Archive for category Fronting
Many companies are hooking into what they consider a unique way to front and misrepresent their BEE status.
The BEE codes define an EME (exempt micro enterprise) as one that has an annual turnover of less than R5 million. The codes also state that a start-up must be measured as an EME in the first year following their formation or incorporation.
Section 6 of Code 000 states:
6 Start-up enterprises
6.1 Start-up enterprises must be measured as Exempted Micro-Enterprises under this statement for the first year following their formation or incorporation. This provision applies regardless of the expected total revenue of the start-up enterprise.
6.2 Start-up Enterprises are deemed to have a B-BBEE Status of “Level Four Contributor’ having a B-BBEE procurement recognition of 100% under this paragraph
6.3 In order to qualify as a Start-up Enterprise, the enterprise must provide an independent confirmation of its status.
6.4 Despite paragraph 6.1 and 6.2, Start-up Enterprises must submit a QSE Scorecard when tendering for any contract, or seeking any other business covered by section 10 of the Act, with a value higher than R 5 million but less than R35 million. For contracts above R35 million they should submit the generic scorecard. The preparation of such scorecards must use annualised data.
The idea that many companies have is to form a new business, that does the exact same work as the old business, but regard themselves as an EME in the first year.
What they don’t know is that “start-up enterprise” is defined in the codes as:
Means a recently formed or incorporated entity that has been in operation for less than one year. A start-up enterprise does not include any newly constituted enterprise which merely a continuation of a pre-existing enterprise;
Note the grammar error “which merely a continuation”.
Also paragraph 2.5 of Code 000 states:
2.5 Initiatives which split separate or divide enterprises as a means of ensuring eligibility as an Exempted Micro-Enterprise, a Qualifying Small Enterprises or a Start-Up Enterprise are a circumvention of the Act and may lead to the disqualification of the entire scorecard of those enterprises concerned.
This has not stopped hundreds of companies choosing to ask their verification agency for an EME status. Some companies are getting quite innovative. They don’t inform their verification agency that they are a start-up – they simply produce audited statements for the first year of operation of this new business. If they have not fully transferred their activities across to this new entity, then the entity will have a turnover of less than R5 million and be an EME. The Codes for Complex Structure and Transactions & Fronting do talk about how complex structure should be verified.
It is certainly a circumvention of the Act to produce or issue an EME certificate if the entity is not an EME.
The B-BBEE Amendment Bill makes allowances for up to 10 years in jail for fronting offenses.
B-BBEE Fraud and Fronting
Fraud and fronting is quite prevalent in the B-BBEE sphere. The expectation initially was that it would be self-regulating. The B-BBEE act and codes do not make sufficient allowance for legal regulation. Anyone who issues an invalid B-BBEE certificate or misrepresents their B-BEE position would be guilty of fronting. The dti and National Treasury have threatened to create a black list of such companies, but this has not worked to any great extent. There is no doubt that B-BBEE fronting is fraud – a company that deliberately issues an incorrect BEE status, and companies can be charged with fraud, or even in terms of the corruption act if they intended to use their BEE certificate in an illegal manner to make profits.
The hope was that companies, competitors, verification agencies would identify fronting activities and stamp it out. This has not happened. If a BEE certificate is presented to a company, it is usually, without question accepted. In some cases companies are checking, and may reject the certificate. Consultants and verification agencies too, often reject certificates that they deem invalid. Few however bother to investigate and report this to the dti. We are one of the few that do report, as per dti guidelines any infringement.
The proposed B-BBEE Amendment Bill, expected to be passed in parliament shortly does indeed criminalise fronting. The bill establishes the office of a B-BBEE Commissioner who is empowered to investigate and prosecute offenders. This however may only happen in one of two years time, after the bill is passed, the BEE Commissioner appointed, budgeted for and staffed properly.
Types of fronting
Companies are guilty of many types of fronting:
Ownership: Shares are sold/given to a black partner who is unaware of his duties/rights or even that he is a shareholder. In some cases the black partner has been forced to sign his sell agreement so the company can “take back” the shares when they wish
General misrepresentation: Companies give incorrect information to the verification agency about turnover, management, employees.
