e. practices that should be required, encouraged or, conversely, prohibited or discouraged), all material aspects of the standards are present. Where the Essential Criteria refer to corporate governance practices, the relevant practices are widespread. Where the Essential Criteria refer to enforcement mechanisms, there are adequate, effective enforcement mechanisms. Where the Essential Criteria refer to remedies, there are adequate, effective and accessible remedies. A Broadly Implemented assessment is likely appropriate where one or more of the applicable Essential Criteria are less than fully implemented in all material respects. A Partly Implemented assessment is appropriate when (1) one or more core elements of the standards described in a minority of the applicable Essential Criteria are missing, but the other applicable Essential Criteria are fully or broadly implemented in all material respects (including those aspects of the Essential Criteria relating to corporate governance practices, enforcement mechanisms and remedies); and (2) the core elements of the standards described in all of the applicable Essential Criteria are present, but incentives and/or disciplinary forces are not operating effectively to encourage at least a significant minority of market participants to adopt the recommended practices; or the core elements of the standards described in all of the applicable Essential Criteria are present, but implementation levels are low because some or all of the standards are new, it is too early to expect high levels of implementation and it appears that the reason for low implementation levels is the newness of the standards (rather than other factors, such as low incentives to adopt the standards). A Not Implemented assessment likely is appropriate where there are major shortcomings. A Not Applicable assessment is appropriate where an OECD Principle (or one of the Essential Criteria) does not apply due to structural, legal or institutional features (e.g. institutional investors acting in a fiduciary capacity may not exist). December 2007 Page 16 Corporate Governance Assessment Kenya Consistency of application. Some market participants have noted that the CMA and NSE do not apply the existing regulations in a consistent or thorough manner; some, like the legal requirements and regulations regarding insider trading, have never been enforced. However, gross violations and abuses have not been reported. Principle IC. The division of responsibilities among different authorities in a jurisdiction should be clearly articulated and ensure that the public interest is served. Assessment: Broadly Implemented Clear division of regulatory responsibility. In general, the division is clear, with the Central Bank overseeing banks, specialized regulators overseeing insurance companies and pension funds, the CMA overseeing issuers and other market intermediaries, and the Registrar performing some functions for all companies, including non-listed ones. There is a limited amount of overlap regarding listed banks and insurance companies. More serious problems involve gaps and areas of under enforcement. This includes potentially incomplete enforcement of the CA—giving the state of the Registrar—and accounting and auditing standards: the standards are currently set by ICPAK, with no explicit legal authority. CMA regulation also makes reference to these standards, but they are not in the position to enforce compliance. Similarly, it is unclear who should police certain kinds of financial fraud, e.g. “pyramid schemes”. Regulatory cooperation. The CMA is empowered to cooperate and sign memorandums of understanding (MoUs) with other domestic and foreign regulators. To date, it has signed MoUs with its counterparts in Tanzania and Uganda, but is still preparing them for domestic counterparts like the Central Bank. Cooperation between Kenyan regulators is currently carried out in an ad-hoc fashion. Legal harmonization. The CA and some other legislation contain provisions that are not consistent with current accounting and auditing standards (see VB). Effectiveness, transparency, and public interest activities of the self-regulatory bodies. The Nairobi Stock Exchange (NSE) has self-regulatory status, and is supposed to monitor trading and the activities of its broker members. In practice its authority has been circumscribed by the CMA and many perceive the NSE as an “old-boys club” that cannot be trusted to police its members. Principle ID. Supervisory, regulatory and enforcement authorities should have the authority, integrity and resources to fulfill their duties in a professional and objective manner. Moreover, their rulings should be timely, transparent and fully explained. Assessment: Partially Implemented Supervisory authority. Under the Capital Market Act, the Capital Market Authority (CMA) has authority to supervise all companies that issue securities, the NSE, CSDC, brokers and dealers, investment banks, fund managers and investment advisors, and the credit rating agency. They approve securities issues and license intermediaries, engage in ongoing market surveillance, investigate complaints from investors and others, inspect the premises of their licenses, issue new regulations, and approve takeovers and off market transfers of securities. They can demand intermediaries provide them with information not available to the public, and refer cases for prosecution to the Attorney General, but do not have authority to engage directly in prosecution. They can also issue reprimands and fines for non-compliance with regulations. In 2006 the CMA carried out 52 investigations and 112 inspections. Decisions of the CMA can be appealed to a Capital Market Tribunal, which is composed of five members appointed by the Ministry of Finance. Decisions can then be appealed from the Tribunal to the courts. Supervisory resources. The CMA has a board of 11 directors, which includes the chief executive (managing director) and 10 non-executive directors, including the chairman. The “non-executives” include the Attorney General, Permanent Secretary (PS) Treasury, and the Governor of the Central Bank, all of whom have designated alternates. The others are all currently in the private sector. The CMA is a state corporation, which puts it under the authority of the Ministry of Finance and limits its legal independence., While the CMA is exempted from some of the provisions of the State Corporations Act (Capital Market Act Cap (485A) §39, 5A) 8 it has to submit its budget to the Ministry for approval, it participates in the performance management system for state corporations, administered by the presidents office, and is regularly audited by the Auditor General. In practice it is considered largely autonomous, but its current status is not consistent with IOSCO Principles should be changed as part of IOSCO membership. The CMA receives substantial fee income, thanks to the recent surge in securities markets, and makes a net contribution to the budget. It has 46 staff, including 9 professional staff involved in “compliance and market operations” and 7 in “legal affairs”. The CMA has a certain degree of freedom to set salaries for junior staff, but the salary of the CEO is set by government guidelines. This acts as a ceiling for salaries. Overall compensation is not as generous as that of the Central 8 For example, the President does not retain the power to remove board members in the public interest. December 2007 Page 17 Corporate Governance Assessment Kenya Bank, but compares favorably to other regulatory bodies. The ceiling on compensation does contribute to relatively high turnover for managerial and some professional staff, who often have more lucrative opportunities in the private sector. CMA staff also receives some ongoing training, and the board and senior management have been trained in corporate governance. Reputation of supervisory bodies. The CMA has a mixed reputation among market participants. Among certain market participants it is not seen as being a leader regarding market development. It also is not seen as effectively policing the NSE or its broker-members, who have developed a reputation for market manipulation and insider trading. The CMA is aware of these problems and working to address them. Regulatory efficiency. Given the rapid growth of the market and limited resources, the CMA seems to carry out its ongoing duties in a relatively efficient manner. The primary issues are more strategic, and the potential limitations placed on the CMA by being a state corporation, as noted above. Courts. In recent years, Kenya has experienced wide-ranging judicial and legal reform to reduce corrupt practices and improve the performance. These reforms include the establishment of a commercial court in Nairobi, and plans for a second one in Mombasa. Indicators developed by the World Bank imply that it takes less time and is less costly to enforce a standard contract in Kenya than other countries in Sub-Saharan Africa, but not as fast or inexpensive when compared to countries in the OECD. It also takes more procedures to enforce a contract in Kenya than in many other countries, indicating that the courts are relatively efficient, but more expensive to use than in more developed economies (See Doing Business 2007 at www.doingbusiness.org). Contract Enforcement Indicator Kenya Sub-Saharan Africa OECD Average Average Number of Procedures 44 39.4 31.3 Time (days) 465 643 443 Cost (% of debt) 26.7 48.7 17.7 SECTION II: THE RIGHTS OF SHAREHOLDERS AND KEY OWNERSHIP FUNCTIONS The corporate governance framework should protect and facilitate the exercise of shareholders’ rights. Principle IIA: The corporate governance framework should protect shareholders’ rights. Basic shareholder rights include the right to: Principle IIA 1: Secure methods of ownership registration Assessment: Partially Implemented Secure share registration. All companies are required to maintain a share registry; this function can be delegated to a third party (CA §112). The Central Depository System also holds shares of listed companies, as share certificates are immobilized, and the proportion of shares held by the CDS is gradually increasing (Central Depositories Act (CDA) 2000, §27). Evidence of ownership for deposited shares is either a statement from the Central Depository System (CDS), or a share certificate (for undeposited shares). Except when the register of members is closed, the shareholder register must be available without charge for inspection by any member of the company (CA §115). A secure method of transfer and registration of shares is also recommended by the CMA Guidelines (§3.3). If a company does not comply with the requirement of maintaining a register of its members, the company and every officer of the company who is in default are liable to a default fine (CA §112). In addition, the shareholders may apply to court to rectify the register. If the company is held liable, it may be ordered to rectify the register and pay any damage sustained by any party aggrieved (CA §118). The CDS system is new but technically proven, and is considered by market participants to be a major improvement from the old paper-based system. Secure custody system. Shareholders access the CDS through Central Depository Agents (CDA), who do not hold securities in their name but manage the shareholder's records in the central depository. The law does not recognize the existence of “nominee owners” (“No notice of any trust, expressed, implied or constructive, shall be entered on the register, or be receivable by the registrar” (CA §119)) but the legal framework is confusing. First, the CDA itself is a custodian and holds shares under the law. Second, custodians exist and are regulated by the Capital Market Authority and the