[2024] KECMT 135 (KLR)

Demey v Capital Markets Authority (Appeal 6 of 2022) [2024] KECMT 135 (KLR) (2 February 2024) (Judgment)

Neutral citation: [2024] KECMT 135 (KLR)

Republic of Kenya

In the Capital Markets Tribunal

Appeal 6 of 2022

Paul Lilan, Chair, P.Wanga & Constance Gikonyo, Members

February 2, 2024

Between

Laurent Demey

Appellant

and

Capital Markets Authority

Respondent

Judgment

Brief Facts 1. The Appellant is the managing partner of a private equity fund, Amethis Finance Luxembourg SICAR SCA regulated in Luxembourg, acting via Amethis Africa Finance Limited which was an investor in Chase Bank Kenya Limited (CBKL) for the period January 2013 to April 2016. The Appellant was nominated by Amethis and served as a non-executive director of CBKL for the period January 2013 to April 2016 as part of Amethis investment in CBKL. During the period January 2013 to April 2016 the Appellant served as a member of the Board Audit and Risk Committee (ARC). He was also a member of the Ad Hoc Committee of the board created to consider the issue of paying a bouns to Mr. Zaffrulah Khan.

2. On 6 February 2015 Chase Bank Kenya Limited (CBKL) lodged an application with the Respondent (The Capital Markets Authority) for approval of the issue of Ksh ten billion Subordinated Multicurrency Medium Term Note Programme (MTN) by way of a public offer of debt securities of CBKL. The application was lodged with the Respondent on behalf of CBKL by Genghis Capital Ltd (lead arranger) and NIC Capital Ltd (as co-arranger).

3. The application was accompanied by an Information Memorandum (IM) prepared by CBKL. The IM was prepared based on the audited financial statements of CBKL for the years 2010 to 2014. As at the time of submitting the IM the auditors, Deloitte & Touche (The Auditors) had issued an unqualified opinion on these financial reports. The financial reports were prepared in accordance with the required International Financial Reporting Standards (IFRS).

4. Upon submission of the IM to the respondent, they sought certain clarifications, CBKL submitted the final IM to the respondent on 26 March 2015. By a letter dated 22 April 2015, the Respondent approved the MTN. It stated that it was satisfied that the IM made adequate disclosure of material information in accordance with the requirements of the Capital Markets Authority Act to enable investors make an informed decision on the programme. Specifically, Part C of the Third Schedule to the Capital Markets (Securities (Public Offers, Listing and Disclosures) Regulations, 2002.

5. The MTN was listed on the Nairobi Stock Exchange on 22 June 2015. By a letter dated 9 June 2015, CBKL through Genghis Capital Ltd, notified the Respondent of the results of the offer for the first tranche of up to Ksh 3 Billion with a green shoe option of Ksh 2 billion in the MTN.

6. As the process of working towards the listing of the MTN was ongoing, in a Board meeting held on 14 May 2015, the Board of Directors of CBKL passed a resolution approving the payment of a retirement bonus compensation of Ksh 1. 052 billion to the chairman and former group managing director of CBKL, Mr. Zafrullah Khan. The said bonus was to be paid over a five (5) year period in equal annual installments from the year 2015. The payment of the bonus was dependent on the liquidity and profitability of the bank.

7. Payment of the bonus was recommended to the Board by an Ad-Hoc Remuneration Committee of the Board of CBKL that had been formed. Its mandate expired on 14 May 2015 once it gave its recommendation to the Board. The Appellant was a member of this Ad Hoc Committee.

8. Contrary to the resolution passed by the Board, the said bonus was paid in full on diverse dates during the month of June 2015. Specifically, five separate payments were made in total; three were paid before 22 June 2015 and the other two after 22 June 2015. Specifically, the first three tranches were paid on 15 June 2016. The last two tranches were paid on 25 June 2015.

9. Nevertheless, despite the payments having been made, in a Board Meeting held on 3 December 2015, the Board vacated its earlier resolution made on 14 May 2015 approving payment of the bonus. Instead, the Board directed that the bonus payment be converted into a loan account. Hence, CBKL would be seeking reimbursement of the amount given from Mr. Zafrullah Khan.

10. In March 2016 the external auditor while undertaking its audit exercise of the 2015 accounts raised issues with the treatment of the following items:(a)The interest receivable account;(b)A loan of Ksh one billion to the former Chairman which was unsecured.(c)Ksh 6. 9 billion of special purpose vehicle assets.

11. A meeting was held between the auditors and the ARC. Thereafter, several meetings were held with the Central Bank of Kenya (CBK), the auditors and the management of CBKL in a bid to resolve the issues. Subsequently, CBK confirmed that the audited accounts conformed with the CBK Prudential Guidelines on the Publication of Financial Statements and Other Disclosures. On 31 March 2016, CBKL was authorized by CBK to publish the 2015 financial statements.

12. However, on 4 April 2016 the auditors forwarded to the management of CBKL and CBK a second set of financial statements and re-stated the financial statements for the year ended 31 December 2015. While re-stating the 2015 accounts, the auditor also re-stated several line items in the audited financial statements for 2014 and issued a disclaimer of its opinion. Upon learning of the re-statement of the financial statements the Appellant travelled to Kenya on 5 April 2016.

13. Publication of the re-stated accounts caused a bank run and consequently, CBKL was unable to meet its obligations. As a result, on 7 April 2016 CBK appointed Kenya Deposit Insurance Corporation (KDIC) as receiver for CBKL. On 8 April 2016 the Respondent directed the NSE to suspend trading activity in the MTN and commenced investigations into the activities of CBKL.

14. By a letter dated 5 July 2021 the Respondent invited the Appellant to show cause and respond to several issues they had raised. The Appellant responded vide a letter dated 20 July 2021. Subsequently, the Appellant was invited for an oral hearing by the Respondent on 28 February 2022 before an Ad Hoc Committee. The Respondent was served with the decision of the Ad Hoc Committee on 2 August 2022. The current appeal stems from the Appellant being aggrieved by the decision of the Respondent’s Ad Hoc Committee.

The Appeal 15. The basis of the appeal is the Respondent’s Ad Hoc Committee ruling dated 2 August 2022. The Committee ruled as follows: The Appellant was culpable for failing in oversight of management of CBKL (in liquidation) leading to preparation and publication of false and misleading financial statements disclosed in the published IM for the MTN issued in 2015.