Exempt Micro Enterprise (EME) fraud: An EME is one that has a turnover of less than R5 million (depending on industry) and is automatically allocated level 4. Many companies deliberately understate their turnover in order to qualify as an EME. An extreme case was a R1.2 billion company that said its turnover was less than R5 million – and won business as a result of its BEE status
Qualifying small enterprise fraud (QSE): A QSE is one that has a turnover of between R5million and R35 million (depending on industry). Companies us the same fraudulent mechanism as for EMEs above.
Unaccredited verification agencies: A certificate is only valid if produced by an accredited verification agency. Agencies are accredited by SANAS or approved by IRBA. Many unscrupulous unaccredited agencies offer to produce genuine looking certificates without following any verification procedures. We have seen unaccredited agencies illegally using the SANAS logo. One non-accredited agency created a standard certificate showing 77 points and used “mail-merge” to put the names of his clients onto it. Companies may say they were scammed by these con artists, but when it is pointed out to them that their certificate remains invalid, they continue to issue it, effectively participating in the fraud and fronting process. Often companies will call in these con artists because they know they will not perform any verification checks, or even give them the level they need. Many of these “agencies” are incompetent. An extreme example was an unaccredited agency whose one page certificate had 20 mistakes.
Responsibility to report Fronting
The dti Code obligate companies and verification agencies to report fronting. Reporting is towards SANAS (who do try to take action where the offense related to SANAS), IRBA (who are new in the arena and tend to take less action) , the sector councils (who seem ot feel they have little power to investigate or take action), and the dti (who also feels that they have too little power. The reality is the current B-BBEE act requires that government “take into account and where possible apply” a BEE certificate when awarding tenders, concessions, licenses or similar activities.
This is probably the worst BEE Certificate I’ve ever seen.
Let’s identify the errors and problems on it:
- Produced by Hansie D Labour Brokers – not an accredited agency or approved auditor
- Ownership states “Male owned”. It does not mention any black ownership. (On contacting the company they confirm they have no black ownership)
- The rating certificate is called “Unaccredited Transitional SMME”. There was a transitional scorecard in 2007 ending in 2008, otherwise “transitional” does not make sense. In B-BBEE terms we use QSE, not SMME.
- Spelling: “procerement recognition rating”. Also “Non Complaint Contributor” instead of “Non-Compliant Contributor”.
- It lists the procurement recognition rating as level 2. The procurement recognition is 125% for level 2. However if you add up the points “earned” on the four elements, it comes to 100, which is level 1
- It lists the 7 elements by number 1100, 1200 up to 1700. This numbering methodology was used in the draft codes of 2005. The gazetted codes of 2007 use 801, 802, up to 807
- It lists code 1200 as “equity ownership”. It should be “Management”
- It lists code 1500 as “preferred procurement”. It should be Preferential Procurement”
- It lists code 1700 as “residual”. This is also a relic of the draft 2005 codes, and should be “Socio Economic Development”
- It awards 25 points to ownership because the business is 100% white owned. It should be zero.
- It awards 25 points to “equity ownership” (should be management) because the business is 100% white managed. It should be zero.
- The certificate is unsigned.
- It mentions a date of 01-02-2011 and a validity date of 28-02-2012. Certificates at most can be valid for one year, not 13 months.
- The table “BEE Status Qualification” describes the points to levels table: e.g “Level Two Contributor > 85 but < 100 on the generic scorecard”. It should be “Level Two Contributor >= 85 but < 100 on the generic scorecard”. There is a big different between greater than, and greater than or equal to. This is why the entity apparently earned 100 points but is level 2.
- The points earned for preferential procurement is 25 and enterprise development also 25. Based on the numerous errors we would doubt their methodology and calculations.
- Based on the errors identified so far we would doubt that they took into account key principle 2.6: “Any representation made by an Entity about its B-BBEE compliance must be supported by suitable evidence or documentation. An Entity that does not provide evidence or documentation supporting any initiative, must not receive any recognition for that initiative.” We doubt that they have the evidence to support their conclusions.
- Based on the errors identified so far we believe that key principle 2.4 applies: “Any misrepresentation or attempt to misrepresent any enterprise’s true B-BBEE Status may lead to the disqualification of the entire scorecard of that enterprise.” This certificate definitely misrepresents the company’s true B-BBEE status.