Retirement Benefits Authority. Authorized custodians – usually banks – are allowed to hold shares on behalf of shareholders and to register under their name. According to the Retirement Benefits Act (1997) pension plan assets must be held by licensed custodians. There are currently nine custodians, with the top four (KCB, NIC, Barclays, and Stanbic) controlling about 99% of the market. Custodians also hold shares for other types of institutional investors (including foreign funds). Brokers also hold nominee accounts. Trust in the custody / CDS system was challenged in early 2007 when some brokerage firms (CDAs) were found to be trading the shares of clients under their control, but without the client's permission. As a result, some shareholders were reportedly ineligible for some dividend payments. December 2007 Page 18 Corporate Governance Assessment Kenya Principle IIA 2: Convey or transfer shares Assessment: Fully Implemented Restrictions on share transfer. Shares of listed companies are freely transferable. Only private companies can restrict the right to transfer their shares. (CA §30 and Capital Market (Securities) Regulations, First Schedule). Clearing and settlement framework. Shares are bought on T. They are then delivered to the buying broker onT+4 and he settles them on T+5 Principle IIA 3: Obtain relevant and material company information on a timely and regular basis Assessment: Broadly Implemented Availability of information (charter, financial statements, minutes, capital structure). Shareholders have the right to obtain all relevant and material information from the company, including the consolidated accounts (CA §146; 148; 150; 157; 158 and CMA Guidelines §3.3). Companies are required to maintain a registry of all minutes of all company meetings, including board meetings. The minutes must be kept at the registered office of the company and be open to inspection by any member of the company without charge (CA §146). Documents such as special resolutions and certain resolutions must be filed in with the Registrar within 30 days (CA §143). Shareholder access to information. When the register of members is open, it is available to inspection by shareholders with no cost. However, copies of the register or of any part are subject to payment of a nominal fee (CA §115). The CMA Guidelines also encourage the company to disclose material information in the annual report. Principle IIA 4: Participate and vote in general shareholder meetings Assessment: Broadly Implemented Voting rights. Ordinary shareholders have the right to attend, participate and vote at meetings (CA §134; First schedule, Table A; CMA §3.3). Preferred and non-voting shareholders are also allowed to attend shareholder meeting although many companies may not vet in practice the class of shareholders attending the GMS. Shareholders can be impeded from participating and voting in a general shareholder meeting only by a court order or by the Chairman in the case of unruly shareholders. Redress. If shareholders are denied their right to vote in a general meeting, they can go to court for a legal redress and invalidate the proceedings. There are no known cases. Principle IIA 5: Elect and remove board members of the board Assessment: Broadly Implemented Election. Directors are elected by shareholders at a GMS (CA, First Schedule, Table A, §52; CMA §3.3). This election should be based on recommendation from a nominating committee (CMA §2.1.1; 3.1.3). Any shareholders can also nominate directors. There are no provisions for cumulative voting in the law and the Articles of Association would normally stipulate a procedure of nomination. In practice, giving significant shareholders board seats is quite common. However, each memorandum may vary so that the controlling shareholders are not always elected as directors. A company can remove a director by ordinary resolution (CA §184, 142). At least a 28-day notice has to be given to the company of an intention to remove a director. According to the model company articles in the CA, a director is entitled to claim compensation for damage for breach of his contract with the company (CA, First Schedule, Table A, §96). Redress. Shareholders can take legal action if they are not allowed to elect or remove board members. They can seek an injunction of the meetings until their rights are honored or seek to have the proceedings annulled. Principle IIA 6: Share in profits of the corporation Assessment: Broadly Implemented Clear legal framework. The CMA Corporate Governance Guidelines (§3.3) require that every shareholder shall be entitled to distributed profit in form of dividend and other rights for bonus shares, script dividend or rights issue, as applicable and in the proportion of its shareholding in the company. The model company articles require that the dividends be declared in general meetings but they shall not exceed the amount recommended by the board to the shareholders meeting. Dividends are paid only out of net profits (CA First Schedule, Table A, §114, 116) and there is no mandatory minimum dividend. Listed companies are required to pay dividends within 90 days from the date of declaration. In case of non-declaration of dividends or payment of interests, a notification should be published in the interim or quarterly report, the annual financial statement or by way of press announcement (Capital Market Act (Securities), Fifth Schedule, §CO.B.02, B.03). December 2007 Page 19 Corporate Governance Assessment Kenya Equitable treatment. All shareholders of a same class are treated equally regarding the distribution of profit (CA §76). Redress. Shareholders can either register a complaint with the Capital Markets Shareholder Complaints Committee or seek an order from the High Court. Principle IIB. Shareholders should have the right to participate in, and to be sufficiently informed on, decisions concerning fundamental corporate changes such as: Principle IIB 1: Amendments to statutes, or articles of incorporation or similar governing company documents Assessment: Fully Implemented Changes to basic governing documents. Shareholders have the exclusive power to amend the company memorandum by a special resolution with a majority of ¾ of the shareholders present at a general meeting. They should be provided with the information not less than 21 days before the meeting. No rules can frustrate the exercise of these rights. A copy of the resolution has to be delivered to the registrar within 14 days from the date it was passed (CA, §8; 13; 141 and First Schedule, Table A, §50). Shareholder Challenges. Shareholders can challenge actions concerning fundamental corporate changes by calling for annulment if procedural requirements have been violated or where directors are in breach of their fiduciary duties Principle IIB 2: Authorization of additional shares Assessment: Broadly Implemented Issuing share capital. For listed companies, shareholders have the power to authorize new capital. An approval from the CMA is also needed (LR Fifth Schedule §G.01). Depending on the articles, shareholder can increase the share capital by an ordinary or a special resolution passed with a majority of ¾ of the shareholders present (CA §63, 13, 141). Model company articles in the CA require an ordinary resolution and a 21-day notice before the general meeting (First Schedule, Table A, Regulations 44, 50). Some companies provide shareholders with information more than 21 days before the meeting, others do not since it is not mandatory provision in that case. A notice of the increase has to be delivered to the registrar within 30 days from the date it was passed, and the registrar shall record the increase (CA §65). Where listed companies have authorized new capital or are committed to increase the capital, they should, before listing the new shares on the stock exchange, disclose 1) the amount of the authorized capital or capital increase and the duration of the authorization; 2) the categories of persons having preferential subscription rights for such additional portions of capital; 3) the terms and arrangements for the share issue corresponding to 38 such portions (Capital Markets Act (Securities) Third Schedule, Part A, §ID.C.10). Shareholder Challenges. Shareholders can either register a complaint with the Capital Markets Shareholder Complaints Committee or go to court to seek a legal redress (Remedy in case of oppression CA §211). Principle IIB 3: Extraordinary transactions, including sales of major corporate assets Assessment: Fully Implemented Sales of major corporate assets. Major corporate transactions (acquisition of another company, sale of a subsidiary or majority shareholding in a subsidiary, and sale of assets of more than 25% of the total assets of the company) require shareholder approval (Capital Markets Act (Securities), Capital Markets Act (Takeovers and Mergers).They should be provided with the information not less than 21 days before the meeting. Also the CMA Guidelines (§2.3.1) encourage shareholders participation in major decisions and require that the board provide shareholders with useful information. In practice, boards of listed companies comply with this requirement and would not try to carry out those transactions without the approval of shareholders. Redress. Shareholders can either register a complaint with the Capital Markets Shareholder Complaints Committee or go to court to seek a legal redress. Principle IIC: Shareholders should have the opportunity to participate effectively and vote in general shareholder meetings and should be informed of the rules, including voting procedures, that govern general shareholder meetings: Principle IIC 1: Sufficient and timely information on date, location, agenda and issues to be decided at the general meeting Assessment: Broadly Implemented Meeting deadline. The board determines the date, time and venue of the GMS. The first GMS must be held within 18 December 2007 Page 20 Corporate Governance Assessment Kenya months of the incorporation. The following ones must be held at least once every 15 months. If the meeting is not held, “the registrar may, on application of any member of the company, call or direct the calling of a general meeting of the company” (CA §131). Unless it is otherwise provided in the articles of the company, two or more shareholders having at least 10% of the issued share capital can call a meeting. Quorum requirements are limited to two shareholders in the case of a private company and to three shareholders in the case of any other company (CA §134). Meeting notice content. Shareholders are notified 21 days in advance for both GMS and EGM.