The Appellant in his capacity as a non-executive board member and a member of the ARC was culpable for failing to ensure disclosure of material information in a supplementary IM on the bonus payment to Mr. Zafrullah Khan after it was agreed upon.

The Appellant in his capacity as a non-executive board member and a member of the ARC was culpable for failing in oversight of CBKL management leading to preparation and publication of false and misleading financial statements disclosed in the published IM for the MTN issues in 2015.

As a result of the above findings, the Ad Hoc Committee imposed a financial penalty of Ksh 2. 5 million on the Appellant.

16. The Appellant is dissatisfied with the findings of the Ad Hoc Committee hence has lodged this appeal with the Tribunal. Specifically, the Appellant raised ten grounds of appeal in the Memorandum of Appeal dated 16 August 2022. As indicated in the Appellant’s submissions these grounds can be summarized as follows:(a)The Committee erred in finding that the Appellant failed in oversight of management of CBKL leading to the preparation and publication of false and misleading financial statements disclosed in the published IM (Ground(b)The Committee erred in finding that the Appellant failed to disclose material information on bonus payment to Mr. Zafrullah Khan in the IM (grounds 2, 6, 7 & 8).(c)The Committee erred in failing to acknowledge and give effect to the issuance of unqualified financial statements by the auditor, Delloitte & Touche on the preparation and publication of the IM and the MTN and therefore failed to hold the Auditors liable for any misinformation. Hence, the Committee erred in finding the Appellant liable for the consequences of actions sanctioned by a qualified consultant Auditor and on whose professional judgement the Appellant relied upon. (Grounds 3 & 9)(d)The Committee erred in failing to consider the import of the evidence presented before it concerning the nature of treatment of Musharakah investments which led to their classification as ‘other assets’ as opposed to ‘loans’. (Ground 4)(e)The Committee erred in finding that the Appellant did not address the issue of overstatement of interest in his response to the show cause letter. (Ground 5)(f)The Committee erred in predisposing itself to finding blanket condemnation against all directors irrespective of their role and actions and not withstanding that for instance some directors were beneficiaries to the bonus payment and therefore had a different access to information. Hence, the Committee failed to ascertain the individual liability of the Appellant. (Ground 10)

Appellant’s Submissions 17. The Appellant is dissatisfied with the findings of the Ad Hoc Committee hence has lodged this appeal with the Tribunal. Specifically, the Appellant raised ten grounds of appeal in the Memorandum of Appeal dated 16 August 2022. As indicated in the Appellant’s submissions these grounds can be summarized as hereunder.

18. On these grounds 1, 3 & 9 the Appellant avers that he had relied on the unqualified financial statements of a competent auditor. The said auditors had been preparing CBKL’s financial statements for the years 2010 – 2014. In support of this point the Appellant refers to the case of R v Graham HC Auckland [2012] NZHC 265 (24 February 2012). In the case the court gave judgement in favour of a director who relied on the defense that he had depended on the advice of a well-known and reputable audit firm and the company’s own advisors in preparing financial statements.

19. The Appellant also reiterates that criminal liability should not attach to him because he cannot be considered a person to have been ‘in- charge of the day to day business of CBKL. They rely on the case of State of Karnataka v Pratap Chand & others in which the court stated that a person in charge should be interpreted to mean an individual who is in overall control of the day-to-day business of a company or firm. Hence, the Committee failed to acknowledge that the Appellant was a non-executive director who was not resident in Kenya, therefore was not involved in the day-to day running of CBKL. Furthermore, it is for this reason that the Appellant placed reliance on the regulatory oversight and reports from the CBK and on the financial statements provided by the Auditors.

20. The statements had been prepared in accordance with the required International Financial Reporting Standards. Moreover, by the time the IM was published the 2014 financial statements had not been restated by the Auditors. Additionally, CBK had approved the statements for publication. CBK did not flag any issues regarding CBKL’s accounting processes or books. The Appellant therefore had no basis to doubt that CBKL was compliant.

21. The Appellants states that at the time of publishing the IM, he was not aware of the misclassification of the musharakah investment financing. Thus, they were not aware of the purported anomalies in the 2014 financial statements at the time of publishing the IM. The restatement was done on 4 April 2016, about 12 months after the IM was published. Consequently, the Appellant could not reasonably be expected to ignore the advice of the Auditors or to forsee that they would restate the 2014 financial statements as they did. Thus, the IM provided information that was correct and reflected the true financial position of CBKL during the relevant period. That is, at the time of issuing the IM.

22. Consequently, that the Committee failed to consider that the Appellant had reasonable grounds to believe and did, up to the time of the issue of the prospectus, that the information contained in the published IM was true, which made the defenses under sections 30D(2) and 34(b) of the CMA act available to the Appellant.

23. The Committee erred in failing to acknowledge and give effect to the issuance of unqualified financial statements by the auditor, Deloitte & Touche on the preparation and publication of the IM and the MTN and therefore failed to hold the Auditors liable for any misinformation. Hence, the Committee erred in finding the Appellant liable for the consequences of actions sanctioned by a qualified consultant Auditor and on whose professional judgement the Appellant relied upon.

24. The Appellant avers that the Respondent failed to appreciate the role played by the Auditors and hence held the unreasonable expectation that the Appellant would conduct an independent assessment of the audit reports even though the auditors had assessed them. Accordingly, the Respondents inferred an additional obligation that requires a director to audit the findings of the expert and the Appellant could not reasonably have been expected to ignore the advice of the Auditors.

25. The Appellant contends that the decision by the Respondent, that he failed in his duty by not disclosing in a supplementary IM the bonus payment to Mr. Zafrullah Khan was not correct. On this issue the Appellant contends that he was not a person responsible for the prospectus as required by regulation 12 of the Listing and Disclosure Regulations. Additionally, there was no intention to pay the bonus from the proceeds of the MTN. Consequently, the publication of the resolution to award Mr. Zaffrullah Khan a bonus in a supplementary IM was not necessary. That the purpose of the MTN was to raise funds to facilitate branch expansion, strengthen the capital base and support growth in IT and product development initiatives and supporting onward lending activities.

26. Moreover, the amount of the bonus payment was not material to the financial position of CBKL. Also, it was paid without the knowledge or approval of the Board or the AHRC. The Appellant only became aware of the payment when the facts were presented to him by the CMA from the CBK forensic report. Hence, he should be held accountable for actions taken by the management of CBKL. The Appellant contends that he did not approve the payment of the bonus because he did not participate in any meeting where the issue of the bonus payment was raised and discussed.