Proposed amendments to the Broad-Based Black Economic Empowerment Act (B- BBEE)
Cabinet approved the publication of the Broad-Based Black Economic Empowerment Act (B-BEE) Amendment Bill for public comment.
The proposed amendments to the Act intend to achieve the following objectives:
(a) Align the Act with other legislation impacting on the B-BBEE and with the codes
(b) Establish the B-BBEE Commission to establish an institutional environment for monitoring and evaluation broad-base black economic empowerment
(c) Provide for the regulation of the verification industry by the Independent Regulatory Board of Auditors
(d) Deal with non-compliance and circumvention by introducing offences and penalties
The proposed changes to the B-BBEE codes of good practice:
(a) Enterprise Development (ED) and Procurement to be elevated with each requiring sub-minimum and enhanced recognition for ED targeted at key sectors in IPAP and the New Growth Path
(b) Penalty provision for non-compliance with Enterprise Development and Procurement elements of the B-BBEE scorecard, and discount from overall score
(c) The points of ownership element should be broadened to include designated groups in the main points, creating greater incentives for genuine broad-based ownership such as employee share ownership, co-operatives and community ownership
(d) Setting sub-minimums/threshold for each element of the scorecard save for the adjusted ownership element
(e) The Qualifying Small Enterprises scorecard will be adjusted and certain elements made mandatory.The thresholds for Exempted Micro Enterprises will be reviewed
(F) The Employment Equity element to receive adjusted recognition and to be aligned to the Employment Equity Act (targets, Reporting and Definitions).
(g) Skills Development Element to be aligned to the New Skills development Strategy and the New Growth Path and
(h) Targets in the Ownership Skills Development Procurement and Enterprise Development will be adjusted.
In general, EconoBEE welcomes the proposed changes. We need to see the actual bill to analyse it in more detail, but in general, all the recommendations we have sent to the dti and BEE Council have been addressed.
We like that B-BBEE is being aligned with other acts, in particular the PPPFA which comes into effect on 7th December 2011.
More than a year ago we recommended to the minister that he establish an office of the BEE Ombudsman, to handle issues of interpretations, valid certificates, fronting, disputes. This is now being done via the establishment of a commission.
We also welcome IRBA as the overall regulatory body for verification. The verification industry has always had problems, starting with ABVA, and subsequently SANAS has struggled to handle our volume of enquiries and sort out various issues. We hope that IRBA will be fully staffed to handle the increased workload.
We were one of the first companies to raise the issue of invalid certificates, fronting and other non-conformances. We therefore welcome the approach that fronting will be penalised, and that the B-BBEE Commission will be tasked to investigate this.
In principle,we also welcome any proposed adjustments to the weightings and targets of the elements or the definitions. We have always like the fact that B-BBEE stands for “broad-based” implying it affects all aspects of the economy, and not necessarily only narrow based ownership.
We look forward to seeing the proposed bill and will make representations
Minister Davies spoke about B-BBEE during his budget vote: He said the following:
“Regarding economic empowerment more generally, the BEE Codes of Good Practice were promulgated 4 years ago and we are now in a better position to assess their impact. The Presidential Advisory Council has made several policy recommendations to allow for greater participation by black people in productive activities and to tackle what is now emerging as increasingly complex practices of fronting. To this end, the dti and the Presidential Advisory Council are focusing on reviewing the BEE Codes of good practice and possibly amending the BBBEE Act. This could entail, amongst others, refinements to ensure greater policy coherence in the application of BBBEE across government and to strengthen access to procurement opportunities through the now approved and aligned PPPFA regulations. We are also looking at ways to strengthen our efforts to combat the fraudulent practice of fronting.”
Business Day – 20th April 2011 is reporting as follows :
“Department of Trade and Industry acting director-general Lionel October said yesterday the recommendations of the advisory council — now being considered by the economic cluster of government departments — would shift the focus of BEE away from equity investment and ownership towards productive activities.
Currently, companies scored high marks on the BEE scorecard for black ownership, which gave them a high overall score even when they performed poorly in areas such as enterprise development and procurement.
A proposal being examined by the economic cluster is that minimum scores would be required for enterprise development and procurement — or the overall score would suffer. This would compel companies to aim for achievement in all areas.
