Addressing conflict of interest and insider dealings

Conflict of interest entails a situation that has the potential to undermine the impartiality of a person because of the possibility of a clash between the person’s self-interest and professional interest or public interest.

For example, a conflict of interest would typically arise if a director:- owned a business that supplied the company or was a major customer, sometimes called ‘connected transactions’, served on the board of another company that has business dealings with the company, had a significant personal shareholding in another company that the board was considering as an acquisition target, interviewed a relative or close friend in a recruitment exercise among others.

In many jurisdictions reporting conflict of interest is required by company law.

Insider dealing commonly referred to as insider trading, involves buying or selling of shares in a listed company on the basis of privileged, share-sensitive insider information.

It may involve making a secret profit by buying shares in the privileged knowledge of events that would drive the price up, or avoiding a loss by selling shares on the basis of privileged intelligence that would cause the price to fall.

The argument against the practice is that insider dealing destroys the credibility and the integrity of the stock market. Insider dealing is a breach of a director’s fiduciary duty. It is also illegal in almost all countries Kenya included with Japan, Hong Kong, and Germany being among the last jurisdictions to criminalize it.

It however and quite often has proved difficult to obtain convincing information to support a prosecution, which is why some jurisdictions including Kenya waited quite longer to introduce anti-insider legislation.

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A related party transaction is defined as a business deal or arrangement between two or more parties who are joined by a special relationship prior to the deal and includes, a business transaction between a major shareholder, or any company in which he holds shareholding, and the company.

The listing rules of most stock exchanges and the rules of securities regulators require related party transactions to be disclosed, and in some cases, to be approved by the shareholders.

These transactions are very common in family firms where there are close links between family members and companies connected with the family. They proved to be a significant problem in the early days of privatization of state companies in both China and Russia, as existing managers arranged transfers of assets for their own benefits.

In the year 2015 and in the exercise of the powers granted by section 11(3)(V) of the Capital Markets Act, Cap. 485A, the Capital Markets Authority issued the Code of Corporate Governance Practices for Issuers of Securities to the Public for application by both listed and unlisted public companies in Kenya.

The code provides that the board members shall in carrying out their mandate remain objective and avoid conflict of interest; shall put in place a policy to manage conflict of interest and related party transactions and that these policies shall meet the requirements of the law and be approved by the board; that upon appointment to the board, and thereafter, where circumstances so demand shall declare any real or perceived conflict of interest with the company; that they shall not take part in the discussions or decision making regarding any subject or transaction in which they have a conflict of interest and that the company shall with the assistance of the company secretary maintain a register of declared conflict of interest.

The “apply or explain” status of the Code remains its soft underbelly. The code may not be the panacea for the corporate governance challenges on conflict of interest, insider trading and related party transactions currently facing most companies.

Nevertheless, if the same is properly and faithfully implemented and mainstreamed as per its spirit into the board affairs it should be able to take the corporate governance situation in listed and unlisted public companies in Kenya to the next level.

Ibrahim Kitoo is Advocate of the High Court of Kenya.