27. On the issue of requiring the publishing of a supplementary IM the Appellant contends that ‘in order for a new matter to be published in a supplementary IM, the CMA Regulations require that the new matter ought to have been significant and whose inclusion would have been so required if it had arisen when the prospectus was prepared.’1 Yet, in this case the publication of the bonus payment in a supplementary IM was not material when the decision was made.1Appellant's submissions. Page 17.

28. The Appellant states that the Respondent failed to consider the explanation they gave on why the Musharakah investment was initially classified as ‘other assets’ as opposed to related party advances. And that both CBK and CBKL auditors had not raised any issues on the prior treatment of Musharakah. Further, the Committee did not consider that the CBKL Board did not validate the creation of the Special Purpose vehicles (SPVs) and did not know under which SPVs the Musharakah investments were held.Hence, the Appellant was not aware of their existence prior to the restatement of the accounts.

29. The Appellant also contends that a blanket condemnation was made against the former directors without considering their individual roles and actions. The Appellant argues that the Committee should have considered issues such as the Appellant being non-executive member.

30. Consequently, the Appellant prays that:(a)That the decision of the Ad Hoc Committee that the Appellant is liable to pay a penalty of Ksh. 2. 5 million be set aside.(b)The decision that the Appellant failed to exercise oversight management of CBKL leading to preparation and publication of false and misleading statements be set aside.(c)The decision that the Appellant failed to ensure disclosure of material information in a supplementary IM on bonus payment to Mr. Zafrullah Khan be set aside.

Respondent’s Submissions 31. That the Appellant failed in his capacity as board member of CBKL, in undertaking the oversight duty of management of CBKL hence leading to the preparation and publication of false and misleading financial statements. As disclosed in the published IM for the MTN. The Respondent maintains that the Appellant should have had an inquiring mind and looked deeper/interrogate financial statements presented to the Board members.

32. That the Appellant failed in his oversight role by failing to ensure disclosure of material information in a supplementary IM relating to the bonus payment to Mr. Zafarullah Khan. The Appellant had actual knowledge of the bonus payment to Mr. Zafrullah Khan by virtue of having been a member of the Ad Hoc Remuneration Committee of the CBKL board that recommended the payment of the bonus. Accordingly, being fully aware of the bonus payment the Appellant failed in his oversight duty as he did not act in good faith by failing to disclose this in a supplementary IM. It also constituted ‘material information’ as well as ‘peculiar circumstances that prevailed with respect to the issuer’. Yet, since the bonus payment was a ‘significant’ occurrence, and it was material information involving a significant amount that had an impact on CBKL financial standing and the investors had a right to know of it in order to make rational investment decisions. Moreover, disclosure was required by Regulation 13A (2) of the Capital Markets (securities) (public Offers, Listing and Disclosures) Regulations, 2002. The Appellant should have caused disclosure of this information in a supplementary IM.

33. That the Appellant being a non-executive board member and a member of the audit & risk committee of CBKL was liable for failing in oversight of CBKL management leading to preparation of false and misleading financial statements disclosed in the IM. By virtue of having made a declaration in paragraph 15. 12 in the IM stating that they accept responsibility for the information contained therein, then the Appellant is liable. The Respondent avers that this is also supported under Sections 30A to 30G CMAact and regulation 17(1) which explicitly lists the directors of a company as individuals who are responsible for the content in a prospectus. Moreover, as stated in the case of Peter O Ngoge T/A O P Ngoge & Associates v Ammu Investment Company Ltd 2012 the brain of a company is the board of directors who make decisions on behalf of the company. This board bears the ultimate responsibility for the company despite the fact that day-to-day management of the company is handled by specific officers tasked to do so on behalf of the board.

34. Although, a director is entitled to rely on other professionals such as external auditors that does not transfer the oversight liability from them. The degree of responsibility and duty applicable to a director is that they should not accept information and advice blindly. Instead, one is expected to exercise the degree of care and diligence that a reasonable person would exercise as a director of a company. As stated in the matter of Sino Australia Oil & Gas v Sino Australia Oil & Gas Limited (2016) FCA 934 this requires that a director should question information they receive and should give it due consideration and exercise his own judgement. That is, a director is expected to bring an informed and independent judgement to bear on the different matters that come to the board for decision.

35. The Respondent avers that this consideration is strengthened by the fact that the Appellant has ‘rich qualifications’ and experience in the banking and investment sector. Accordingly, the Appellant had the necessary skills and expertise to exercise independent judgement.

36. Since the Appellant was a member of the Ad Hoc Remuneration Committee that approved the bonus payment to Mr. Zafrullah khan he had a second chance to keenly revisit the financial statements to ascertain whether CBKL was in a position to part with a huge amount of money. Nevertheless, the Appellant chose to rely on third parties even if the matter involved making a significant decision.

37. On the issue of the misclassification of the musharakah investments, as ‘other assets’ instead of loans, the respondent avers that the Appellant initially pleaded ignorance in his reply to the notice to show cause. However, during the oral enforcement proceedings, the Appellant projected the view that classification of musharakah investments as ‘other assets’ had the effect of inflating the asset base of CBKL. Consequently, the misstatement resulted in presenting an impressive overall position of CBKL since the liabilities of the shareholder’s equity was higher than the liabilities.

38. Further the overstatement of the cash and bank balances and the cumulative interest receivable income as contained in the IM created an impression of a highly profitable entity. The overstatement of the interest receivable income was done for the period 2011 to 2014. This overstatement results in an overstated net income or profit which then appeared in the balance sheet as retained earnings. Consequently, this inflates the shareholders’ equity. Subsequently, even after the issuance of the MTN, the Appellant should be estopped from advancing the argument that the management just decided without the Board’s approval to restructure ‘musharakah’ assets by creating SPVs owned by management. Because had the Appellant been diligent he ought to have known of this move.

39. As a result of the issues highlighted above, the Respondent avers that the Appellant is guilty of gross dereliction of their duty of ensuring that the contents of the IM and also neglected to perform his oversight duty as a director. The Appellant by virtue of being a member of the ARC was compelled, under paragraph 3. 5.2 of the 2002 Guidelines on corporate governance practices by public listed companies in Kenya, to ensure that the financial statements were in compliance with the IFRS and other relevant legal requirements.