Mr Davies said what was under consideration was that points would be deducted from the overall score if minimum scores for enterprise development and procurement from small companies were not achieved.
It would also not be enough to merely hand over money for an incubator or enterprise development project. Companies would have to be actively involved in fostering small businesses.
“In Asia, small and big businesses have a symbiotic relationship where big business gets a lot of input from small business and works hard to ensure that it has the required capacity and the technology,” Mr Davies said.
Complex forms of fronting also had to be addressed.
“We have seen that people who participate in ownership deals imagine that they have one thing, but then when they look at the fine print, they have something else,” Mr Davies said.
“There is now a whole industry of lawyers and accountants who are structuring these deals in particular ways.”
The above is not too different from our crystal ball gazing in our previous newsletter. This is what we said:
The dti has been looking at revising the codes, and recently issued a tender for companies, presumably law firms to take this further. Once the service providers are appointed, the process will take many months or even years to evaluate and then re-evaluate the B-BBEE codes. We are quite sure that this will not result in “canceling” B-BBEE, but gazing into a crystal ball we expect in one or two years time to see the following:
Ownership indicators will change to award more points to broad-based and employee ownership schemes. Individual ownership will be awarded less points. Less emphasis will be placed on direct voting rights and more emphasis placed on a new form of economic interest to ensure that new owners get direct benefit out of their investment. To date many companies do not declare dividends so a minority owner has no benefit, other than when he sells his shares, and in private companies there is no good way to value shares like the JSE does.
Will be worth less points than present. Currently one new black director can be “worth” up to 6 points. This is seen as only benefiting a few, it is not broad-based enough. Management may be reduced to 5 points or even consolidated into the Employment Equity element reducing the number of elements to 6.
Definitions will be cleared up. Allowing a significantly more objective measure of “senior, middle and junior” management employees. More points will be awarded. There is a possibility to have the definitions expanded to broaden the reach of the management levels. It should be noted that as from next year the targets for EE go up anyway.
Skills is anticipated to be the biggest beneficiary of the re-evaluations and will certainly be worth more points. Additional indicators, similar to the excellent construction charter will be created. This will include a more detailed breakdown including mentorships and bursaries. The cost of Skills Development will not be a major discussion point, rather what does that spend get used for. The cost will therefore be targeted in more specific and beneficial areas.
As from next year the targets for procurement go up anyway. Definitions and interpretations, especially around exclusions – imports, third party will be cleared up. The procurement element cannot change substantially as it is the theoretical driver behind Black Economic Empowerment.
Points may drop slightly. More indicators like those in the construction charter will be added. Some “easy” points, may decrease in importance. Mentorships for developing enterprises will be added. Increased emphasis will be placed on the type of beneficiary ensuring better Enterprise Development opportunities and not generic spend with any qualifying beneficiary.
Points may drop slightly in favour of the EE and Skills elements.
QSEs may find that the “easy” points on ED and SED will have less value.
The thresholds on EMEs will rise.
The charters will also have to be re-evaluated, so there may be a recommendation to decrease the number of gazetted charters
Let’s re-look at this in two years time and see how accurate we were.
Please advise urgently.
My client is a QSE BEP. If he follows the BEP scorecard his ED target is R22 500 because ED is based on leviable amount. His SED target is R11250.
If he follows the codes of good practice his ED target is R2800 because we will use indicative profit and R1400 for SED.
If he follows the BEP scorecard he will need to pay R33 750 for both ED and SED, but if he follows the codes his cost is R4200 – a differential of R29 550.
Since the dti and SANAS are still seeking clarity, apparently now from the DG, and you have not any statement either, I need to know if the dti will condone my client following the codes that most suit him. The precedents have of course been set and we all know that SANAS will not regard this as a non-conformance and dti will not withdraw the certificate…….
On the other hand I’ve got some clients who are NOT in the construction sector but tend to like the lower adjustment for gender so are going to follow the construction/BEP codes. Is this also okay?
I know of a company that signed the final gazetted forestry charter but wants to follow AgriBEE and will use generic until that happens. Is this ok?
