Editor’s note: This is general educational information about what Kenyan law and market infrastructure do when a licensed stockbroker fails, drawn from the statutes, regulations and depository documents listed at the end. It is not investment advice and does not describe any particular firm.
The question sounds like one about insolvency. It is mostly a question about where the record of ownership lives. In Kenya, a listed share you bought through a stockbroker is not an entry on that stockbroker’s books that a liquidator would inherit. It is a book-entry security standing to the credit of a securities account in the central depository, and the broker is an agent that can write to that account rather than a party that owns what is in it. Everything else in the answer follows from that separation, and from three separate money pools that sit behind it.
The record sits at the depository, not at the broker
The Central Depositories Act, 2000 defines a book-entry security as a security standing to the credit of a securities account, transferable by way of book-entry in the record of depositors. A central depository is a company licensed by the Authority to establish and operate a system for central handling of securities where they are deposited and held in custody by, or registered in the name of, the company or its nominee company for depositors, and where dealings are effected by entries in securities accounts without the physical delivery of certificates. A record of an entry in a securities account in respect of a transaction in book-entry securities is prima facie evidence of the truth of the matters recorded.
Central depository agents, which the depository identifies as stockbrokers, investment banks or custodian banks, open and maintain those accounts. Clients’ securities accounts are segregated from participants’ own proprietary or dealer accounts. An investor may register the same account number with more than one agent, and can move securities from one agent to another by making the request through the current agent. That transferability is the practical remedy when an agent stops functioning: the account and its contents are not tied to the firm that opened them.
Settlement is designed to prevent a failing agent from taking anyone else’s assets with it. The depository operates delivery versus payment on DvP Model 2, settling securities trade for trade on a gross basis while funds settle on a net basis through the settlement bank, within a rolling T+3 cycle. On settlement date, the seller’s securities account is debited and the buyer’s credited simultaneously with the funds transfer, which the depository describes as guaranteeing irrevocability of settlement.
Three pools of money, each for a different failure
The first is client money at the broker. Regulation 20 of the Capital Markets (Licensing Requirements) (General) Regulations, 2002 requires a stockbroker to deposit clients’ funds in one or more bank accounts containing only clients’ funds and clearly marked as clients’ accounts, and provides that such accounts shall not be overdrawn for any reason. The broker must keep a separate record for each account showing the bank, the dates and amounts of deposits and withdrawals and the exact amount of each client’s beneficial interest, reconcile the accounts regularly, and execute payment orders no later than one month from receipt of the funds. Capital rules sit alongside: shareholders’ funds for stockbrokers shall not fall below fifty million shillings at any time during the licence period, the minimum paid up share capital shall always be unimpaired and shall not be advanced to directors or associates, and a stockbroker shall maintain liquid capital of thirty million shillings or eight per cent of total liabilities, whichever is higher.
The second is the settlement layer. Section 60B of the Central Depositories Act allows a central depository to establish a Central Depository Guarantee Fund for settlement of trades through the depository, funded by a variable risk based contribution determined by the depository in consultation with the Authority and payable by central depository agents involved in settlement, together with penalties and fines imposed under the Act, interest and profits from investing the Fund, contributions from the depository’s revenue, and other funds the depository’s board approves. Section 60C requires the depository to manage it as a separate fund, disclose it in its annual balance sheet, keep proper accounts, and have them audited. The depository describes the fund as the mechanism ensuring that the selling agent delivers the securities and the buying agent effects payment, and its published fee schedule charges guarantee fund administration at 1% of the Fund value.
The third is the Investor Compensation Fund, established by section 18 of the Capital Markets Act for the purposes of granting compensation to investors who suffer pecuniary loss resulting from the failure of a licensed stockbroker or dealer to meet his contractual obligations. It is funded by moneys paid in by licensed persons, fines and penalties, ill-gotten gains recovered under section 34 where those harmed are not specifically identifiable, interest and profits from investing its moneys, sums recovered from entities whose failure caused payments out of the fund, and interest deemed to accrue on the proceeds of a public issue between the closing date and the dispatch of refunds or share certificates.
What the regulator can do before liquidation
Section 33A gives the Authority intervention powers that apply where a licence is suspended, where a petition is filed or a resolution proposed for winding up a licensed person, where a receiver or receiver manager is appointed over the licensed person or any part of its assets, or where the Authority becomes aware of any fact that in its opinion warrants intervention in the interests of investors, subject to giving the licensed person an opportunity to be heard. Notwithstanding any other written law, the Authority may appoint a statutory manager to assume the management, control and conduct of the affairs and business of the licensed person and to exercise all its powers to the exclusion of its board, remove an officer or employee who caused or contributed to a contravention or to a deterioration in financial stability, appoint a director who cannot be removed without the Authority’s approval other than by order of the High Court, and revoke existing powers by notice in the Gazette.
Decisions about compensation are appealable. Section 35 lets a person aggrieved by a decision of the Authority or of the Investor Compensation Fund Board, including a refusal to grant compensation to an investor who suffered pecuniary loss from the failure of a licensed stockbroker or dealer to meet contractual obligations, or to pay unclaimed dividends to a beneficiary who resurfaces, appeal to the Capital Markets Tribunal.
Analysis: the shares are the easy part
The structure protects the securities far better than it protects the cash, and the reason is architectural rather than financial. Securities are recorded in a system the broker does not own, in accounts segregated from the broker’s proprietary accounts, transferable to another agent on the holder’s instruction. A collapse therefore presents as an access problem rather than a title problem, and the fix is a transfer between agents rather than a claim in a winding up.
Cash is different. Client money sits in a bank account at the broker’s chosen bank, protected by a rule that it must contain only clients’ funds and must not be overdrawn, plus a reconciliation duty. Those are conduct obligations, and whether they held in any particular failure is a question answered by the administration of that firm rather than by the rule itself. The Investor Compensation Fund exists precisely for that residue, and its wording is narrow: pecuniary loss resulting from the failure of a licensed stockbroker or dealer to meet contractual obligations. It does not reach a loss caused by the market, by an issuer’s default, or by the failure of an intermediary that is not a licensed stockbroker or dealer.
The two funds are also easy to confuse and do opposite jobs. The Guarantee Fund is a settlement backstop for the depository’s own participants, sized by a risk based contribution and disclosed in the depository’s balance sheet; it makes a trade complete when an agent fails on settlement day. The Compensation Fund is an investor backstop administered under the Capital Markets Act. A holder trying to understand their position after a broker failure has a short checklist: confirm the securities account balance directly with the depository rather than through the broker, initiate a transfer of the account relationship to another central depository agent, separate any claim for cash from any question about securities, and treat the compensation route as applying only to the cash side and only where the statutory wording fits.