40. The Respondent states that it did not give blanket condemnation against all directors. It meticulously considered the oral and written submissions made by each director of CBKL. The Respondent avers that it considered that the Appellant was non-executive director of CBKL and a member of the ARC. Additionally, he had the relevant skill and background experience that is suitable for the position. Hence, he owed a higher duty of care, skill and diligence. The Appellant breached that duty by allowing preparation and publication of false misleading financial statements or even ensuring the publication of a supplementary IM.

Analysis 41. Having read and considered the pleadings and submissions we find that the matters for adjudication can be summarized as follows:1. Whether the Appellant was responsible for preparation and publication of false and misleading financial statements and material non-disclosures on the Information Memorandum.2. Whether the sanctions imposed on the Appellant were lawful and justifiable.

Issue 1 Whether the Appellant was responsible for preparation and publication of false and misleading financial statements and material non-disclosures on the Information Memorandum. 42. This relates to the following grounds as presented in the Memorandum of appeal:(a)The Committee erred in finding that the Appellant failed in oversight of management of CBKL leading to the preparation and publication of false and misleading financial statements disclosed in the published IM (Ground 1)(b)The Committee erred in finding that the Appellant failed to disclose material information on bonus payment to Mr. Zafrullah Khan in the IM (grounds 2, 6, 7 & 8).(c)The Committee erred in failing to acknowledge and give effect to the issuance of unqualified financial statements by the auditor, Delloitte & Touche on the preparation and publication of the IM and the MTN and therefore failed to hold the Auditors liable for any misinformation. Hence, the Committee erred in finding the Appellant liable for the consequences of actions sanctioned by a qualified consultant Auditor and on whose professional judgement the Appellant relied upon. (Grounds 3 & 9)(d)The Committee erred in failing to consider the import of the evidence presented before it concerning the nature of treatment of Musharakah investments which led to their classification as ‘other assets’ as opposed to ‘loans’. (Ground 4)(e)The Committee erred in finding that the Appellant did not address the issue of overstatement of interest in his response to the show cause letter. (Ground 5)

43. It is important to evaluate the role of a company director since some aspects of it are pegged onto the duties of a director. Denning L. J in H.L Bolton (Engineering) Co. Limited – Versus- T.L Graham & Sons Limited (1957) CA 159 at 172, stated thus, “...A company may in many ways be likened to a human body. It has a brain and nerve center which controls what it does. It also has hands which hold the tools and act in accordance with directions from the center. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will.Others are directors and managers who represent the directing mind and will of the company, and control what it does. The state of mind of these managers is the state of mind of the company and is treated by the law as such.”

44. In essence, the state of mind of these managerial figures is considered synonymous with the company's state of mind in the eyes of the law. This characterization underscores the significance of the decisions and actions of directors and managers in shaping and defining the legal personality and responsibilities of the company. Company Law incorporates corporate governance, and it spells out the roles of each individual in the space, executive directors and non-executive directors not being an exception.

45. A company director is a person appointed to serve on the board of directors of a company. The board of directors is responsible for overseeing the company's management and making key strategic and operational decisions. Company directors have various duties, including setting the company's strategic direction, ensuring financial accountability, complying with legal obligations and overseeing its performance. They act as fiduciaries, holding the best interests of the company and its stakeholders (shareholders, creditors, employees, etc.) paramount in their decisions. The Board of Directors is comprised of both executive and non-executive members.

46. The executive directors are typically part of the company's management team and are involved in the day-to-day running of the business. They are usually employees of the company holding key positions such as CEO, CFO, and other senior management positions. They have specific managerial responsibilities and are actively involved in the formulation and implementation of corporate policies and strategies. They are directly responsible for the company's performance and answerable to the Board and shareholders. However, their independence can be compromised due to involvement in daily management.

47. Non-executive directors do not participate in the daily management of the company. They are not employees but are appointed to the board for their expertise and insight. Their engagement is in board meetings and through board committees. They may also contribute to specific strategic initiatives or projects. As evidenced in Equitable Life Assurance Society v Bowley and others [2003] 1 All ER (D) 308, non-executive directors share a duty akin to their executive counterparts albeit with some divergence. This duty emphasises an ongoing responsibility to comprehend and manage the company's affairs. Their primary responsibility is to provide independent oversight and constructive challenge to the executive directors. They are often involved in areas requiring an objective view, such as audit, risk management, and performance evaluations.

48. The non-executive directors are supposed to act independently of the company's executive team, providing an objective and critical perspective. Further, they are expected to offer their expertise and knowledge, to question and challenge the executive decisions constructively. Essentially, executive directors bring operational expertise and agility, while non-executive directors inject objectivity, long-term vision, and stakeholder representation. Both types of directors are supposed to provide a balanced dynamic that works towards the best interests of the company as well as its stakeholders.

49. The Companies Act, 2015, provides for general duties of directors which are based on common law rules and equitable principles. These are aimed at ensuring responsible corporate governance and protecting the interests of the company and its stakeholders. These duties include:i.Duty to act within powersii.Duty to promote the success of the company iii. Duty to exercise an independent mindiv.Duty to exercise reasonable care, skill, and diligence v. Duty to avoid conflicts of interestvi.Duty not to accept benefits from third partiesvii.Duty to declare interest in proposed or existing transaction or arrangement

50. Case law provides that, irrespective of their executive or non- executive status, directors are to act honestly, in good faith, and in the company's best interests. The required degree of care, skill, and diligence is contingent on the individual director's knowledge, skill and experience. (See Ajay Shah v Deposit Protection Fund Board as Liquidator of Trust Bank Limited (In Liquidation) NRB CA Civil Appeal No. 158 of 2013 [2016] eKLR, Nyandarua Progressive Agencies Limited v Cyrus Wahome Nduhiu and Another NYR CA Civil Appeal No. 213 of 2013 [2017] eKLR; Pan Africa Insurance Holdings Limited & another v Dickson Ngatia Gachuche [2021] eKLR).

