BEE Partner, South Africa Economy Watch

High risk indicators

High risk indicators include the following:

• An enterprise claims that Black people are shareholders, executives or management, but the Black people are unaware or uncertain of their roles in the enterprise. If Black people are not given responsibility in keeping with their titles then there is unlikely to be any substance behind the claim.
• Black people who serve in executive management positions are paid significantly lower rates than the market standard. Unless all salaries in that enterprise are lower than market standards they are probably empty titles with no responsibility and further investigation will be conducted.
• An empowered operation only performs peripheral or marketing functions and no other significant operational functions as would be expected from such an enterprise. In order to obtain government contracts, the enterprise needs to have a high BEE score. A manufacturing concern sells off the marketing function to Newco (Pty) Ltd, which sells 51% of that business to a Black partner. The marketing business has a fixed contract to sell one company’s product only to specified customers who require BEE credentials. It is majority Black owned and scores highly on all the elements apart from procurement and stands a good chance of obtaining business from the public sector contracts. The white-owned manufacturer retains the core business with no need to comply with BEE to secure public sector contracts. The marketing company will either be deemed an opportunistic intermediary (front) or it could be seen as the sale of an asset and therefore contribute to the ownership element or it could be classified as enterprise development. It is a fine line and the answer lies in the substance.

The enterprise relies on a third party to conduct the majority of its core functions.

• The enterprise cannot operate independently without a third party as a result of contractual obligations or the lack of technical or operational competence.
• Any practice that circumvents or attempts to circumvent the Codes — this is a fairly sweeping statement as it implies that no creative implementation that is not in line with the spirit of the Codes will be accepted.

Moderate risk indicators

Moderate risk indicators include the following:

• Black people claimed by the enterprise as shareholders, executives or management have limited knowledge of an enterprise.
• There is no apparent active participation by Black people claimed as top management at strategic decision-making level.
• An enterprise pays management or administration fees to a related person or shareholder with no BEE status (transfer pricing).
• An enterprise obtains goods or services at a significantly different rate than market rates from a related person or shareholder (transfer pricing).
• An enterprise receives loans not linked to share acquisition from a related person at an excessive rate (thin capitalisation).
• An enterprise shares premises and infrastructure with a related person or shareholder with no BEE status operating in the same industry where costs of such premises are disproportionate to market-related costs (transfer pricing/opportunistic intermediary).

Businesses should review risk indicators to change initiatives so that they are in line with the requirements of BEE. If a person is appointed to a role above their level of expertise, educate that person and develop their skills so that they are capable of satisfying the needs of the role.

If the measured entity knowingly engages in business with a front, it is also fronting. The BEE status level of a front may be stripped, in which case the entity purchasing from the front will lose its preferential procurement points. In this situation, the Minister of Trade and Industry has the power to disqualify both entities’ BEE score for a period he or she sees fit. If detected by a verification agency, the commen-surate points will be adjusted accordingly.

The legislation only binds the organs of state and not the private sector. Therefore any fronting detected may not be automatically treated as fraud as per the broad-based BEE Act. However, there may be other laws that may be used by the government to take legal action against fronting companies.

Turnaround Fronts

This is an example of how a front can be manipulated by Black people to their advantage. An intended front was transformed leaving the established company hanging out to dry. A variation of the classical fronting model was used.

A Black party who owned a small business was approached by an established company to form an entity together, with the white shareholders to source business from government and any other companies that required BEE credentials. The newly formed company would be 51% Black owned and it would then outsource all the business to the established company.

The Black partner knew that this could be seen as fronting. Therefore, to ensure that this would not be detected he cleverly negotiated a shareholders agreement with the established company that took out most of the restrictive terms.

In the first few months of operation the company received good volumes of business based on their unverified BEE credentials. The Black partner used this period to learn more about the technical aspects of the business and started building operational capacity in the company. The other partner could not legally stop him from doing so because of the cleverly crafted shareholders agreement.

Within two years the Black-owned company had full operational capacity and a booming business leaving the old established company a shell. The white shareholder of the established company who had 49% in the Black-owned company saw his fortunes rising along with those of the Black shareholder who had control of the company.

Fixing Fronts

The fronts that are easy to fix are those where there are restrictive terms in the shareholders agreements, where the white shareholders seek too much protection. In these cases, the shareholders agreements can be amended to give the Black partners more breathing space to function without undue restrictions in the company.

There are fronts where the Black partners do not have the requisite skills to run the business but are appointed as managing directors. The Black partner is given a role which that person is not necessarily equipped for, setting him or her up for potential failure.

If the situation is reasonable, an aggressive and constructive skills development programme can be put in place. If the Black director accepts the challenge, the front is on its way to being transformed.

There are those fronts that will never be transformed and the only remedy may be “blacklisting” (pardon the pun!) all the parties involved, including the directors of those entities. This may be the only way to curb the scourge of fronting.

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