(CA §133; CA, First Schedule, Table A §7, LR Fifth Schedule §E.01). Model articles note that an adjourned meeting should be held “the same day in the next week, at the same time and place” or “other time and place as directors may determine” (CA, First Schedule, Table A §54). The 2008 Financial Bill seeks to amend the existing CA to allow for electronic notice. The Companies Act does not require any specific content regarding the information provided to the shareholders before the meeting. However, the CMA Corporate Governance Guidelines (§2.3.2) and the Principles for Corporate Governance in Kenya recommend that the board should provide sufficient and timely information on the date, location, agenda and issues to be decided at the meeting. For example, the text of special resolution and the accounting report should circulate with the notice. The memorandum, articles and additional financial information can also be obtained by shareholders. Even if the information procedures have not been respected, the meeting can be still considered valid if it is agreed 1) in the case of general meeting, by all members entitled to attend and vote, or 2) in the case of other meetings, by a majority in number of shareholders entitled to attend and vote, being a majority together holding at least 95% of the shares giving those rights or, if the company does not have a share capital, representing at least 95% of the total voting rights at that meeting of all the members (CA §133). In practice, listed companies comply with those rules. Redress. If default is made in holding a meeting, the company and every officer of the company is liable to a fine (CA §131). In case of violation of the procedure, shareholders can either register a complaint with the Capital Markets Shareholder Complaints Committee or go to court to seek a legal redress. Principle IIC 2: Opportunity to ask the board questions at the general meeting Assessment: Fully implemented Shareholder questions. There appears to be no limits for shareholders to ask questions at meetings. The CMA (§3.3) and CCG guidelines encourage shareholders to participate effectively in general meetings and to ask questions. They also require that shareholders hold directors accountable and responsible for the proper governance of their companies. In practice, there have been a few confrontations between directors and members but the quality of the dialogue seems to be improving. Boards have been influenced to review some of their decisions or recommendations after shareholders comments or suggestions. Forcing items onto the agenda. Shareholders who are entitled to attend and vote at meetings can submit resolutions of not more that 1,000 words before the first agenda is published and not after. Either one or more shareholders representing at least one-twentieth of the total voting rights (individually or as a group) or “not less then 100 shareholders of the company in which there has been paid up an average sum, per member, of not less than 2,000 shilling” may submit resolutions. The company must receive the request at least 28 days before the meeting (CA §140; 142). The CMA Guidelines also require the possibility for the shareholders to place items on the agenda at annual general meetings (§3.4). Redress. If their rights are violated, shareholders have the right of appeal or redress by appeal to the Registrar of Companies, the Capital Markets Authority and the courts. Principle IIC 3: Effective shareholder participation in key governance decisions including board and key executive remuneration policy Assessment: Partially implemented Facilitation of shareholder participation. The principles for Corporate Governance and the CMA Guidelines (§3.3; 3.4) encourage shareholders participation in key governance decisions. The draft Bill also proposes creation of shareholder committees which shall be responsible for nominating board members who can be then elected at the GMS. To facilitate shareholder participation, listed companies tend to hold their GMS in Nairobi or provincial headquarters where they have most of there shareholders. Approval of board and key executive remuneration. Model articles give shareholders the right to determine board remuneration in the GMS (CA, First Schedule, Table A §76). In practice, they only approve notes in accounts stating directors’ remuneration the previous year. Principle IIC 4: Availability to vote both in person or in absentia Assessment: Partially implemented December 2007 Page 21 Corporate Governance Assessment Kenya Proxy regulations. The vote in absentia is recommended by the CMA Guidelines (§3.4). Shareholders entitled to attend and vote at meetings can nominate another person as his proxy to attend and vote (CA §136). Proxies should be natural persons only. There is no requirement for proxy forms to be notarized. For listed companies, the form should be sent with the notice and comply with all requirements set out in the articles of association (LR Fifth Schedule §E.03). Redress. In some cases, the High Court has ordered directors to enforce shareholders rights. Postal and electronic voting. Neither postal nor electronic voting is permitted in Kenya. Principle IID: Capital structures and arrangements that enable certain shareholders to obtain a degree of control disproportionate to their equity ownership should be disclosed. Assessment: Partially Implemented Classes of shares. Most of the shares offered on the NSE are ordinary ones. Kenyan listed corporations essentially issue ordinary shares and preference shares with no voting rights. Depending on the provisions in the Articles of Association preference shares maybe redeemable (CA §60). There do not appear to be any restriction on golden shares or voting caps but they are not used in practice. Any proposed change in the company’s capital should be publicly announced and notified to the NSE and the CMA (LR Fifth Schedule §.01) Disclosure of disproportionate control. The Principles for Corporate Governance (p.19) encourage companies to disclose capital structures and arrangements that allow certain shareholders to obtain a degree of control disproportionate to their equity ownership. In practice, listed companies tend to comply with this requirement. Disclosure of company group. The LR requires disclosure of “the name of the parent company and parent company of the group”. IFRS requires consolidation and a discussion of the basis for consolidation that would include mention of relevant subsidiaries, though not all companies comply fully with this requirement. It appears that the draft Bill also requires disclosure of company group. Listed companies are also required to obtain approval from shareholders and disclose any acquisition of shares of another company or any transaction resulting in such other company becoming a subsidiary or related company of the issuer. The company is also to disclose any sale of shares in another company resulting in that company ceasing to be a subsidiary of the issuer (LR Fifth Schedule § G.06). Disclosure of shareholder agreements. Shareholders agreements can include shareholders equity, minority protection rights, board appointments, chairman appointment, employment of shareholders, decisions reserved for the board or for shareholders, restraint of trade, preemption rights, deadlock, and dispute resolutions. Except when they offer shares to the public, shareholders agreements are not required to be disclosed. Principle IIE: Markets for corporate control should be allowed to function in an efficient and transparent manner. Principle IIE 1: Transparent and fair rules and procedures governing acquisition of corporate control Assessment: Broadly Implemented Basic description of market for corporate control. Takeovers in Kenya are regulated by the Capital Markets (Takeovers and Mergers) Regulations 2002. There have been some friendly mergers off the Stock Exchange. A recent hostile takeover is still pending in Court. The changes in corporate control are also regulated by the Monopolies Act and the Restrictive Trade Practices Act. The Commissioners of monopolies is responsible for the oversight of the transactions. Also, the Stock Exchanges Listing Rules and the CMA Guidelines require disclosure of the transaction. Although regulations are provided to protect shareholders during change of control, in practice enforcement of those rules is difficult and minority shareholders may be treated unfairly. Shareholders do not always understand their rights and remedies partially because of a lack of shareholders associations (although those associations are recommended by the CMA Guidelines (§3.3)). Disclosure of substantial acquisition of shares. The legal ownership has to be disclosed to the Capital Market Authority and to the Commissioner of monopolies: the Capital Market Authority (Securities) (Third Schedule, Part A, §ID.F.01), requires that information regarding “shareholders that are the beneficial owners of at least 3% or more of each class of the issuer’s voting securities” should be disclosed. The company shall also disclose quarterly this ownership to the NSE (LR, Fifth Schedule §D.01). The CMA Corporate Governance Guidelines (§2.1.3) also require the disclosure of the top 10 major shareholders. Tender rules/mandatory bid rules. The Capital Markets (Takeovers and Mergers) Regulations requires a public tender offer to all shareholders be made by anyone acquiring 25 percent or more of a company’s shares with the intent of taking control of that company. The board of the target company must hire an independent advisor on the offer, and share their advice with shareholders. The Companies act (§210) and the Takeovers and Mergers Regulations (§12) also provides for compulsory acquisition of shares: when a bidder has acquired 90% or more of the shares, he may offer the remaining shareholders either the offered price or the market price (whichever is higher). December 2007 Page 22 Corporate Governance Assessment Kenya The Companies Act (§210) also provides the rights for the shareholders to require the bidder to acquire the remaining shares when the latter holds at least 90% of the shares. Delisting/going private procedures. The Capital Markets (Securities) Regulations provide procedures governing the delisting. The Authority may require a securities exchange to de-list a security certain circumstances (Capital Markets (Securities) Regulations, Part III). Principle IIE 2: Anti-take-over devices Assessment: Broadly Implemented Description of anti-takeover devices in use in the market. Capital Markets (Takeovers and Mergers) Regulations (§ 9; 10 & 27) restrict the target company’s ability to prevent the take-over: The target should not 1) issue any authorized but un- issued shares; 2) issue or grant options in respect of any un-issued shares; 3) create, issue or permit the creation or subscription of any shares; 4) sell, dispose of or acquire or agree to sell assets of the target or of any of its subsidiaries; 5) enter into or allow contracts other than in the ordinary course of business of the target. Duty of loyalty in the event of a takeover. Board members should act in the best interest of the company and the shareholders. Within 14 days after the receipt of the take-over offer document, the board should issue a circular to the shareholders stating whether or not it recommends the acceptance of the offer. It should provide all information necessary and appoint an independent advisor. Principle IIF: The exercise of ownership rights by all shareholders, including institutional investors, should be facilitated. Principle IIF 1: Disclosure of corporate governance and voting policies by institutional investors Assessment: Not implemented Blocked shares/record date. There do not appear to be any disincentive to the exercise of voting rights. Indeed, there is neither restriction on share transfer before a shareholder meeting nor a date of record that establishes the list of shareholders eligible to attend the annual meeting. General obligations to vote. There is no obligation or recommendation that institutional investors vote or weight the costs and benefits of voting. Institutional shareholders generally tend to take side with management at the annual meetings or vote alongside the management. Disclosure of voting policy. Institutional investors are not required to disclose either their voting policies or their activities. Principle IIF 2: Disclosure of management of material conflicts of interest by institutional investors Assessment: Partially implemented Institutional investor policies on conflicts of interests. Reporting obligations for institutional investors are limited to financial disclosure. They are not required to disclose their policies on conflicts of interest. However, they should disclose to their clients any material conflict of interest which could “impair the rendering of unbiased and objective advice” ((Capital Markets (Licensing Requirement) Regulations §32, §33 (1) (h) and (6)). There is no report on the compliance with this disclosure. Principle IIG: Shareholders, including institutional shareholders, should be allowed to consult with each other on issues concerning their basic shareholder rights as defined in the Principles, subject to exceptions to prevent abuse. Assessment: Broadly Implemented Rules on shareholder consultation and acting in concert. There appear to be no rules that obstruct the ability of shareholders to consult with each other on the execution of their basic shareholder rights. Shareholders associations exist and are encouraged (CMA Guidelines §3.3) but they are not active in practice. Capital Markets (Takeovers and Mergers) Regulations defines acting in concert and requires that shareholders acting as such must abide by the rules for tender-offers and disclosure in that act. December 2007 Page 23 Corporate Governance Assessment Kenya SECTION III: THE EQUITABLE TREATMENT OF SHAREHOLDERS The corporate governance framework should ensure the equitable treatment of all shareholders, including minority and foreign shareholders. All shareholders should have the opportunity to obtain effective redress for violation of their rights. Principle IIIA: All shareholders of the same series of a class should be treated equally. Principle IIIA 1: Equality, fairness and disclosure of rights within and between share classes Assessment: Broadly Implemented Equality within share classes. The Companies Act states that all shares of a same class shall “rank pari passu for all purposes…” (§76). Availability of share class information. Investors are able to obtain information about the voting rights attached to all classes of shares before they purchase them. The information is disclosed in the members register maintained by the company and available for inspection by investors at nominal cost (CA §115). Approval by the negatively impacted classes of changes in the voting rights. The memorandum or articles of the company can authorize the variations of the rights attached to any class of shares with the consent of any proportion of the holders of the issued shares of that class or by a resolution passed at a separate meeting of the holders of those shares (CA §74). The model company articles in the CA require a written consent obtained from three-fourths of the members of that class or a special resolution passed at a separate general meeting of the holders of the shares of the class. To every such separate general meeting the provisions relating to general meetings (in the model articles) shall apply, but so that the necessary quorum shall be two persons at least holding or representing by proxy one-third of the issued shares of the class and that any holder of shares of the class present in person or by proxy may demand a poll” (CA, First Schedule, Table A, §4). Redress. Not less than 15% of the holders of the shares may apply to the court to have the variation cancelled (CA §74). In the case of a listed company, shareholders can register a complaint with the complaint committee of the Capital Market Authority. Principle IIIA 2: Minority protection from controlling shareholder abuse; minority redress Assessment: Partially implemented EX ANTE PROTECTIONS Pre-emptive rights. Where listed companies propose to issue shares for cash, they may first offer those shares to the existing shareholders in proportion to their existing holding. The company cannot issue shares conferring a controlling interest without prior approval of shareholder by a special resolution (Capital Markets Act (Securities) Fourth Schedule). Ability to call meeting. Shareholders who hold at least one-tenth of the paid-up capital can call an extraordinary shareholders meeting (CA, §132). Qualified majority. By special resolutions with a majority of at least ¾ of the shareholders present or voting by proxy at a general meeting (CA §141), the shareholders have the power to 1) alter the provisions of the company’s memorandum and articles (CA §8, 13), 2) authorize new capital (in some cases – see principle IIB2), 3) approve issue of shares conferring a controlling interest (Capital Markets Act (Securities) Fourth Schedule). In order to change rights of a particular class of shares, model company articles in the CA require the consent in writing of the holders of three-fourths of the issued shares of that class, or a special resolution passed at a separate general meeting of the holders of the shares of the class (CA, First Schedule, Table A, 4). Cumulative Voting / Proportional Representation. There is no provision in the Companies Act for special voting rules to encourage effective shareholder participation (i.e. cumulative voting or proportional representation). EX POST PROTECTION The court system tends to be slow. In average, private shareholder litigation would take two to three years to be fully heard and determined. The use of technicalities to delay hearings and conclusions are quite common. Ability to sue to overturn meeting decisions. If a variation of the rights attached to any class of shares has been authorized, not less “than fifteen percent of the issued shares of that class, being persons who did not consent to or vote in favor of the resolution for the variation, may apply to the court to have the variation cancelled, and, where any such application is made, the variation shall not have effect unless and until it is confirmed by the court” (CA §74). Ability to sue directors. Shareholders may apply to the court through representative suits (see principle VIA). In contrast, according to the English precedent on corporate law Foss vs Harbottle (1843), derivative law suites are not allowed, except under limited circumstances. The first rule derived from this case is “the proper plaintiff rule”: when a company is wronged by its directors, only the company can sue the directors. Minority shareholders cannot initiate the suit. The second rule is “the December 2007 Page 24 Corporate Governance Assessment Kenya majority rule principle”; if the alleged wrong can be confirmed or ratified by a simple majority of members in a general meeting, then the court will not intervene. Redress from regulators. Shareholders could register a complaint with the Capital Markets Shareholder Complaints Committee. In addition, the registrar may, by written order, ask the company to produce all or any of its books or furnish in writing information or explanation regarding the accounts disclosed. If after examination, the registrar is not satisfied, he may report the circumstances of the case in writing to the court which may appoint inspectors (CA §164, 165). Inspection Rights. The court may appoint inspector if the company, by special resolution, declares that its affairs has to be investigated by an inspector appointed by the court (CA §166). Principle IIIA 3: Custodian voting by instruction from beneficial owners Assessment: Broadly implemented Rights of beneficial owners. Financial institutions do hold shares on behalf of beneficial owners. In practice, custodians provide shareholders with information concerning their options in the use of their voting rights, although there is no legal requirement to do so (Capital Markets (Licensing Requirements) Regulations §35). In addition, most of the instructions given by beneficial owners are respected although no legal provisions make the instructions binding. The proxy material should be sent with every meeting notice. Blanks votes and abstentions are ignored. Principle IIIA 4: Obstacles to cross border voting should be eliminated Assessment: Broadly implemented Meeting notice requirements. The meeting notice must be issued 21 days before a meeting, as for domestic investors. Procedures to facilitate voting by foreign investors. Shareholders can vote in person or appoint a proxy. No specific obstacles other than potential problems identified above were noted for foreign investors. Principle IIIA 5: Equitable treatment of all shareholders at GMs Assessment: Broadly implemented Procedures to facilitate voting (electronic and postal voting systems). In the shareholders meetings, votes can be given personally or by proxy (CA §136). Neither postal nor electronic voting is permitted in Kenya. Equitable treatment of shareholders at meetings. On a poll, a shareholder may be entitled to more than one vote (CA §138). In contrast, in the model articles, voting is by show-of-hands and every member present in person has one vote. On a poll, every member has a vote for each share he holds (CA, First Schedule, Part A §62). If shareholders believe their rights are violated, they can apply to the court. Disclosure of voting results. The minutes of shareholder meetings must be kept at the company registered office and open to inspection by any member of the company (CA §146). Listed companies shall also send the minutes to the CMA and the securities exchange (LR Fifth Schedule §E.05(b)). Shareholders can apply to the court to compel the board to announce the result. Principle IIIB: Insider trading and abusive self-dealing should be prohibited. Assessment: Partially implemented Basic insider trading rules. Insider trading is prohibited by the Capital Market Act “: A person who is, or at any time in the preceding six months has been, connected with a body corporate shall not deal in any securities of that body corporate if by reason of his being, or having been, connected with that body corporate he is in possession of information that is not generally available but, if it were, would be likely materially affect the price of those securities…”. Penalties can include a fine of 5 million Ksh (about USD 75.000) in case of a corporate body, or a fine of 2.5 millions Ksh (about USD 37.500) and/or 5 years of imprisonment in case of an individual person (§33). The Capital Market Authority is responsible for the enforcement of this regulation (Capital Market Act §11). However, in practice, this legislation is not effective. There do not appear to be any prosecution and the only investigation known in Uchumi Supermarket has not been made public. Insider trading disclosure. Every director is required to disclose his shareholding when it exceeds 1% of the issued share capital of a class carrying rights to vote in all circumstances at general meetings of the company (Capital Markets (Licensing Requirements) Regulations §75). Most listed companies have guidelines for insider trading. Directors and executives are not entitled to deal in company shares when sensitive price information has not been released to the public. Such periods are just before the financial year disclosures, announcements on acquisitions, mergers or negative information on performance known to directors and management. Directors are not required to disclose transactions in their company’s shares. However, a register of directors December 2007 Page 25 Corporate Governance Assessment Kenya shareholding must be kept by the company and available for public inspection (CA §196). Disclosure of other types of self dealing. Directors must declare at a meeting of directors their direct or indirect interest in a contract or proposed contract with the company (CA, §200). Redress. In case of abusive self-dealing and insider trading, shareholders and stakeholders can report to the Capital Market Authority for investigation or to the Registrar of Companies. Principle IIIC: Members of the board and key executives should be required to disclose to the board whether they, directly, indirectly or on behalf of third parties, have a material interest in any transaction or matter directly affecting the corporation. Assessment: Broadly implemented Conflict of interest rules and use of business opportunities. The Companies Act (§200) requires that directors disclose to the board their