51. Furthermore, directors are expected to exercise the skill and care that is considered normal and reasonable in the particular field of commerce in which the company operates. A director is expected to bring an independent mind, inquiring mind. They are supposed to take reasonable steps to inform themselves before making decisions. This ties in with the duty of care, skill and diligence that is expected of them. Directors may rely on the expertise of experts and advisers in discharging their functions. Indeed, a failure to seek expert advice may amount to a breach of duty. Nevertheless, the right (or duty) to seek advice does not absolve a director from the duty to supervise the discharge of delegated functions. (See the following cases Australian Securities and Investments Commission v Healey [2011] FCA 717, Australian Securities and Investments Commission v Macdonald (No 11) [2009] NSWSC 287, Australian Securities and Investments Commission v Fortescue Metals Group Ltd [2011] FCAFC 19). It must be reasonable for directors to rely on the advice of colleagues or advisers. For example, directors must ensure that advisers have appropriate expertise and are instructed to address relevant issues; they should also ensure that advisers are free from conflicts of interest. Essentially, directors must balance reliance on expert advice with their own informed judgement and oversight responsibilities; reliance must be combined with due diligence.

52. From the statement of facts, the Appellant in addition to being a board member, was a member of the Board’s Audit and risk committee (ARC). Generally, the key functions of ARC are: To provide oversight of financial reporting for the company

Reviewing the effectiveness of the company's internal control systems

Overseeing the work of the internal audit function

Identifying and assessing the main risks facing the company and Risk Management oversight

53. Essentially, the ARC plays a vital role in reinforcing transparency, accountability, and good corporate governance within an organization. They provide critical oversight that helps to reduce the risk of financial misstatements or mismanagement and enhance the overall trust in the company by shareholders and other stakeholders.

54. In addition, considering that the Appellant had the relevant skills and experience to be involved in the ARC since he had a background in the financial sector and the relevant experience working for a financial institution. Accordingly, he was in a position to exercise independent judgment in terms of reviewing the financial statements presented by CBKL’s auditors. Considering the discussion above on the general duties of directors it is evident that the Appellant ought to have exercised his independent judgement and questioned the financial statement as presented by the auditors.

55. As a director he did not sign off on his obligation to ensure the accuracy of the financial statements and information in the IM. In exercising the duty of care and skill he should have undertaken to test the veracity and accuracy of the financial statements. It should not have been a case of entirely relying on the auditors’ work and just signing-off the financial statements.

56. Moreover, this aspect of the director’s responsibility for the preparation of financial statements that reflect the true financial position of a company is reiterated and specifically stated in the annual reports and financial statements of CBKL. Specifically, there is a paragraph titled, ‘Director’s responsibility for the financial statements.’ It states as follows:The directors are responsible for the preparation of financial statements that give a true and fair view in accordance with International Financial Reporting Standards and in the manner required by the Kenyan Companies Act and the Banking Act, and for such internal controls as directors determine are necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.

57. This statement reiterates the duty of care and skill expected of a director. That as a director one does not sign-off on their obligation to ensure the accuracy of the financial statements. Instead in exercising the duty of care and skill they should undertake to test the veracity and accuracy of the financial statements.

58. The Appellant was a member of the Ad Hoc Committee of the board that was created to consider the bonus payment to Mr. Zaffrulah Khan. So as a separate committee they considered the matter and presented the recommendation to the Board and the Board endorsed the said recommendation. Hence, The Appellant was privy to the discussion and approval of the payment of the bonus.

59. According to the facts the chronological order of events relating to the award of a bonus to Mr. Zafrullah Khan and granting of authority to publish the IM were as follows: On 06/02/2015 CBKL lodged an application for the MTN with CMA

CMA sought clarification on 26/03/2015

CMA approved the MTN on 22/04/2015

CBKL board approved bonus payment on 14/05/2015

MTN listed on the NSE on 22/06/2015

CBKL Board vacated its decision to pay the bonus on 03/12/2015

60. The bonus payment was paid out in five tranches on diverse dates in the month of June 2015. Three payments paid before the NSE listing, two paid after the NSE listing.

61. Though the Board had approved payment of the bonus it had provided a qualification that the payment was to be done yearly depending on the liquidity and profitability of the bank. Nevertheless, the payments were paid out without following the provided rider. It is also important to note that the sum of Ksh one billion is a significant amount and such an amount would definitely have had an impact, whether positive or negative, on the company’s books of account even if the company was making a profit. Since it would have the overall effect of painting a particular picture of the company’s financial position. Consequently, this is important information that the investors in CBKL would want to know. This aspect is magnified when one considers what is the nature of an MTN.

62. An MTN is a financing tool used by corporations and financial institutions to raise capital by issuing debt securities in multiple currencies over a set period. The total amount for the MTN issued by CBKL was to be Ksh 10 billion which was to be issued in tranches. The first tranche, which was issued, was for 3 billion with a green shoe option2 of Ksh 2 billion. From the facts it is evident that CBKL still had an outstanding amount of Ksh 7 billion under the MTN that it could offer to the public. Thus, the MTN was not a one- time event but an ongoing undertaking/process hence there was need to keep disclosing new and relevant information once it was available. Therefore, as discussed above it would have been important to the subscribers of the future MTN tranches to know of the bonus payment and other material financial information, considering the financial effect, whether positive or negative, it would have on CBKL.2A green shoe option, also known as an over-allotment option, is a special provision in an initial public offering (IPO) underwriting agreement that grants the underwriters the right to sell more shares than initially planned by the issuer, if demand for the shares proves higher than expected.

63. From the chronology of events CMA approved the MTN on 22/04/2015, however, before it was listed on the NSE on 22/06/2015 the CBKL Board approved the bonus payment on 14/05/2015. Moreover, one is left pondering precisely when did the ad hoc committee of the board consider the issue of paying the bonus in readiness to present it to the board. The likely event is that the consideration was done before the board meeting approving it was held. Hence, the ad hoc committee members may have known of the bonus payment before the MTN was approved by CMA.

64. Nevertheless, since CBKL board approved bonus payment on 14/05/2015 and the MTN listed on the NSE on 22/06/2015, there was a window period within which the Appellant could have orchestrated the filing of a supplementary IM. Moreover, the board vacated the decision on payment of a bonus on 03/12/2015. This means there was another window when the supplementary IM could have been filed. The bonus payment was converted to a loan, albeit an unsecured loan. The other important issue is, was there a legal requirement to file a supplementary IM? Yes, there is. This is provided for under regulation 13A Capital Markets (securities public offers listing and disclosures) regulations 2002.

