On 20 October 2020, the Broad-based Black Economic Empowerment Commission sent an unflinching message to those entities attempting to circumvent their transformation responsibilities: there is zero tolerance for entities involved in fronting and/or misrepresentation of their Broad-based Black Economic Empowerment (B-BBEE) status and such activities will lead to criminal investigation and prosecution.
Following investigation into 822 matters, the Commission has as many as 436 matters that are being criminally investigated or prosecuted. The Commission has referred seven matters for prosecution to the South African Police Services (SAPS) and the National Prosecuting Authority (NPA), and twenty-two to the Companies and Intellectual Property Commission (CIPC). Seven further matters are under institution of legal proceedings for remedial relief, while six are defending legal proceedings. Another twenty-two matters are involved in alternative dispute resolution.
This information was shared by the Commission during a webinar which sought to update the public on the progress it has made since its inception in 2016, in terms of the investigation of non-B-BBEE compliance which includes fronting, misrepresentation of B-BBEE status and falsification of B-BBEE certificates.
B-BBEE Commissioner Zodwa Ntuli has long flagged the practice of fronting as a critical impediment to transformation. More than 80% of the complaints received by the Commission relate to this practice, the majority of which stem from the mining, transport and construction sectors.
In order to ensure a coordinated effort in the bid to root out the practice of fronting, the Commission said that it had been working closely with the Specialised Crime Unit, the NPA, the CIPC and the Department of Trade and Industry (dti) (all of whom participated in the webinar). Now the Commission intends to ramp this up by enhancing cooperation with law enforcement agencies; increasing the issuance of summons; and ensuring the early referral of matters to the SAPS, the NPA and the South African Revenue Service.
Fronting is a criminal act
In terms of the Broad-based Black Economic Empowerment Act (referred to hereafter as the Act), fronting can be summarised as any initiative or practice frustrating or undermining the objectives of the Act. All organs of state and public entities are required to include B-BBEE requirements for a number of activities. This includes determining the qualification criteria for the issuance of licences, concessions or other authorisations; the development and implementation of a preferential procurement policy; the determination of qualifying criteria in the sale of state owned enterprises; the development of criteria for entering into partnerships with the private sector; and the determination of criteria for awarding incentives, grants and investment schemes in support of B-BBEE.
Non-compliant entities that seek to devise structures and schemes to circumvent these requirements in order to access government opportunities are, in effect, engaged in fronting. So too are those public and private entities that undertake the same to misrepresent their B-BBEE credentials when engaging in business with other entities. Thus, any B-BBEE information provided for a rating or otherwise can be the subject of fronting.
The Commission has unearthed schemes ranging from basic ownership structures including one or two shareholders, to highly complex structures that involve thousands of people through multiple corporate vehicles which purport to have Black ownership.
Fronting was criminalised in the BEE Amendment Act in 2013. Individuals deemed to have had actual knowledge of a fronting practice can face criminal sanctions that might include a fine and/or up to ten years’ imprisonment. Convicted individuals could be barred from doing business with organs of state for a period of ten years from the date of conviction. Companies could be given an administrative penalty of up to 10% of annual turnover, and awarded contracts with organs of state cancelled.
Which activities are deemed to be fronting?
Should there be any uncertainty about what constitutes fronting, the Commission has compiled a list of those indicators that raise red flags. The list includes twenty practices, of which six – in bold text below as per the Commission’s highlights – are particularly prevalent:
- Off-the-shelf ownership models;
- 51% ownership schemes and Trusts;
- Complex structures with multiple purposes or non-operating corporate vehicles;
- Opportunistic intermediaries;
- Registering new companies for automatic start-up B-BBEE Level;
- Extending B-BBEE Level to entities that are not compliant under the Act;
- White people, Chinese people and Foreign Nationals claiming Black ownership;
- False or fraudulent B-BBEE certificates;
- Non-adherence to section 10 of the Act by organs of state and public entities;
- Breaches of licence and tender conditions;
- Objections to outcomes of tendering processes;
- Deposing to an Affidavit when an entity must be measured;
- Requirements of sub-contracting in tenders/joint ventures/ED requirements;
- Enterprise and Supplier Development (ESD) abuse where Black people are required to sign and confirm benefits not granted;
- Contractual/ Shareholder/ Director disputes;
- Willing participants;
- Private settlements;
- Victimisation/ intimidation of complaints by the Respondents;
- Whistle-blower status in complaints; and
- Complainants not accepting the outcome.