direct or indirect interest in a contract or proposed contract with the company or its related companies. This requirement also appears in the draft bill. In practice, companies generally comply with this requirement. Companies are not allowed to make loans to directors or to directors of group companies (unless the company is in the business of making loans). In private companies, loans to directors are permitted. Loans are to be disclosed and approved at a general meeting. For listed companies, they should also be disclosed in the annual report. Loans cannot be provided to directors to buy company’s shares (only to staff under certain arrangements) (CA §191; 56). Board responsibility for managing conflicts of interest. The board should monitor and manage potential conflict of interests. It should establish an audit committee of at least 3 independent and non-executive directors which shall consider any related party transaction (LR Fifth Schedule §F.01, CMA Guidelines §3.5.1 and 3.5.3 (ix)). SECTION IV: THE ROLE OF STAKEHOLDERS IN CORPORATE GOVERNANCE The corporate governance framework should recognize the rights of stakeholders established by law or through mutual agreements and encourage active co-operation between corporations and stakeholders in creating wealth, jobs, and the sustainability of financially sound enterprises. Principle IVA: The rights of stakeholders that are established by law or through mutual agreements are to be respected. Assessment: Broadly Implemented Stakeholder participation in corporate governance. Employees, creditors, and other stakeholders (who are not also shareholders) do not have any special right to serve as or select directors or play some other explicit corporate governance role. Labor law gives employees the right to join unions and sets out the procedures for settling and solving disputes. About 40 percent of the formal work force belongs to a trade union. Some companies also have work councils for communication between workers and management. Creditors only have a formal governance role if the company enters insolvency. Corporate social responsibility and codes for stakeholders. Most listed companies have Corporate Social Responsibility (CSR) programs which are described in their annual reports. These normally include company AIDs policies, other employee programs, as well as education, environmental, and other forms of community outreach. The CMA Guidelines call for “(Company boards to) Take into consideration the interests of the Company’s stakeholders in its decision making process.” The Federation of Kenyan Employers has issued “Social Responsibility Guidelines: Promoting Wealth Creation, Labour Rights, and Responsible Business Practices”. The Guidelines cover the workplace and treatment of employees, corruption and legal compliance, environmental protection, and relations with customers and suppliers. They reference International Labour Organisation (ILO) standards, the UN Global Compact, and include a list of relevant national laws. Other business organisations have also developed CSR codes for their members. Companies in which the state has 50 percent plus one shares are required to have performance contracts that include non commercial objectives such as customer satisfaction and community development. This includes Kengen, Portland Cement, and other listed SOEs. The success of the SOE in achieving their various objectives is monitored by the Office of the President and disclosed to the public. Principle IVB: Where stakeholder interests are protected by law, stakeholders should have the opportunity to obtain effective redress for violation of their rights. Assessment: Partially Implemented Stakeholders may seek redress in the courts, which have seen broad reform in recent years (see ID). Labor disputes may be first referred to the Ministry of Labour, and, if they cannot be resolved voluntarily, to the specialized Industrial Court. Principle IVC: Performance-enhancing mechanisms for employee participation should be permitted to develop. December 2007 Page 26 Corporate Governance Assessment Kenya Assessment: Broadly Implemented There are no significant legal barriers to companies using performance based pay. Employee Stock Ownership Plans (ESOPs) in listed companies are becoming more common, and companies use other forms of performance based pay, including limited use of stock options. There are 1300 occupational pension schemes in Kenya, almost all listed companies have one for their employees. These include defined benefit and defined contribution plans which may invest in domestic equities and other investments subject to relatively high (and mostly non-binding) ceilings. They cannot have more than 10 percent of their assets in the sponsoring company’s shares. The schemes are overseen by a board of trustees that includes representatives of the sponsor company and employees. The fund is managed by financial company chosen by the trustees (Old Mutual is the biggest fund manager). Pensions are overseen by the Retirement Benefits Authority (RBA), which also provides training for trustees, scheme members, and the general public. Principle IVD: Where stakeholders participate in the corporate governance process, they should have access to relevant, sufficient and reliable information on a timely and regular basis. Assessment: Not applicable This principle is rated as “Not Applicable” because (per the OECD Methodology) stakeholders in Kenya do not directly participate in the corporate governance process. The general public, including stakeholders, have access to company information through annual reports, company websites, and fillings with the Registrar. Annual reports generally include discussion of CSR, and sometimes employee and other stakeholder related issues. Principle IVE: Stakeholders, including individual employees and their representative bodies, should be able to freely communicate their concerns about illegal or unethical practices to the board and their rights should not be compromised for doing this. Assessment: Not Implemented Whistleblower rules. The Kenyan Anticorruption Commission has an “Anonymous Whistleblower’s System”, but it is only for misdeeds involving the government and public sector. A Witness Protection Act has also been introduced. However, there is no general protection for employees that report questionable behavior, and in practice whistle blowing is considered risky and does not happen frequently. Principle IVF: The corporate governance framework should be complemented by an effective, efficient insolvency framework and by effective enforcement of creditor rights. Assessment: Partially Implemented Effectiveness of bankruptcy, security/collateral, and debt collection/enforcement codes. Standard measures developed by the World Bank indicate that legal rights for creditors are relatively strong. However, access to information through credit registries and bureaus is weak. (See Doing Business 2008 at www.doingbusiness.org.) Creditor Rights Indicator Kenya Regional OECD Average Average Legal Rights Index (out of a possible 10) 8 4.0 6.4 Credit Information Index 4 1.3 4.8 Public credit registry coverage (percentage adults) 0.0 2.1 8.6 Private bureau coverage (percentage adults) 1.5 4.5 59.3 SECTION V: DISCLOSURE AND TRANSPARENCY The corporate governance framework should ensure that timely and accurate disclosure is made on all material matters regarding the corporation, including the financial situation, performance, ownership, and governance of the company. Principle VA: Disclosure should include, but not be limited to, material information on: Principle VA 1: Financial and operating results of the company Assessment: Fully Implemented Overview of Financial Reporting. The CA require all companies in Kenya—listed and unlisted—to prepare and present audited financial statements on an annual basis. Listing Regulations (LR Fifth Schedule §B.07) issued by the CMA also require listed companies to issue quarterly and semiannual financial statements. These statements must be prepared using December 2007 Page 27 Corporate Governance Assessment Kenya IFRS, subject to the requirements of the CA and LR. The annual statements should include a balance sheet, income statement, changes in equity, cash-flow statement, and explanatory notes. The annual statements should disclose the number and kinds of shares issued, the distribution of shareholding, the top ten (direct) shareholders, major transactions and (certain) related party transactions. In practice, companies do prepare and distribute the various reports, including relatively detailed annual reports which include financial statements, reports by the board, chairman, and or management, and generally also include reporting on CSR and corporate governance. The interim and annual audited statements should also be submitted to the CMA. The CMA Guidelines encourage the company to disclose additional information on director and management remuneration. Consolidation. The CA, LR (Fifth Schedule), and IFRS require listed companies to produce consolidated financial statements. Companies seem to comply, but do not always follow IFRS in disclosing the accounting policies used for consolidation. Management discussion and analysis. Annual reports normally include a directors’ report and sometimes a chairman’s report and management report. The law and Guidelines provide limited guidance on content—“operations and principal activities”(LR), “change…in the…company's business”(CA). In practice the reports do describe both current operations, strategy, and future plans. Oversight, sanctions and remedies. For listed companies, reporting requirements depend primarily on the guidelines and regulations issued by the CMA, which oversees compliance. Principle VA 2: Company objectives Assessment: Broadly Implemented The memorandum establishing the company must describe its “objects” (CA §4) and the LR requires that prospectus for new share issues describe company objectives or changes to objectives. If it is not disclosed elsewhere, the company should also include in its financial statements a description of the nature of the company’s operations and its principal activities (LR Fifth Schedule §B.28(b)). Principle VA 3: Major share ownership and voting rights Assessment: Partially/Broadly Implemented Law and regulation include a number of disclosure requirements, however, in practice only direct ownership is disclosed. Market participants have expressed concern that control in some companies is not entirely transparent. Periodic disclosure of significant ownership. The annual report should include the top ten (direct) shareholders (LR, Fifth Schedule §D.01) and the company should also provide a complete list of shareholders to the Registrar on an annual basis. “To the extent known to the issuer” direct or indirect control of the company is supposed to be disclosed, this includes “the nature of such control, including the amount and proportion of capital held giving a right to vote”. In addition, listed companies must make quarterly reports to the CMA and NSE disclosing “every person who holds or acquires 3% or more of the issuers ordinary shares” (LR, Fifth Schedule §D.01). Timely disclosure of significant ownership. The Takeover regulations requires that any shareholder that seeks to takeover a listed company to disclose in the press their shareholdings as well as the shareholdings of anyone with which they may be acting in concert. Regulatory agency access to ownership information. The company must provide shareholder information to the CMA or NSE when requested (LR, Fifth Schedule). The Registrar may also call for information on shareholding. Disclosure of company group structures. The LR requires disclosure of “the name of the parent company and parent company