65. Specifically, regulations 12 (1) provides the key areas that must be covered in an IM for purposes of assisting an investor make an informed decision these are: The assets and liabilities

Financial position

Profits and losses

Prospects of the issuer and

Rights attaching to the securities.

66. The information to be included by virtue of these Regulations shall be such information as is referred to in paragraph (1) which is within the knowledge of any person responsible for the prospectus, or which it would be reasonable for him to obtain by making enquiries. Regulation 17(1) explicitly states the persons responsible for the information in the IM; these are the directors of the issuer.

67. Regulation 13A imposes a duty on those responsible for the prospectus to publish a supplementary prospectus where:‘(a)there is a significant change affecting any matter contained in the listing statement the inclusion of which was required by these regulations;(b)a significant new matter arises the disclosure of which would have been required if it had arisen when the listing statement was prepared; or(c)there is a significant inaccuracy in the listing statement, the issuer shall, on its own motion, with prior consent of the Securities Exchange, or if required by the Securities Exchange, publish a supplementary listing statement containing particulars of the change or new matter or in the case of inaccuracy, correct it.’

68. The regulations provide further clarity by explaining the term "significant" means material change for the purposes of making an informed assessment of the matters mentioned in these Regulations. 70. Additionally, under the interpretation/definitions section of the Regulations material information is defined as follows:“Material information” means any information that may affect the price of an issuer’s securities or influence investment decisions and includes information on;(a)A merger, acquisition or joint venture; (b) A block split or stock dividend;(c)Earnings and dividends of an unusual nature;(d)the acquisition or loss of a significant contract;(e)A significant new product or discovery;(f)A change in control or significant change in management; (g) A call of securities for redemption;(h)The public or private sale of a significant amount of additional securities;(i)The purchase or sale of a significant asset; (j) A significant labour dispute;(k)A significant lawsuit against the issuer;(l)Establishment of a programme to make purchases of the issuer’s own shares;(m)A tender offer for another issuer’s securities;(n)Significant alteration of the memorandum and articles of association of the issuer; or(o)Any other peculiar circumstances that may prevail with respect to the issuer or the relevant industry.

69. Accordingly, the payment of a bonus totaling Ksh. 1. 52 to Mr. Zafrullah Khan was both significant, material information and a peculiar prevailing circumstance considering the amount involved and that he was the former Group Managing director and at the time of approving the bonus payment he was the chairman of the board. Payment of this amount would have had an impact, whether positive or otherwise on the financial statements of CBKL. Hence, it is information that a potential investor would want to know. Moreover, although the bonus was later reversed after disbursement and treated as a term loan did not oust the requirement for the issuance of a supplementary IM. Since, this new categorisation still adversely affected the cash balances of CBKL.

70. Further, according to the annual report and financial statements for the year ended 31 December 2016 at page 6 it is evident that the Appellant attended three out of the four board meetings held. He also attended all three of the ARC meetings held during the year. Therefore, all these present opportunities for the Appellant to have queried further various issues such as the bonus payment to Mr. Khan.

71. To what extent can executive and non-executive directors rely on advice or information provided by third parties? The courts (see Fyffes Plc v Dcc Plc and others [2005] IEHC 47; Australian Securities and Investments Commission v Healey [2011] FCA 717, Australian Securities and Investments Commission v Macdonald (No 11) [2009] NSWSC 287, Australian Securities and Investments Commission v Fortescue Metals Group Ltd [2011] FCAFC 19)) have said that directors cannot substitute reliance upon the advice of management for their own attention and examination of an important matter that falls specifically within the Board’s responsibilities as with the reporting obligations.

72. Consequently, each member of the board was charged with the responsibility of attending to and focusing on the accounts and, under the circumstances, could not delegate or ‘abdicate’ that responsibility to others.

73. The upshot of the foregoing is that directors cannot absolve themselves of their duty by solely relying on the advice of others; they must actively engage in the examination of important matters falling under their purview, particularly those central to their core duties and reporting obligations.

74. In addition, the duty to prioritize the interests of the company over personal gain restricts the extent to which directors can rely on external information that may compromise these fundamental fiduciary duties. This is one of the major grounds of limitation on the extent to which company executive directors and non-executive directors can rely on the information from third parties such as auditors and solicitors to the company.

75. In this case the Appellant possessed the relevant skills, expertise and experience to enable him to interrogate the books of accounts. Additionally, he was a member of the ARC. This committee is supposed to review and approve the company's financial statements before submission to the Board. This involves ensuring the accuracy and completeness of the financial statements and identifying any potential accounting or reporting issues. In other words, its duty is to review and monitor the integrity of the company's financial statements and annual reports to ensure accuracy and compliance with financial reporting standards.

76. In line with this duty the board members, and this can be done through the ARC, are supposed to review and monitor the external auditor’s independence, objectivity, and effectiveness. Further to an examination of the annual report and financial statements there is a statement to the effect that the directors accept responsibility for the annual financial statements. Hence, the directors’ obligation as to the accuracy of the statements should not be delegated.

77. Accordingly, the Appellant as a member of the ARC cannot pass on his duty to the auditors. The duty to review the integrity of CBKLs financial statements was upon him. Despite placing reliance on expert advice, he was expected to exercise an independent mind when interrogating the financial statements. The Appellant was supposed to test the veracity and accuracy of the financial statements by bringing an independent and inquiring mind as to the accuracy of the statements. One must take reasonable steps to inform themselves before making decisions. Hence, ensure a balance between relying on expert advice employing their own due diligence.