Driving compliance to meet transformation
The Commission has reiterated its concerns about the low level of B-BBEE reporting and the overall slow pace of economic transformation. To address this, it has begun conducting site visits on the corresponding reports submitted in order to verify the accuracy of the information supplied, as well as to identify best practices which could then be shared with other measured entities. Companies that have failed to submit reports will also be scrutinised further as their conduct not only violates the Act, but could enable the harbouring of fronting arrangements. Those entities that have been slow to heed the warnings will now feel the might of the Commission as they find themselves faced with criminal prosecution.
The Commission is intent on improving the pace of transformation and encourages oversight structures such as accounting authorities and boards, accounting officers, social and ethics committees and audit and risk committees to enhance vigilance in reviewing and monitoring the measured entities’ compliance with the requirements of the Act. Furthermore, the Commission is committed to compelling B-BBEE compliance of entities through legal process under the Act for non-compliance as well as the imposition of fines and penalties as provided for.
The issue of ownership schemes and trusts
A third of all major B-BBEE transactions utilise ownership schemes or trusts. However, Commissioner Ntuli remains highly critical of this model, stating that there is little certainty around whether broad-based ownership is really benefiting the intended recipients.
Ntuli explains that the concern with trusts, broad-based ownership schemes and employee share ownership programmes is that they lean towards “passive” shareholding, meaning that there are no specific Black individuals able to drive transformation in the company. Additionally, Black participants of a trust do not own the shares in their personal names – the shares are rather held by trustees on behalf of the beneficiaries. While this is a feature of trusts under South African trust law and is also expressly permitted within the Codes, the Act requires full disclosure of beneficiaries, and the Commission looks to the Act for guidance on this matter.
In Annexure 100 (D) of the Act, the qualification criteria for the recognition of trusts include:
“4.1.1 the trust deed must define the beneficiaries and the proportion of their entitlement to receive distributions;
4.1.2 a written record of the names of the beneficiaries or the use of a defined class of natural person satisfies the requirement for identification;
4.1.3 a written record of fixed percentages of entitlement or the use of a formula for calculating entitlement satisfies the need for defining proportion of benefit; and
4.1.4 the trustees must have no discretion on the abovementioned terms.”
Furthermore, Commissioner Nutli has made it clear that the Commission does not want to see “CSI masquerading as ownership”. Thus, the advice for any company considering using the trust model is to ensure that the intended beneficiaries can be named and listed, and that the transformation transaction is clearly divorced from corporate social responsibility initiatives. The alternative is for companies to steer clear of this model.
Impact of trusts and broad-based schemes on B-BBEE in South Africa
Financial research house Intellidex issued a report in 2017 which found that since 2002, R51.6bn in value has been created specifically for charitable recipients through B-BBEE deals, including community trusts, existing charities and newly established foundations. The report challenged the widely held view that empowerment deals have benefited only a handful of politically connected elites and had little to no broad-based effect on the majority of black South Africans. The stated spending priorities of newly created foundations were overwhelmingly education, with 67% going to this cause. Community projects followed at 10.6%, with entrepreneurship at 8.4%. Other priorities included children and youth, women and skills development.
A further report issued by Intellidex in 2018, which examined in close detail the charitable and community components of some of the 100 largest JSE companies’ empowerment deals, reported a net asset value of R37bn (which reflected growth of about 31% from the value estimated at the time of the 2017 report) and the disbursement of some R3.3bn in public benefit projects.
Hay comments that the value created for beneficiaries through trusts and broad-based ownership schemes was potentially a game changer that could help alter South Africa’s history of inequality and unemployment if the money was well spent. However, the current uncertainty with regards to the requirements for trusts is becoming a potential minefield for corporates seeking to implement carefully structured B-BBEE ownership transactions.
Broad-based Black Economic Empowerment Commission gives fair warning
As the Commission’s progress to drive B-BBEE begins to gain momentum, it is crucial for entities and individuals that are entering, or considering entering, into empowerment transactions, to be fully cognisant of the nuances and complexities prior to structuring such transactions. It is more expensive and time-consuming to remedy a transaction once in progress, or worse yet, to discover that the transaction unwittingly includes what the Commission deems to be the “red flags” of fronting. Investment banking firm Bravura’s B-BBEE advisory services provide clients with knowledgeable, well-honed and insightful guidance to ensure that a compliant and equitable balance between economic transformation and shareholder benefit can be successfully achieved.
Published: Business Brief