Delving Deeper: Supreme Court Affirms Dual Enforcement and Investigatory Mandates of the Capital Markets Authority

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In Issue 12 of our Newsletter published in August 2020, we featured an article on the powers and role of the Capital Markets Authority (the Authority) which concluded that the Authority is empowered to take robust administrative action in combating insider trading, albeit obligated to adhere to the principles of natural justice, the Fair Administrative Action Act, 2015 and the Constitution, while doing so. We also highlighted the appeal processes provided in the Capital Markets Act (the Act) which are to ensure that there are sufficient corrective mechanisms to mitigate and safeguard against any potential excesses or errors that the Authority might make in the carrying out of its mandate.

In this edition we consider a recent decision of the Supreme Court of Kenya in the case of Alnashir Popat & 7 Others v Capital Markets Authority (2020) eKLR, in which the Supreme Court considered the inquisitorial and enforcement mandate of the Authority.

The Authority’s Inquisitorial and Enforcement Mandate

The Act provides for the inquisitorial powers of the Authority by mandating it to inquire into the affairs of persons it has granted a licence or an approval to, and any public company whose securities are publicly traded or offered on an approved securities market or over the counter market. The Authority may also appoint an auditor to investigate the affairs of any collective investment scheme or public company whose securities are publicly offered or traded on an approved securities exchange or on an over-the-counter market. The Authority’s inquisitorial mandate exists contemporaneously with an enforcement mandate, which ordinarily comes into play after the inquisitorial stage. To this end, the Authority may impose sanctions, give directions, and trace assets of persons it has found to have engaged in fraudulent dealings or insider trading. The Act empowers the Authority to order the placing of caveats against the title to assets or prohibit suspected persons from operating their bank accounts pending the determination of charges that the Authority may have levelled against them. The Authority may also have recourse against any person whose act or omission has resulted in a payment from the Compensation Fund established under the Act to compensate investors who suffer losses due to the failure of a licensed broker or dealer to meet its contractual obligations.

The Imperial Bank Matter

Alnashir Popat & 7 Others v Capital Markets Authority concerned a corporate bond issued by Imperial Bank Limited (now in receivership) (the Bank) that had been approved by the Authority. Things took a grim turn when the Bank’s Managing Director, Mr. Janmohamed, collapsed and died. After his passing, the Acting Managing Director and his deputy revealed to the non-executive Chairman of the Bank’s Board, Mr. Popat (one of the Petitioners in the case) that the deceased had authorised many illegal disbursements of vast amounts of the Bank’s monies in transactions that were concealed from the Central Bank of Kenya (CBK) and the Bank’s Board.

Mr. Popat then moved the Board to appoint a consultant to carry out a forensic audit of the Bank’s financial affairs and report on its accurate financial position. The Board authorised this and also resolved not to utilise the corporate bond issue pending the outcome of the investigations by the consultant. The consultant’s report confirmed the assertions made by the Acting Managing Director and is deputy, and that the Bank had incurred losses running into billions of shillings. The Board reported the matter to the CBK, which on 13th October 2015, placed the Bank under receivership and appointed the Kenya Deposit Insurance Corporation as the Bank’s receiver manager for a period of twelve (12) months. A moratorium was also placed on the Bank.

On this same day, the Authority instructed the Nairobi Securities Exchange not to proceed with the listing of the Bank’s bond issue until further notice. The Authority then decided to inquire into the circumstances prevailing in the Bank during the bond application and approval period to determine whether the Petitioners, i.e. the directors of the Bank, had contravened regulatory requirements. On 6th May 2016, the Respondent served the Petitioners with notices to show cause and required them to respond within fourteen (14) days to various allegations of negligence in the discharge of their mandate as directors of the Bank. The Petitioners were summoned to appear before the Authority’s Board on 24th May 2016 to answer those allegations. However, the hearing did not proceed as the Petitioners filed a Petition before the High Court challenging the proceedings before the Authority.

Proceedings before the High Court and Court of Appeal

In the High Court, the Petitioners challenged the propriety of the Authority’s conduct of the enquiry. The main argument that the Petitioners made was that the Authority, having approved the bond issue, and certain officers, including the Chairman of the Board, having conducted the preliminary enquiry, was conflicted and could not be impartial in the enforcement proceedings. The Petitioners consequently sought an order of certiorari to quash the notices to show cause.