of the group”. IFRS requires consolidation and a discussion of the basis for consolidation that would include mention of relevant subsidiaries, though not all companies comply fully with this requirement. Principle VA 4: Remuneration policy for board and key executives, and information about directors Assessment: Partially Implemented Material information about directors (qualification, selection, independence). The annual report is required to note the directors, and if they are the chairman, managing director (CEO), or other company executive. Announcements for the general meeting must also list director nominees by name. Companies generally provide additional information, but are not required to do so. Disclosure of directors’ interests. The company is required to maintain a register of directors interest in the securities of the company and related (parent or subsidiary) companies (CA §196) and disclose this in the annual report (LR, Fifth Schedule). Companies should also disclose directors’ interest and other information on directors in the prospectus for the issue of new securities (LR). The CMA Guidelines encourage companies to disclose aggregate loans to directors. Full disclosure of remuneration and remuneration policy. The legal framework requires disclosure of aggregate (not individual) remuneration to management and directors in financial statements, and this is what is disclosed in practice. The December 2007 Page 28 Corporate Governance Assessment Kenya Guidelines also require disclosure of the remuneration policy for directors, which in practice tends to be quite brief. Principle VA 5: Related party transactions Assessment: Broadly/Partially Implemented Ex-ante disclosure of material related party transactions. There is no general requirement to specifically disclose related party transactions before they take place. The LR requires, as part of the prospectus to issue new securities, disclosure of related party transactions or proposed related party transactions. The regulations defined related party, which include related companies, major shareholder, and directors and other key management personnel. The CMA Guidelines and the LR Fifth Schedule (§F.02) note that “There shall be public disclosure in respect of any management or business agreements entered into between the Company and its related companies, which may result in a conflict of interest.” The Fifth Schedule also requires that those related parties transactions be made available at the company’s registered office, but this disclosure takes place after the contract already exists (§G.02, G.07). Periodic disclosure of related party transactions. IAS 24 requires disclosure of related party transactions and in practice the great majority of companies include such disclosure as in the notes to the financials statements in the annual report. The transactions are listed, but limited detail is provided on the nature of the transactions. Principle VA 6: Foreseeable risk factors Assessment: Partially Implemented Disclosure of material risks. Companies are required to disclose potential risks in the prospectus for an issue of new securities (LR). IFRS requires banks to disclose various sorts of risks and their exposure in financial statements, and listed banks in Kenya do seem to comply. Principle VA 7: Issues regarding employees and other stakeholders Assessment: Partially Implemented Disclosure of stakeholder issues. IFRS requires disclosure of employee benefits, and the LR (Fifth Schedule §B.28(d)) the number of employees, in the annual report. Beyond this, companies may discuss employees or other stakeholders in their CSR statements. Overall disclosure in this area is mixed. Principle VA 8: Governance structures and policies Assessment: Partially Implemented Disclosure of corporate governance report (including structure and operation of board). The legal framework requires disclosure of directors, major shareholders, and a statement of the director’s responsibilities, in the annual report. This is supplemented by a requirement to disclose compliance with the Guidelines, which in practice normally includes board committees and their functions. Comply-or-explain in force. All listed companies are to note their compliance, or non-compliance, with the Guidelines. Regulator enforcement practice. Listed companies that do not disclose compliance with the Guidelines are violating CMA regulations. In practice, companies include corporate governance statements in their annual reports, but have a certain discretion in regards to what they disclose. There is no detailed review of the statements contents. Principle VB: Information should be prepared and disclosed in accordance with high quality standards of accounting and financial and non-financial disclosure. Assessment: Broadly Implemented Quality of Accounting Standards. All companies in Kenya are required to use IFRS. This is a regulatory requirement for listed companies and banks, and is mandated for other companies by a decision of the ICPAK—the de facto standard setter. The CA also prescribes what should be included in financial statements, and these requirements are not entirely consistent with IFRS. There are also some contradictions between the requirements of the Insurance Act and IFRS for insurance companies. Standard-setting body. The Institute of Certified Public Accountants of Kenya (ICPAK) is empowered by the Accountants Act to act as the self regulatory membership body for accountants and auditors. It has long acted, and been accepted, as the accounting standard setter, but does not have explicit legal authority to set accounting standards. A draft revision of the Accountants Act would provide explicit authority. Review/enforcement of compliance. While CMA and KCB regulation require the use of IFRS, neither institution has the resources to review compliance. Nor does the Registrar, to which all companies are required to submit their financial statements. Compliance depends on the accountants compiling the statements, the auditors auditing them and the efforts of ICPAK to December 2007 Page 29 Corporate Governance Assessment Kenya educate both. ICPAK has a Standards Committee that focuses on implementation, and engages in annual training of its members, including training focused on complying with various IFRS standards. ICPAK, the CMA, and the NSE have also established the Financial Reporting Award (FiRe) that reviews the annual reports of participating companies and gives awards in various categories. IFRS compliance is part of the award criteria. In 2006 80 companies submitted annual reports. In 2005, none of the companies that submitted for the competition reached 100 percent compliance. 16 percent achieved 80 percent or higher compliance and 44 percent 60 to 80 percent compliance, but 27 percent where at 50 percent or lower. Principle VC: An annual audit should be conducted by an independent, competent and qualified, auditor in order to provide an external and objective assurance to the board and shareholders that the financial statements fairly represent the financial position and performance of the company in all material respects. Assessment: Broadly Implemented Audit Requirements. The CA and the LR (Fifth Schedule §F.09) require companies to appoint auditors who are members of ICPAK and include an auditors report with the financial statements. The LR also notes that auditors for listed companies should comply with ISA. Auditor qualifications. The Accountants Act established three bodies involved in certifying auditors. The Kenya Accountants and Secretaries National Examination Board (KASNEB) administers examinations, the Registration of Accountants Board (RAB) is responsible for licensing, and ICPAK is a self regulatory membership organization. To receive the certificate from RAB to be a practicing auditor requires passing the KASNEB examination, membership in ICPAK, and at least two years auditing experience. ICPAK requires its members to undergo a certain amount of training each year, and this includes training in ISA. It can also recommend to RAB that an auditor can loose his or her license for improper conduct. Auditor Independence. ICPAK members are required to comply with the IFAC Code of Ethics, and this provides the basis for independence and avoiding conflicts of interest. In practice, auditors do perform other services for their clients, including “tax-management” and assistance in preparing the annual accounts. On a voluntary basis, major accounting firms generally rotate auditors working on a particular company every five years. Only banks are required to rotate auditors, rotating partners every five years. Audit quality assurance / enforcement. ICPAK has launched a quality review program for audits, and found a number of deficiencies in the application of ISA. They have expanded the audit review process and are seeking international assistance to review audits of the “Big Four” firms. ICPAK also receives complaints of improper conduct, and, after investigation, can send a warning, make that warning public, or recommend that RAB decertify the auditor. No listed company has received a qualified audit. Audit standards development. ICPAK has fully adopted ISA and the IFAC Code of Ethics. As with accounting standards, the legal basis for this is not as strong as it could be, but the LR does explicitly require ISA for listed companies. Principle VD: External auditors should be accountable to the shareholders and owe a duty to the company to exercise due professional care in the conduct of the audit. Assessment: Partially Implemented Auditor accountability to shareholders. Auditors are chosen, and can be replaced, by shareholders at the GMS. Shareholders may also call for a special audit of the company. In practice auditors are recommended by the directors and tend to report to management, though increasingly they are reporting to the Audit Committee, as recommended by the Guidelines. Penalties for auditors who fail to perform with due care. Under the CA, auditors can be held liable for false or misleading statements. As Kenya is a common law country, they may also be held liable for violating their fiduciary duties, to the company, and it may also be possible for shareholders to file suit against them. In practice, auditors do have liability insurance, but market participants did not recall a case of auditors being sued successfully. Principle VE: Channels for disseminating information should provide for equal, timely and cost-efficient access to relevant information by users. Assessment: Broadly Material facts. Listed companies are to publicly announce major developments within 24 hours (LR, Fifth Schedule §G.05). This includes (but is not limited to) developments that may lead to substantial movements in the price of securities, change in directors, company secretary or auditors, or anticipation that profits may drop by 25 percent or more from the previous year. In practice companies do make announcements to shareholders via the NSE website. Oversight, sanctions and remedies. The CMA oversees compliance. Easy accessibility of disclosed information. Current shareholders are mailed the annual report or can receive one at the GMS. Many companies also make it available on their website. The NSE site also includes summary information on issuers and issuer announcements. On the other hand, there is no single site, e.g. the NSE site or CMA site, where more complete December 2007 Page 30 Corporate Governance Assessment Kenya information can be accessed by potential investors, and it can be difficult to access corporate information at the Registrar, though it has been making efforts to improve its filling. Prohibitions on selective disclosure of information. The LR (Fifth Schedule) limits selective disclosure to shareholders: “Where it is proposed to announce at any meeting of holders of an issuers’ listed securities, information which might lead to substantial movement in their price, arrangements must be made for publication of that information to the securities exchange and the market so that the announcement at the meeting is made no earlier than the time at which the information is published to the market and forwarded to the Authority.” However, it does allow for confidential disclosure to underwriters and other potential providers of finance. Principle VF: The corporate governance framework should be complemented by an effective approach that addresses and promotes the provision of analysis or advice by analysts, brokers, rating agencies and others, that is relevant to decisions by investors, free from material conflicts of interest that might compromise the integrity of their analysis or advice. Assessment: Partially implemented Disclosure of conflicts of interest by analysts, brokers, rating agencies. CMA regulations require investment advisors, fund managers, and investment banks acting as such to disclose potential conflicts of interest to clients. There are no specific requirements for credit rating agencies to disclose conflicts of interest. Regulation of credit rating agency conflict of interest. The CMA has issued guidelines for the “Approval and Registration of Credit Rating Agencies”. They contain a number of indirect provisions to mitigate or avoid conflicts of interest. The Guidelines require that the agency “demonstrate its independence and objectivity”, have “sufficient internal checks and balances to safeguard objectivity”, and emphasize the importance of a quantitative and consistent methodology. The agency must also have an “institutional investor of repute” as at least one owner, “shareholders,…directors, (and) management…of impeccable character”, and an international recognized rating agency as another owner or should have a contractual relationship with such an agency to provide expertise and reinforce objectivity. Regulation of sell-side analyst conflicts of interest. CMA regulations prohibit stockbrokers and dealers from making recommendations on particular securities. Investment banks do produce “sell-side” reports; and are required to disclose conflicts of interest, as noted above, and to act “fair and equitably” in the case of conflicts of interest. Regulations also require that information provide by investment banks be factual and accurate. SECTION VI: THE RESPONSIBILITIES OF THE BOARD The corporate governance framework should ensure the strategic guidance of the company, the effective monitoring of management by the board, and the board’s accountability to the company and the shareholders. Principle VIA: Board members should act on a fully informed basis, in good faith, with due diligence and care, and in the best interest of the company and the shareholders. Assessment: Broadly implemented Kenya has a one tier board system. The minimum number of directors for a listed company registered after the appointed day is two. It is one for the ones registered before the appointed day. Each director should be between 21 and 70 years old at the day of the appointment and hold a specified share qualification (CA §186; 183). Directors other than managing director shall retire by rotation at least once every three years and at least one third of them shall be appointed as non- executive directors (Fifth Schedule § G.04). The CMA Corporate Governance Guidelines (§2.1.4; 3.1.2; 3.1.3) recommend that at least one third of the board should be independent but the board should reflect a balance between independent, non- executive directors and executive directors of diverse skills and expertise. The composition of the board should also reflect the company’s shareholding structure and offer a mechanism for representation of the minority shareholders. In addition, “the process of the appointment of directors should be sensitive to gender representation, national outlook and should not be perceived to represent single or narrow community interest”. “Duty of care” and “Duty of loyalty”. Fiduciary duties of directors are not present in the law. However, since Kenya is a common law country, those duties are based on precedents. Those precedents and the Principles for Corporate Governance require that directors act in the best interest of the company and shareholders. The draft Bill 2006 also requires that directors promote the company’s interests. Effective enforcement. In the event that shareholders feel that directors are not following their duties, a number of potential legal actions can be taken, including direct or representative suits. In limited companies, the liability of directors may be unlimited. The Company Act does not include any “business judgment rule” that protects board decisions if board members are informed and disinterested. However, the draft Bill 2006 does contain such a protection. Board members can subscribe insurance for their liability but it is not mandatory and there appear to be not public information on those subscriptions. Principle VIB: Where board decisions may affect different shareholder groups differently, the board should treat all shareholders fairly. Assessment: Broadly Implemented December 2007 Page 31 Corporate Governance Assessment Kenya Board “duty of loyalty” / duty to treat all shareholders fairly. The CMA Corporate Governance Guidelines (§3.1.1) state that the board of directors should threat all shareholders fairly and ensure equitable terms of shareholders, including minority and foreign shareholders. If they are not treated fairly, shareholders have the right to take action using the oppression remedy (CA §211). Principle VIC: The board should apply high ethical standards. It should take into account the interests of stakeholders. Assessment: Partially Implemented Development of company codes of ethics. Except for state-owned companies, there do not appear to be any requirements for companies to develop a Code of Ethics. However, most listed companies have one. Board and interests of stakeholders. The Companies Act does not require the board to take stakeholders interests into account. However, the CMA Corporate Governance Guidelines recommend it (§3.1.1). The draft Companies Bill 2006 requires that interests of employees be taken into account. Principle VID: The board should fulfill certain key functions, including: Principle VID 1: Board oversight of general corporate strategy and major decisions Assessment: Broadly Implemented Central and strategic role played by boards. The Company Act does not specifically stipulate the strategic role of the board but the CMA Corporate Governance Guidelines make recommendations (§3.1.1). For example, the board is required to define the company’s mission, its strategy, goals, risk policy plans and objectives including approval of its annual budgets Principle VID 2: Monitoring effectiveness of company governance practices Assessment: Broadly implemented Board oversight of legal compliance. The CMA Corporate Governance Guidelines (§3.1.1) recommend that the board review the compliance by the company with laws, regulations, and rules. The Principles of Corporate governance recommend that the Company secretary ensure the compliance with the CA regarding the GMS, the proxy forms, and the voting process. They also recommend that the Company secretary monitor and ensure compliance with the Stock Exchange requirements. In addition, he could advise directors on compliance with CA and Stock Exchange requirements and monitor and lay in place procedures which allow for compliance with regulatory and legal requirements (Principles of CG for Kenya and Sample Code of Best Practice for CG, Annex 3 §3.2, 3.4, 3.19). Board oversight of code compliance. In addition of reviewing the compliance with laws, regulations and rules, the board should also oversee the compliance with the guidelines and monitor the effectiveness of the corporate governance practices under which the company operates. The LR and the CMA Corporate Governance Guidelines state that the company should disclose, in the annual report, the degree of compliance and non-compliance with those guidelines. The reasons for non- compliance and the efforts being made should also be identified (LR Fifth Schedule §F.08, Guidelines §1.8; 1.10). The Principles of Corporate Governance also recommend that the company secretary supervise the implementation of the model code and/or the company code for dealing in the company’s securities (Principles of CG for Kenya and Sample Code of Best Practice for CG, Annex 3 §3.4, 3.13). Board self-evaluation. The CMA Corporate Governance Guidelines (§3.1.3) also state that the board should “implement a process of assessing the effectiveness of the board as a whole, the committees of the board, as well as of each individual director”. However, most evidence suggests that a few companies have begun a formal process of board self-evaluation. Principle VID 3: Selecting/compensating/monitoring/replacing key executives Assessment: Fully Implemented Board oversight of selecting and replacing key executives. The CMA Corporate Governance Guidelines (§3.1.3) recommends that the board of every public listed company should appoint a nominating committee making suggestions to the board on candidates for directorship. This committee – with a specific mandate – or a remuneration committee also appointed by the board recommends to the board the remuneration and the structure of compensation package for the executive directors. The LR (Fifth Schedule §F.03) and the CMA Corporate Governance Guidelines (§2.1.6; 3.1.3, 2.1.7) require that no director should hold the same position in more than five listed companies at the same time. In addition, the nominating committee should suggest only skilled and experienced people. CVs including experience, current commitment, and professional qualifications are provided. The CFO should be a member of the Institute of Certified Public Accountants of Kenya and the Company secretary a member of the Institute of Certified Public Secretaries (LR, Fifth Schedule F.05, F.07). The guidelines (§2.1.7) also recommend that mandates should not excess 3 years but do not suggest any limit regarding the number of December 2007 Page 32 Corporate Governance Assessment Kenya possible re-election. However, Executive directors’ mandates should not exceed five years and their renewal should be subject to regular performance appraisal and shareholders approval. The Center for Corporate Governance guidelines and the Sample of Best Practice also recommend that board put in place succession plans, appoint the CEO and ensure effective motivation and protection of the human and intellectual capital of the corporation, identify corporate risk and keep performance indicators and monitor this. Principle VID 4: Aligning executive and board pay with long term company and shareholder interests Assessment: Broadly implemented Develop and disclose remuneration policy. The CMA Corporate Governance Guidelines (§2.1.3) recommend that the board should disclose its policies remuneration. They also recommend that the nominating committee – with a specific mandate – or a remuneration committee also appointed by the board suggests to the board the remuneration and the structure of compensation package for the executive directors (§3.1.4). Directors’ remuneration should be “sufficient to attract and retain directors to run the company effectively”. The remuneration of the executive directors should be linked to corporate performance (§ 2.1.2). The remuneration of the non-executive directors is determined by the whole board. It should be aligned with remuneration in competitive sectors (§ 3.14; 2.1.2). It is also suggested by