While investment managers often worry about the stock market, a different kind of threat can destroy a company from the inside. It’s called operational risk. This refers to losses from problems with your internal processes, mistakes made by people, or failures in your technology systems.
These aren’t dramatic market crashes; they’re the everyday errors and oversights that can grow into huge problems. A failure in your operations can cost you millions of shillings in fines and client compensation, permanently damage your reputation, and attract close, unwanted attention from regulators like the Capital Markets Authority (CMA).
Here are the five most common internal failures that can put your investment firm in Kenya out of business.
The 5 Critical Internal Failures
Failure #1: Poor Controls Over Client Funds
This is the most common and dangerous failure, where the core job of managing money goes wrong. A manager makes a risky trade that isn’t allowed by the client’s rules. Or, a simple mistake sends money from a low-risk pension fund into a high-risk investment.
- Warning Signs: Taking too long to balance accounts, not requiring a second person to approve large transactions, or giving one “star” manager too much power without oversight.
The CMA has very strict rules for how funds should be managed, as outlined in their Collective Investment Schemes Regulations. Breaking these rules can lead to severe penalties.
- Prevention: The best prevention is having strong, simple rules that everyone must follow. This includes automatic checks on trades and requiring two managers to sign off on big decisions.
Failure #2: Weak Client Risk Checks
If you don’t truly understand how much risk your client is comfortable with, you’re setting yourself up for disaster. For instance, an advisor may use a generic form to sign up a new client and wrongly label them as an “aggressive” investor. Their money is put into risky stocks on the Nairobi Securities Exchange (NSE) right before a market dip.
- Warning Signs: Rushing through the sign-up process, using one-size-fits-all questionnaires, and not regularly checking in with clients to see if their situation has changed.
The ups and downs of the NSE, which you can see in their official market data, make this mistake especially costly. A client can lose a lot of money quickly if their investment doesn’t match their risk level.
- Prevention: Create a solid process for checking risk. This means having real conversations with clients, asking them how they would feel if they lost money, and reviewing their profile regularly.
Failure #3: Bad Record-Keeping
In the world of investment, if it wasn’t written down, it didn’t happen. Messy records are a huge legal risk. A client calls and asks you to sell a stock. You do it, but you don’t write it down. Later, the stock price goes up, and the client denies ever giving you the instruction to sell. Without a record, you can’t prove it.
- Warning Signs: Using messy filing systems, having no clear trail of client decisions, and relying on memory or emails for important instructions.
Both the Insurance Regulatory Authority (IRA) and the CMA require you to keep very detailed records of everything. These are the first things they’ll ask for in an audit.
- Prevention: Use a centralized digital system to log every client conversation and decision. This creates a clear record that can’t be disputed and protects you from “he said, she said” arguments.
Failure #4: Not Enough Employee Training and Oversight
Your employees can be your company’s best strength or its biggest weakness. A dishonest employee figures out how to make small, fraudulent transfers that go unnoticed for months. Or, an undertrained junior employee makes a simple mistake that ends up costing the firm millions.
- Warning Signs: Lots of employees quitting, not doing proper background checks on new hires, and managers who are too busy to properly supervise their teams.
Finding and keeping skilled financial talent is tough in Kenya. As noted in industry reports like this one from PwC, rushing the hiring process or failing to train staff properly increases the risk of costly mistakes and even fraud.
- Prevention: You need to use several methods at once: do thorough background checks, provide regular training, limit access to sensitive information, and make sure managers are actively supervising their teams.
Failure #5: Technology System Failures
As business moves online, your technology can become a major point of failure. Your trading system crashes on a busy day when the market is falling. Clients can’t sell their stocks, and they suffer huge losses that could have been prevented.
- Warning Signs: Using old software, experiencing frequent system glitches, not spending enough on IT, and not having a tested backup plan for when things go wrong.
Kenya’s push to become more digital is great for business, but it comes with risks. News outlets like Business Daily often cover this transformation. Firms that don’t invest in good, secure technology are asking for trouble.
- Prevention: There is no shortcut. You must invest in modern, reliable technology. This includes regular updates, testing your backup systems, and having a clear business continuity plan.
The Domino Effect: How One Mistake Leads to Another
Operational mistakes rarely happen on their own. They often trigger a chain reaction that makes the damage much, much worse. For example, a small tech failure (#5) leads to a bad trade. In the panic to fix it, an employee ignores fund controls (#1). The problem is discussed, but nothing is written down, causing a record-keeping failure (#3). When an investigation happens, it reveals there was a lack of employee oversight (#4) all along.
This is how a single crack can bring the whole house down.
Building Your Defense
Protecting your firm requires two things: preventing problems before they start and having a safety net for when they do.
Prevention First
- Regularly check your processes: Don’t just do financial audits. Review your day-to-day operations to find weak spots.
- Train your people: Make sure every employee understands the risks and their role in preventing them.
- Invest in good technology: Don’t cut corners on your IT systems.
- Have clear rules: Write down your company’s procedures and make sure everyone follows them.
- Stay compliant: Follow the CMA’s Guidelines on Risk Management to keep your business safe.
When Prevention Isn’t Enough
Even with the best plans, mistakes can happen. That’s why insurance is crucial. You need specialized coverage like:
- Professional Indemnity (PI) Insurance: Covers you for mistakes or negligence.
- Crime Insurance: Protects you from employee theft and fraud.
- Directors & Officers (D&O) Insurance: Protects your leaders from being held personally responsible for management decisions.
You can either be proactive and build a strong, safe company, or you can be reactive and wait to clean up a costly mess. Contact us today for a risk assessment and learn about our Comprehensive Investment Management Insurance solutions.