The High Court noted the Authority’s dual inquisitorial and enforcement mandate and the fact that it had considered and approved the bond issue. It found that a well informed and fair-minded observer, given all the facts, would conclude that there existed a possibility of bias on the part of the Authority against the Petitioners. The High Court quashed the notices to show cause as prayed, holding that since the Authority’s regulatory mandate would not be hampered as under Section 11A of the Act, it could delegate its functions to an independent body.

The Authority appealed this decision to the Court of Appeal, the outcome of which was a finding that the overlapping inquisitorial and enforcement functions of the Authority are expressly authorised in the Act. Therefore, the Authority was expected to make unprejudiced judgment on matters it had investigated. The Court of Appeal allowed the appeal and clarified that the Authority was at liberty to continue with the administrative proceedings it had commenced against the Petitioners.

Supreme Court Decision

The Petitioners petitioned the Supreme Court pursuant to Article 163 (4) (a) of the Constitution which provides that appeals shall lie from the Court of Appeal to the Supreme Court as of right in any case involving the interpretation or application of the Constitution. On this basis, the live issues before the Court were whether the overlapping roles that the Act vests in the Authority constitute a violation of the Constitution and whether the Respondent’s attempted enforcement proceedings were or were likely to be biased against the Petitioners.

The apex Court held that whereas the dual roles were not unconstitutional per se, the manner of discharging the dual mandate is what might turn out to be unconstitutional. The Court reasoned that the for the purpose of efficiency and in carrying out the objectives of the Act i.e. expeditious disposal of disputes that arise in the operations of the capital markets, the functions of enforcement and investigation could not be performed by separate bodies. However, when it came to judicial and quasi-judicial proceeding that are likely to adversely affect the rights of the persons or bodies under investigation, the Authority was obligated to comply with the requirements of impartiality and independence under Articles 50 (1) and 47 of the Constitution. The Court noted that the Authority’s power to delegate its functions and powers to other bodies or persons would enable it to fulfil the objectives of the Act while complying with the constitutional requirements of impartiality and independence.

On the issue of bias, the Court held that there was a possibility of bias in the case. It reasoned that the Authority had approved the corporate bond issue and thereafter it emerged that the management of the Bank had been running a scheme of fraudulent disbursements leading to losses in the billions of shillings. As this was a matter that the Authority probably ought to have discovered when conducting due diligence on the bond issue, it would cast aspersions on the Authority’s diligence. Therefore, the Court held that the Authority was unlikely to approach the proceedings with the impartiality appropriate for that decision.

The Court allowed the appeal to the extent that the Authority could proceed with its enforcement proceedings against the petitioners through its delegated authority under section 11A (1) or section 14 (1) of the Act.

The Position in Canada

The case of Brosseau v Alberta Securities Commission (1989) 1 SCR 301 illustrates the Canadian position on the issue of the dual investigative and enforcement mandate of an administrative body. In this case, Brosseau, a solicitor, prepared the prospectus of a company that later became insolvent. The Respondent, who had approved the prospectus of the company, investigated the company to deter[1]mine whether the Appellants should be subject to a cease trading order and deprived them of certain exemptions provided by the Canadian Securities Act.

n the hearing before the Alberta Securities Commission, the Appellants sought an order that the Commission did not have jurisdiction to hold a hearing against them. The Commission ruled that it had jurisdiction and directed that the hearing proceed. Aggrieved by this decision, the Appellants lodged an appeal with the Alberta Court of Appeal which was unsuccessful. The Appellant then lodged an appeal with the Alberta Supreme Court.

The Alberta Supreme Court found that the relevant statute permitted the Commission to be involved in both the investigatory and adjudicatory functions, which does not by itself, give rise to a reasonable apprehension of bias. The reasoning given is that securities commissions, by their nature, undertake several different functions. They would therefore have repeated dealings with the same parties. The Court held that it is not enough to merely claim bias because a Commission, in undertaking its preliminary internal review, did not act like a Court. If it is clear from its empowering legislation that certain activities which might otherwise be considered “biased” formed an integral part of its operations and the Commission has not acted outside its statutory authority, the doctrine of reasonable apprehension of bias cannot be sustained. Therefore, this ground of appeal was dismissed.

The position in Canada is thus similar to that prevailing in Kenya as highlighted by the reasoning of the Kenyan Supreme Court in Alnashir Popat & 7 Others v Capital Markets Authority, which concurred with the Alberta Supreme Court in Brosseau v. Alberta Securities Commission.