the CAM guidelines that the directors’ remunerations should be approved by the shareholders disclosed in the annual report (CMA § 3.1.4). Oversight by non-executives. The CMA corporate governance guidelines recommend that the nominating committee and the remuneration committee should mainly be composed by independent and non-executive directors. Principle VID 5: Transparent board nomination/election process Assessment: Partially implemented Clear and transparent board nomination process. There are no provisions in the Companies Act for a formal and transparent nomination process. However, the CMA Corporate Governance Guidelines (§2.15) encourage it and all candidates should also disclose any potential conflict of interest. Moreover, it recommends that no director should hold the same position in more than five listed companies at the same time (§2.1.6; 3.1.3). In addition, the nominating committee should suggest only skilled and experienced people. CVs including experience, current commitment, and professional qualifications are provided. Effective shareholder participation in board nomination process. Appointment of board members is made at a shareholders meeting (Companies Act §184), on recommendation by the nominating committee of the board (according to the CMA guidelines). Disclosure of nomination procedures. There appear to be no requirements for the disclosure of board nomination procedures. Principle VID 6: Oversight of insider conflicts of interest, including misuse of company assets and abuse in RPTs Assessment: Partially implemented Board oversight of related party transactions. Directors must declare at a meeting of directors their direct or indirect interest in a contract or proposed contract with the company (Companies Act, §200). The board should monitor and manage potential conflict of interests. It should establish an audit committee of at least 3 independent and non-executive directors which shall consider any related party transaction (CMA Guidelines §3.5.1 and 3.5.3 (ix), LR Fifth Schedule §F.01). Principle VID 7: Oversight of accounting and financial reporting systems, including independent audit and control systems Assessment: Broadly implemented Board oversight of financial reporting. According to the Companies Act (§148, 156), directors are responsible for the year-end preparation of annual accounts and for getting them audited before the GMS. The CMA Corporate Governance Guidelines (§2.4.1) go further and say that board should ensure that accounts are in line with International Accounting Standards. Board oversight of internal controls. The board should maintain a good system of internal control to protect shareholders investments and assets (CMA §2.4.2) by, for example, regularly reviewing “systems, processes, and procedures to ensure the effectiveness” of this system (Principles of Good Corporate Governance). The board should establish an Audit Committee with written terms of reference confirmed by the board. It should at least include three independent and non-executive directors (LR Fifth Schedule §F.01, CMA Guidelines, §3.5.1). The board December 2007 Page 33 Corporate Governance Assessment Kenya should also establish an internal audit function independent of the activities they audit (§3.5.4). This internal audit function report to the audit committee which should be attended by the finance director, the head of internal audit and a representative of the external auditors (§3.5.5). Board oversight of external auditors. The CMA Corporate Governance Guidelines also require that the audit committee manage the relationship with the external auditors (§3.5.3). Internal compliance programs. – The CCG Code and the CMA Corporate Governance Guidelines encourage board to set up internal program and procedure to promote compliance with law, regulation and standards (CMA Guidelines §1). Principle VID 8: Overseeing disclosure and communications processes Assessment: Broadly implemented Board oversight of disclosure process. According to the Listing Rules (Fifth Schedule) and the CMA Corporate Governance Guidelines, the board should disclose a number of aspects of material information about the company including “its policies for remuneration including incentives for the board and senior management”, the total remuneration of the directors, the resignation of directors and the reasons of such resignation, any change in the company secretary or auditors, any agreement between the company and its related companies which may result in a conflict of interest, the compliance or non-compliance with the recommendations of having at least one-third of independent and non-executive directors and a mechanism ensuring the representation of the minority shareholders, whether it has an audit committee and the mandate of such committee, any proposed significant alteration of the memorandum and articles.. Board responsibility for communications strategy. According to the Principles for Corporate Governance and a Sample Code of Best Practice for Corporate Governance, the board should be “proactive in developing an effective communication strategy for the company”. Principle VIE: The board should be able to exercise objective independent judgment on corporate affairs. Principle VIE 1: Boards should consider assigning a sufficient number of non-executive board members capable of exercising independent judgment to tasks where there is a potential for conflict of interest. Examples of such key responsibilities are ensuring the integrity of financial and non-financial reporting, the review of related party transactions, nomination of board members and key executives, and board remuneration. Assessment: Broadly Implemented Director independence requirements. The CMA Corporate Governance Guidelines require that the board should be composed of at least one third independent and non-executive directors. Independent directors are defined as anyone who has not been employed by the company in an executive capacity within the last five years, has not had any business with the company, is not employed by a public listed company at which an executive officer of the company serves as a director, is not a member of the immediate family of executive officers or senior manager, has not had important relationships with any affiliate of the company (§2.1.4; 2.1.4.1). Non-executive director is anyone who is not involved in the administrative or managerial operations of the company (§2.1.4.2). In practice, boards are primarily composed of non executive directors. Separation of Chairman / CEO. The CMA Guidelines (§2.2; 3.2) recommend that the Chairman should be separate from the CEO. The chairman of a public listed company should be an independent and non-executive director and cannot hold the same position in more than 2 public listed companies (LR Fifth Schedule §F.04). If the CEO and Chairman roles are combined, a rationale should be disclosed to the shareholders. In practice, the positions of the chairman and CEO are filed by different persons. Company disclosure of independence. The CMA Guidelines (§3.1.2) recommend that the board should disclose in the annual report whether independent and non-executive directors constitute one third of the board and whether it satisfies the representation of the minority shareholders. Independent oversight of key board tasks including: Financial Reporting. The LR and the CMA Corporate Governance Guidelines (LR Fifth Schedule §F.01, Guidelines §3.5.3) require the establishment of an audit committee, with at least three independent and non-executive directors. The committee has oversight over the financial reporting and the internal controls. The entire board (not the committee) should define the company’s risk policy and objectives including approval of its annual budgets, as well as review the adequacy and integrity of the company’s internal control. Related Party Transactions. The CMA Guidelines (§3.5.3) recommend that the audit committee should consider any related party transactions that may arise within the company or group. Board and executive nomination. The CMA Guidelines (§3.1.3) recommend the establishment of a nominating committee mainly composed of independent and non-executive directors to propose new candidates for the board. The committee is responsible to identify only persons of caliber, credibility, skill and experienced. It also considers candidates proposed by the chief executives and shareholders. December 2007 Page 34 Corporate Governance Assessment Kenya Principle VIE 2: Clear and transparent rules on board committees Assessment: Broadly Implemented Requirements and experience with committees of the board. The LR, the Corporate Governance Guidelines and the CMA Guidelines (LR Fifth Schedule §F.01, Guidelines §3.5.1; 3.1.3; 3.1.4) require that boards establish board committees for audit, nomination and remuneration. The audit committee should have terms of references and reporting procedures. The Central Bank Act also recommends that all financial institutions have a credit risk committee. Disclosure of mandate, composition, and working procedures of important committees. CMA Guidelines (§3.1.3) states that the nominating committee should disclose its required mix of skills and expertise that directors bring to the board. The board should also disclose in the annual report whether it has an audit committee and the mandate of such committee (§3.5.1). Principle VIE 3: Board commitment to responsibilities Assessment: Broadly implemented Restrictions on the number of board seats. Each director cannot hold the same position in more than five listed companies (LR, Fifth Schedule §F.03). Company disclosure of board member activity. There are no requirements to disclose board member activity. Only conflicts of interest are generally disclosed. Requirements for initial and on-going training. The CMA Corporate Governance Guidelines (§3.1.3) require that newly appointed directors should be provided with necessary training in the area of the company’s business in order to enhance their effectiveness in the board. The Principles for Corporate Governance in Kenya and a Sample Code of Best Practice for Corporate Governance note the importance of director training, and recommend that directors “receive formal training on their role, duties, responsibilities, and obligations, as well as Board practices and procedures on first appointment”. The Center of Corporate Governance provides trainings and accreditation for board members. Among its activities, an Institute of Directors was also launched in 2003 to provide recommendations on good practice. In practice, most directors in Kenya have received trainings. Principle VIF: In order to fulfill their responsibilities, board members should have access to accurate, relevant and timely information. Assessment: Broadly implemented Board access to information. The CMA Corporate Governance Guidelines (§2.1.3) recommends that the board should be supplied with “relevant, accurate and timely information”. All companies should employ a Company Secretary which is neither the sole director of the company, nor a corporation the sole director of which is a sole director of the company, nor a corporation the sole director of which is secretary to the company (Companies Act §179). The secretary should be responsible for advising the company on the implementation of the Code of Best Practice for Corporate governance and should have direct access to the Chairman (Principles for Corporate Governance and Sample Code of Best Practice for Corporate Governance). Free access to qualified advisors. All directors should have access to the advice and services of the Company Secretary and be entitled to seek independent professional advice about the affairs of the corporation at its expense. December 2007 Page 35