Now that I think of it, another client who has a turnover of over R1billion would like to follow the QSE scorecard for tourism. Also, a difficult client (you know how clients are) likes the Construction generic ownership element, the freight transport management control (for QSEs), the codes for EE, the QSE codes for Skills, and forestry for the other elements. Can I please have special permission to change the codes to suit my difficult client? He also wants to use a verification agency that had a pre-assessment letter in Feb 2010 but has now expired.
Another client would like to use ArcelorMittal as their verification agency. According to SANAS, ArcelorMittal has been accredited (for legal metrology, specifically weighing instruments), and the client feels that since ArcelorMittal, like SANAS, has no BEE certificate, they are a good organisation to do their BEE verification. Is this possible?
Minister, in any event we know that the dti/BEE Council will never be able to identify and really does not care about fronting, but being law abiding I’d like your approval to recommend fronting to my clients, who are being hamstrung by my honesty.
Serra® Services is a company that provides washroom products and services. According to their web site,
“the company was established in 1985 and grown to create a competitive position in the washroom industry. According to independent market surveys, Serra® branded products are the preferred choice in seven (7) out of ten (10) “A” Grade buildings.”
I cannot find a definition of an A grade building but it appears to be similar to premium, top class office blocks etc. For example in March 2010, Redefine (a leadng property company issued a press release that it had acquired R520 million worth of A grade buildings), and there are hundreds of such properties.
Serra ® Manufacturing is part of the Serra®Group. It manufactures the washroom equipment that Serra® Services sells to these “A” grade buildings, and probably to lower grade buildings as well. They are the preferred choice in 70% of A grade buildings.
I know they offer services that include replenishing washroom supplies like soap dispensers etc and have monthly income from some of these customers.
Yet both Serra® Services and Serra ® Manufacturing state they are EMEs – i.e each entity, Serra ® Manufacturing and Serra ® Services has an annual turnover of less than R5 million – less than R416 000 per month!
Is this suspect?
1) Note how both scorecards use the same company registration number, even though they have different company registration numbers.
2) Both certificates are produced by SEIFSA, a non-accredited agency. The certificate produced in July 2010 is signed by the “analyst”, Charl Cilliers, but there is no signature of an officer from Serra ® or their accountant. The codes are clear: Only an accredited agency or the companies auditor of financial officer may sign EME certificates after 1st February 2010. The certificate is therefore invalid.
3) I do not believe that this company, that boasts of having its products in 70% of all A grade buildings is an EME in the first place. Note how they have even trademarked their company name. A R5 million per annum company does not do this.
This looks very much fronting, and joint blame must lie with Serra ® and SEIFSA which did not check with their accountant, or even use any initiative to decide if the company can indeed have a turnover of less than R5 million per annum. SEIFSA deserves criticism for continuing to sign verification certificates when it has no mandate to do so.
We have written to Serra ®, querying their turnover. There has been no response.
Fronting is defined as misrepresenting your BEE score. There is another method that people are using to front. In many cases people think that if they give a scorecard that on the face of it is correct, it will not be fronting.
Companies with holding companies are now beginning to use the scorecard from the holding company as their certificate. On the face of it this seems ok. The codes allow a consolidation and if they send a holding company’s scorecard, many people will regard it as perfectly correct. However a holding company is not the operating company and the codes allow a consolidated scorecard, not necessarily one from the holding company.
The problem with a holding company is its turnover is generally quite small. It receives dividends or management fees from its operating entities. It has large assets – being the value of the businesses it owns, but its turnover may well be less than R5 million. This is how people front. They produce an EME certificate showing the business to be an EME – level 4, and ignore the operating companies.
On the face if it the certificate is 100% correct. The holding company is indeed an EME. However, who is your supplier? The supplier is the name of the company and the company registration number that appears on the invoice supplied by the supplier to you. This is the operating company, not a holding company. The certificate you need is the one that uses the operating company’s data, which may well be a generic and non-compliant. When the company is confronted they often feign ignorance or apologise that they supplied the wrong scorecard, and promise to supply the correct one.
This is fronting. It is a deliberate attempt to supply a scorecard that misrepresents the true BEE situation. If you ask for a certificate from your supplier and they give you the wrong certificate, they are fronting and could be guilty of fraud.
