LEGAL AUDIT FRAMEWORK IN KENYA’S CAPITAL MARKETS: HIGHLIGHTS
Background and Introduction
Over the years, financial audits have gained prominence, acceptance and value. The term audit is derived from the Latin word ‘audire’ which means ‘to hear’. This was because historically auditors listened to the oral reports of company officials and boards in order to confirm the authenticity of the reports.
This document highlights the existing legal and regulatory framework on legal audits in Kenya. It builds a case for a standard framework for conducting legal audits for issuers of securities to the public.
Importance of Legal Audit
a) Help a firm understand its current legal condition, identify any problems and take corrective actions as necessary to avoid legal liability;
b) Help a firm identify the applicable laws, regulations and standards that it is required to comply with;
c) Help a firm update itself on new and emerging laws applicable to its operations;
d) Helps avoid the costs of non-compliance by ensuring that the firm is aware of its legal obligations hence mitigating the legal risks;
e) Helps a firm maintain a reputation of compliance with the law, thereby gaining trust from regulators, stakeholders and third parties;
Relevant laws to consider when conducting legal audits
It is not possible to provide an exhaustive list of the applicable laws for a firm. This is because the applicable laws depend on the industry that the firm operates in. The legal requirements for a bank are different from those of a school. The applicable laws will therefore vary depending on the entity being audited. However, the following laws often apply in most firms-
- a) Constitution of Kenya
b) Taxation laws
c) Employment and labour laws
d) Environment laws
e) Occupational health and safety
f) Financial reporting requirements
g) Data protection
The Code of Corporate Governance Practices for Issuers of Securities to the Public, 2015
Section 11(3) (v) of the Capital Markets Act empowers the Capital Markets Authorityto prescribe notices or guidelines on corporate governance of a company whose securities have been issued to the public or a section of the public. By this power, the Authority developed and gazetted the Code of Corporate Governance Practices for Issuers of Securities to the Public, 2015.
The Code sets out the principles and specific recommendations on the structures and processes which issuers should adopt in making good corporate governance an integral part of their business dealings and culture. It advocates for the application of standards on corporate governance that go beyond the minimum prescribed by legislation. The Code was gazetted into law in March 2016 and became fully
applicable with effect from March 4, 2017.
The Code defines corporate governance as the process and structure used to direct and manage the business affairs of a company towards enhancing business prosperity and corporate accountability with the ultimate objective of realizing long- term shareholder value whist considering the interests of other stakeholders. The Code introduced the requirement for issuers to conduct legal audits.
A legal audit can be defined as a systematic review of a company’s transactions, systems, procedures, contracts, practices and legal requirements to ensure compliance. A legal audit seeks to assess compliance with the law and minimize legal liability
Clause 2.10 of the Code requires the board of an issuer to identify all applicable laws, regulations and standards that the issuer is required to comply with. The Code requires the issuer to comply with the Constitution, all applicable laws and regulations, national and international standards. In order to ensure compliance, the board is required to develop a strategy on compliance.
The Code provides that an internal legal and compliance audit shall be carried out once a year while an independent legal audit should be done at least once every two years. The independent legal audit is to be done by a legal professional in good standing with the Law Society of Kenya. The findings of the audits are to be actedupon and any non-compliance issues should be corrected.
In addition to the capital markets legal framework, legal audits are also founded on the following legal instruments.
2. The Constitution of Kenya.
Article 10 of the Constitution provides for national values and principles of governance which are binding on all persons. These values and principles include good governance, integrity, transparency and accountability.
Legal audits are therefore mechanisms to enhance good governance, integrity, transparency and accountability as underpinned in the Constitution.
3. Companies Act, 2015
4. The State Corporations Act, Cap 446.
This Act makes provisions for the establishment of state corporations, control and regulation. Section 7 of the Act gives power to the President to give directions of a general or specific nature to a board with regard to the better exercise and performance of the functions of the state corporation. This is the basis for the issuance of the Mwongozo Code of Governance for State Corporations.
5. Mwongozo Code of Governance for State Corporations, 2015
The Mwongozo Code of Governance for State Corporations seeks to address effectiveness of boards, transparency and disclosure, accountability, risk management, internal controls ethical leadership and good governance. These principles are underpinned by Article 232 of the Constitution of Kenya.
Under Clause 8.4 of Mwongozo, the board of a State Corporation is required to ensure that-
- a legal compliance audit is carried out at least annually, with the objective of establishing the level of adherence to applicable laws, rules, regulations and standards;
- a comprehensive and independent legal audit is carried out at least once in every two years
Mwongozo’s provisions on legal audits are similar to those under the Corporate Governance Code for Issuers.
6. Law Society of Kenya Act
The Law Society of Kenya Act establishes the Law Society of Kenya. Under Section 5 of the Act, the objects and functions of the Society include-
- (a) ensure that all persons who practise law in Kenya or provide legal services in Kenya meet the standards of learning, professional competence and professional conduct that are appropriate for the legal services they provide;
- (b) set, maintain and continuously improve the standards of learning, professional competence and professional conduct for the provision of legal services in Kenya;
(c) facilitate the acquisition of legal knowledge by members of the Society;
(d) develop and facilitate adequate training programmes for legal practitioners.
The development of a framework for conducting legal audits is within the mandate and functions of the Law Society of Kenya. The Society (and partners organizations) should therefore facilitate the formulation of an effective legal audit framework for issuers of securities to the public, a mandate assigned to the Society through the Corporate Governance Code and the Mwongozo Code.
The requirement for legal audits is new in Kenya’s capital market and the public sector at large. While is it a positive development, there is need for a clear implementation framework to guide the issuers as well as the professional conducting the legal audits. It is noteworthy that though this is new, some organizations and professional bodies have been conducting legal audits for their clients both private and public institutions.
The distinction between legal audit and governance audit needs to be clarified especially given that governance audits cover to some extent legal compliance aspects. While the scope of governance audit is clearly demarcated in the Code, there is minimal specification for legal audit scope.
The Legal Audit Taskforce as established in April 2018 should align the existing curriculum, guidelines and manuals for legal audits to ensure consistency, uniformity and clarity.