78. On the issue of the nature of Musharakah investments which led to their classification as ‘other assets’ as opposed to ‘loans’. We have considered the following:(a)What is musharakah: Musharakah or shirkah al-Amwal means ‘sharing’.3 The term ‘musharakah’ can be spelled in various ways, these variations are due to differences in pronunciation, transliteration, or regional preferences. Nevertheless, the most common spellings seen in various publications are ‘musharaka’ or ‘musharakah’. Musharakah is governed by Islamic law known as Sharia law.3Muhammad Taqi Usmani, Concept of Musharakah and Its Application as an Islamic Method of Financing (1999) 14(Part 3) Arab Law Quarterly 203 at 203 & 206. (b)What is its purpose: It is a form of partnership contract in Islamic finance where two or more parties pool their capital whether in form of cash, assets, or labour to undertake a joint business venture. They can be considered similar to conventional venture capital principles.4 The concept of musharakah is founded on the idea that both profit and loss should be shared among the partners. Essentially, it is a form of equity-based financing contract.5 Its main aim is to assist in capital mobilisation through the pooling together of finances from different partners. Hence, it can also be considered as method of participatory finance.4Aisyah Abdul-Rahman, Shifa Mohd NoM, Challenges of profit-and-loss sharing financing in Malaysian Islamic banking Malaysian Journal of Society and Space, (2016) 12 (2) (39 - 46) at 40. Abdul Rahman, Aisyah, Shifa Mohd Nor, and Mohd Fadzli Salmat. The application of venture capital strategies to musharakah financing, (2020) Journal of Islamic Accounting and Business Research 11. 4 (2020): 827-844 at 828. 5Abdul Rahman, Aisyah, Shifa Mohd Nor, and Mohd Fadzli Salmat, The application of venture capital strategies to musharakah financing, (2020) Journal of Islamic Accounting and Business Research 11 (4) 827-844 at 827. Muhammad Taqi Usmani, Concept of Musharakah and Its Application as an Islamic Method of Financing (1999) 14(Part 3) Arab Law Quarterly 203 at 216. (c)What are the types of musharakah: Musharakah can be for a period of time or permanent in nature. These are diminishing musharakah (musharakah mutanaqisah)6 and permanent musharakah (musharakah da'imah). In diminishing musharakah, the ownership of the asset is gradually transferred from one partner to the other. In permanent musharakah, the partnership continues indefinitely. This form is often used for long-term projects or businesses that are expected to operate for an extended period. 76See Saad, Norma Md, and Dzuljastri Abdul Razak, Towards an application of Musharakah Mutanaqisah principle in Islamic microfinance (2013) International Journal of Business and Society 14. 2 (2013): 221. 7Mustafa Gamal-Eldin Abdalla, Partnership (Musharakah): A New Option for Financing Small Enterprises? (1999) Arab Law Quarterly 14 (3) (1999), pp. 257-267 at 262-263. (d)The principles of musharakah: The basic principles specific to and guiding musharakah are as follows.8 First, the nature of financing through musharakah can be by contributing cash or assets. Second, an investor must share the loss incurred by the business to the extent of his financing. Third, the partners are at liberty to determine, with mutual consent, the ratio of profit allocated to each one of them, which may differ from the ratio of investment. Fourth, the loss suffered by each partner must be exactly in the proportion of his investment.8Muhammad Taqi Usmani, 'Concept of Musharakah and Its Application as an Islamic Method of Financing' (1999) 14(Part 3) Arab Law Quarterly 203 at 217. Abdalla, Mustafa Gamai-Eldin, "Partnership (Musharakah): A new option for financing small enterprises." Arab LQ 14 (1999): 257 at 262. Maulana Taqi Usmani, Musharakah and Mudarabah as Modes of Finance, https://islamicdatabase.org/sites/default/files/ islam_modes_of_finance.pdf (accessed 04/12/23) at 2. Muhammad Taqi Usmani, 'Concept of Musharakah and Its Application as an Islamic Method of Financing' (1999) 14(Part 3) Arab Law Quarterly 203 at 217. (e)The basic principle of managing a musharakah is that all the partners can be actively involved in the management of the business. Hence the reason why it can be considered as method of participatory finance. Nevertheless, it is permitted for the partners to agree to one or more of them to oversee operations while there be ‘sleeping’ partners. 9 The partnerships can be dissolved through mutual agreement or specific clauses addressing the termination of the musharakah arrangement.9Muhammad Taqi Usmani, 'Concept of Musharakah and Its Application as an Islamic Method of Financing' (1999) 14(Part 3) Arab Law Quarterly 203 at 210. (f)Is musharakah an asset or liability: From a reading of literature, it is evident that from an Islamic perspective, although musharakah is a type of financing option it can be viewed as a form of asset. This is because the capital contributed by partners becomes part of the business assets, and any profits generated are considered joint assets. In other words, the ownership interest in the joint venture represents an asset for the partners, reflecting their investment and potential share of profits. However, in the event of losses, the liability is shared among the partners based on their respective capital contributions. The concept of considering musharakah as a form of asset has been aptly captured by an author as follows:‘Islamic Finance is said to be asset based as opposed to currency based, whereby an investment is structured on exchange or ownership of assets, and money is simply the payment mechanism to effect the transaction.’1010Rashidah Abdul Rahman, Fauziah Hanim Tafri, Yaseen AlJanadi, Instruments And Risks In Islamic Financial Institutions, Malaysian Accounting Review, Special Issue 9 (2) 11-21, 2010 at 13

79. Additionally, the question whether musharakah is an asset or liability can also be considered from the perspective of the type of financial reporting standards that are applied. Financial reporting standards govern how and the number of particular types of transactions, information and events that should be reported in financial statements. There are several different accounting standards that are set and maintained by various standard setting bodies. These standards serve the purpose of ensuring that financial information is relevant, reliable, comparable, and understandable for the users of financial statements. 1111See Suharsono, Riyanto Setiawan, Nazief Nirwanto, and Diana Zuhroh "Voluntary disclosure, financial reporting quality and asymmetry information" Journal of Asian Finance, Economics and Business 7. 12 (2020): 1185-1194 at 1186. Mary E. Barth, Global comparability in financial reporting: What, why, how, and when? (2013), China Journal of Accounting Studies, 1:1, 2-12. Iatridis, George "International Financial Reporting Standards and the quality of financial statement information" International review of financial analysis 19. 3 (2010): 193-204 at 194.

80. There are two prominent frameworks of financial reporting standards in the world: The International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP). With respect to the matter at hand, it is important to note that the CMA has adopted IFRS as the basis for financial reporting for all listed companies and other entities that are required to prepare financial statements under the Capital Markets Act.12 These standards apply to conventional banking products.12Capital Markets Authority Handbook (2021)

81. Therefore, considering that musharakah are supposed to be compliant with Sharia law then it follows that conventional financial accounting standards may not be appropriately applicable in the context. Consequently, Islamic financial accounting standards which are based on the principles of Sharia law can be applied when dealing with Islamic methods of finance.

82. This is the standard that is issued by the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) and is applicable to Islamic finance transactions and products. It covers the accounting treatment and recognition criteria for different types of Islamic finance instruments such as musharakah. The International Financial Reporting Standards (IFRS) are different from the Islamic financial accounting standards. Nevertheless, since the applicable standard in this case is the IFRS the question is how should musharakah be treated under these rules; is it an asset or a liability?