Here is a good example: Look at www.zealous.co.za Their web site shows them to have at least two businesses: Zealous Automotive and Zealous Pressure Castings. The web site reports that Zealous Automotive alone employs 160 employees and the land is 12000m2 . The holding company is Zealous Holdings. The scorecard for Zealous Holdings (Pty) Ltd, same address, is that of an EME. They are trying to use this certificate as the valid one to all customers. They have to know full well that the holding company does not supply their customers and that it does not earn income.
Simple mistake or deliberate to misrepresent their BEE position?
We come across hundreds of black owned companies, all hoping to invest in your business. They tout themselves as being the ideal BEE partner. We have seen hundreds of deals, and companies advertising their new BEE partner. Our usual approach is to calculate the points they will earn as a result of the deal.
In addition we also look to see if this ideal BEE partner themselves have a BEE certificate, and invariable they do not. As far as I am concerned a company that sets itself out to be a BEE Partner, should also make the effort to obtain their own BEE certificate. Unfortunately this seldom happens. We could name hundreds of companies that think they are an ideal BEE partner, because they are majority black owned, but if they don’t bother to get their own BEE certificate, I have to suspect that they are not genuine about transformation and B-BBEE. If they were genuine surely they would want the whole world to know what their own BEE credentials are. In many cases they have not even bothered to do a self-assessment.
Often the company web site talks about empowerment, but seldom do they put their own BEE Certificate on the site, yet they use their “empowerment” credentials to get business, and to make deals.
If you do not have a BEE certificate showing at least level 4, you do NOT have good empowerment credentials.
Try the following exercise: Google “Black owned investment company”, and then look at each of their web sites, and see how many businesses are hoping to be BEE partners, but have no BEE certificate on their site.
There are two types of fronting taking place.
Fronting Activity 1:
The first, and most important, and most harmful is where a company allocates, or pretends to allocate shares to a black person, and puts him on the board, with the express intention of misrepresenting their business.
This is wrong, but happens in reaction to requests from predominantly government and public enterprises for details of the black ownership of the entity.
It is becoming commonly accepted that to do business with government or a public enterprise, you need to have anywhere between 25% and 60% black ownership.
There is no consistency: Various public enterprises and government departments have different requirements. Even within the same department, tenders have different requirements.
All public tenders are governed by the PPPFA (preferential procurement policy framework act) which lay down procedures and process from evaluating tenders. It even states that all tenders must take into account the empowerment credentials of each tenderer. It does not give any specific details on how those empowerment credentials will be evaluated, which is why each tender document looks different.
There is no clear interpretation of black ownership. As a result many unethical companies are creating front companies that are 51% black owned – where in some cases the black ownership has no idea he is even a shareholder, or has signed a proxy giving the other owners full rights to run the business as they please. There are cases where the new owner is only a temporary owner, and HAS to sell the shares back to the company some time in the future. While the ArcelorMittal deal is not necessarily fronting, this is exactly what their share deal is doing.
Fronting Activity 2:
The second type of fronting relates to the B-BBEE scorecard/certificate. A scorecard is usually only asked for by private enterprise, and measures the entities B-BBEE status against a wide rage of indicators – that is why it is called “broad-based”. Some companies will misrepresent their B-BBEE status to obtain a higher score than they would otherwise achieve. One recent example is of Shield Chemicals who forged their B-BBEE certificate – a fraudulent activity.
Because a certificate is based on up to 30 indicators, it becomes more difficult for a company to front, and it becomes easier for an analyst to identify that fronting. If a company used the dubious ownership methods mentioned previously, a consultant or rating/verification agency would quite easily pick it up and award zero points to the company as we estimated with the ArcelorMittal deal. The indicators are cleverly interlinked – if a company earns zero points on ownership and employment equity, it would be unusual, though not impossible if it earned full marks on management control and skills development, and these specific indicators would be checked by the rating agency.
A verified scorecard becomes a public document that is scrutinized, and is more likely to be caught out if fronting than where a company submits a tender to a government department, and includes falsified information. It is most likely that the customer will identify an invalid scorecard, or even a competitor. A verification agency will also examine certificates to see if there is an indication of fronting.
Most incidences of fronting are due to fronting activity 1, not 2. A broad-based scorecard is less likely to be fronting than a share certificate.
The best way to reduce fronting is for government to follow the B-BBEE scorecard approach.