83. According to IFRS 9, dealing with financial instruments, it sets the principles for recognising, measuring and presenting financial assets and liabilities, including equity instruments. It emphasizes substance over form, hence requiring entities to assess the economic substance of an asset or liability to determine itsappropriate classification. In other words, correctly classifying an equity-based financing contract requires a thorough examination of its substance, not just its form. The main aim being to understand the economic reality of the agreement, not simply relying on labels like "equity" or "loan."

84. Accordingly, under IFRS, the classification of a "musharakah" as an asset or liability depends on its economic substance, not solely on its label or the form it takes. This is because misclassification can lead to misleading financial statements and inaccurate representations of the company's financial position. Essentially, classifying an equity instrument as a liability, or vice versa, can distort profit or loss figures and impact key financial ratios. The substance of a contract can be influenced by various factors, such as: The terms and conditions of the contract

The rights and obligations of the parties

The economic reality and purpose of the contract

The accounting standards and policies applicable to the contract

85. Therefore, one must carefully evaluate these factors to determine if to categorize a particular equity-based financing contract as an asset or a liability. Consequently, in relation to musharakah the correct classification depends on carefully analysing the specific terms and conditions of the specific musharakah agreement. Some of these key factors to consider include: Do the musharakah partners have any control over the venture's management decisions or the use of the pooled capital?

Is there any legal obligation to repay the initial investment, even if the venture incurs losses?

In case of liquidation do the partners have any claim on the remaining assets after all other liabilities are settled?

In the event of losses how will the liabilities be shared?

86. In reference to the substance of the musharakah agreement, in question in this matter, it is clearly stated in the pleadings and submissions that it was an ‘unsecured related party advance’. Meaning the borrower and the lender are related parties. Similarly, it could also mean any party that might exert significant influence over the entity, or where the entity might exert significant influence over the party. Apart from the bank some of the other parties involved were individuals in top management positions of CBKL, through the Special Purpose Vehicles (SPVs) created. Essentially, in this case, the bank was entering into a musharakah financing arrangement with entities owned by its top management, clearly establishing a related party relationship. This triggers the disclosure requirements of IAS 24. 1313International Accounting Standards (IAS): These were the older set of standards issued by the International Accounting Standards Committee (IASC) from 1973 until 2001. When the IASB took over from the IASC in 2001, it continued to develop standards under a new name. International Financial Reporting Standards (IFRS) are the newer set of standards issued by the IASB since 2001. The IASB has also continued to update the existing IAS and issue new standards, which are collectively known as IFRS.

87. IAS 24 requires entities to disclose the nature of related party transactions, their extent, and their financial effects. This includes information such as: The identity of the related party

The nature of the transaction (e.g. musharakah financing)

The amount of the transaction

Any outstanding balances

The effect of the transaction on the financial statements (e.g., impact on profit or loss, balance sheet)

88. Disclosing related party transactions is crucial for transparency and accountability. It allows users of the financial statements to assess the potential for conflicts of interest and make informed decisions about the entity. Therefore, it is mandatory for the bank to disclose the musharakah financing arrangement under IAS 24 due to the involvement of top management, who are considered related parties. This arrangement also raises ethical and governance considerations under corporate governance reporting standards.

89. Moreover, since it is an unsecured advance, it may involve significant risks: credit, liquidity, operational and reputational risks. Such as in the event of losses, the liability is shared among the partners based on their respective capital contributions. In this particular case the bank would have shouldered a significant percentage of the liabilities in the event of losses.

90. Further consideration of the matter leads one to draw the inference that information relating to the musharakah agreement should have been included in the original IM or in a subsequent supplementary IM. Specifically, section 15. 5 in the IM deals with related party agreements. Consequently, considering the substance of the musharakah investments, they should have been included under this section. We are persuaded that this was a significant information that potential investors would require to know in order to make an informed decision.

91. Thus, considering the explanation above the musharakah agreements could not have been correctly classified as assets. We agree with the Respondent that Musharakah was misclassified as assets of CBKL when on the contrary it posed significant credit, liquidity, operational and reputational risks to the Bank.

92. Accordingly, this Tribunal affirms the Respondent's Ad Hoc Committee finding that the Appellant was responsible for preparation and publication of false and misleading financial statements and material non-disclosures on the Information Memorandum.

ISSUE 2: Whether the sanctions imposed on the Appellant were lawful and justifiable. 93. This relates to the following grounds as presented in the memorandum of appeal:The Committee erred in predisposing itself to finding blanket condemnation against all directors irrespective of their role and actions and not withstanding that for instance some directors were beneficiaries to the bonus payment and therefore had a different access to information. Hence, the Committee failed to ascertain the individual liability of the Appellant. (Ground 10)

94. After evaluating the fines that the Respondent given out to the CBKL board members, one draws an inference that they did not find a blanket condemnation against all directors. Rather the respondent considered the liability of each director individually. Based on the discussion above on the duties of directors, and upon considering the pleadings it is apparent that the Respondent considered different aspects. For example, was one an executive or a non- executive director, what was there level of expertise and experience. As a board member, did they hold any other special position. For example, the special position and duties bestowed upon them by virtue of being in the ARC.

95. Additionally, from the record, we have noted that the Appellant was given an opportunity to present their arguments both orally and in writing to the Respondent. From the decision given by the Respondent, it is evident they did take into consideration what the Appellant presented.

96. From the discussion above, it is evident that the Appellant's actions or lack thereof resulted in inaccurate disclosures and publications which were relied upon by investors and other stakeholders. Consequently, this resulted in investors, stakeholders and depositors in the institution suffering harm. Moreover, the fine imposed is in line with the law; Sections 30D; 25A Capital Markets Act.

97. This Tribunal, by unanimous decision (Hon. G. Wang’ong’u having recused himself and Hon. J. Eboko abstaining) determines that the entire appeal is without merit and we make the following orders;(a)The appeal is hereby dismissed in its entirety. (b)Costs of the Appeal be borne by the Appellant.

DATED AND DELIVERED AT NAIROBI THIS 2ND DAY OF FEBRUARY 20241. HON. PAUL LILAN, MBS -(CHAIRMAN)2. HON. PAUL WANGA -(MEMBER)3. HON. DR. CONSTANCE GIKONYO -(MEMBER)