By Keith Levenstein
Currently there is no legal recourse for BEE fronting, but getting caught could cause a business to lose customers and there is a stigma attached. But when the B-BBEE Amendment Bill is passed sometime this year directors could face up to a 10 year jail term.
The B-BBEE Amendment Bill says:
‘fronting practice‘ means a transaction, arrangement or other act or conduct that directly or indirectly undermines or frustrates the achievement of the objectives of this Act or the implementation of any of the provisions of this Act, including but not limited to practices in connection with a B-BBEE initiative. To assist companies, here are some current methods used to front:
An exempt micro enterprise (EME) is automatically level 4. An EME is one that has an annual turnover of less than R5-million (depending on industry and sector code), or is a star tup enterprise.
Many companies are either stating that their turnover is less than R5-million, or that they are a start up. An extreme case was a 50 year old company that created a new company (using the identical name as they have always had). The new company, with the same name as the previous company, had a registration date of 2011. Their auditor, also a verification agency, issued them with a level 4 EME statement.
This was notwithstanding that the company has been in business for 50 years and has a turnover of well over R100-million, 2 200 employees, and nine branches. The codes define a start up as being a newly established entity that is not merely a continuation of an existing business. They did not disclose to their agency that they were a well-established business and the agency (also their auditor) failed to check.
Same/Similar name fronting:
This is an extension of EME fronting. A company creates another company, with a similar name. It does no business, or very little business so this new enterprise is small and an EME, or sometimes a Qualifying Small Enterprise (QSE) defined as having an annual turnover of between R5-million and R35-million. Every call for a BEE certificate is met with the EME certificate, while the actual operating company is non-compliant.
A multi-national personnel agency produced an EME certificate for its management company of a similar name. The management company earns income in the form of profits from the operating company and pays it to their head office overseas. Its income is less than R5-million, and two independent verification agencies have issued it with an EME certificate.
Neither agency asked why a non-operating company whose only income is from “management fees” of the local operating business and whose only expense is paying profits over to a foreign country would want a BEE certificate. Their only “customer” is their foreign holding company that will never ask or require them to have a BEE certificate. Neither of the verification agencies asked why the main operating business did not have a BEE certificate. We have hundreds of examples of where this is happening.
Apparent Ignorance Fronting
Another company, a labour broker used the “same name” fronting activity. This involves having two similar sounding names and when caught out explained that they thought that they could not become compliant because they had no black ownership, so had to create a new business.
They even went as far as finding a black person to hold 52% of a non-operating business, while their genuine business had a turnover of nearly R100-million. To its credit, their verification agency on becoming aware of this practice refused to verify the front company the following year.
A JSE-listed company has produced a BEE certificate for a QSE showing 51% black ownership. Its only difference is they added the letters ‘SA ‘ onto the end of the name. The main operating business is well over R500-million. When reported to their verification agency, the agency did approach them. The company then moved to another SANAS accredited agency who were prepared to continue this practice. SANAS took no action.
Holding Company Fronting
Many companies are owned by a holding company. What they do wrong is look only at the income of the holding company, and not the total income of the entire group. Since some holding companies have their own separate financials for their own (head office) activities, they show the verification agency a turnover of less than R35- million, while the entire group has a turnover of billions. An extreme example is a listed company with a turnover of R1,3-billion that had a very lean head office – with a turnover of less than R5-million.This company produced and used an EME certificate.
We still see forged certificates bearing names of well-known verification agencies. The companies involved always blame their “verification agency”, but they must surely know that no verification, site visit was performed, and no file produced.
We are even beginning to see certificates using the EMEX or Harvard letterheads. Both companies no longer exist. Fronters probably use those logos knowing that no one from EMEX of Harvard will complain or catch them out. Some businesses have used our letterhead without knowing that we do not verify.
There are still businesses who pretend to be accredited verification agencies. Some go as far as using the SANAS logo on their certificates. They don’t know that the Accreditation Act makes it an offense punishable by up to 24 months in prison. Businesses should check if the agency is accredited by visiting www.sanas.co.za or www.irba.co.za
Some unaccredited agencies have a tiny disclaimer at the bottom of their certificate stating that they are not accredited. Many don’t even bother with this. They call it a “BEE rating Certificate” and in many instances their clients pretend that they do not know better. The problem is when we point out to the company that their certificate is invalid, they often ignore the situation and continue to issue the certificate that they now know to be invalid. This also meets the definition of fronting, but companies get away with it by claiming ignorance.
Sector Code Fronting
The first sector codes appeared in 2009. Companies were slow on the uptake, and many continued using the codes of good practice. Today still some companies use the codes of good practice rather than following a sector code, even though they belong to that sector. Initially this was caused by verification agencies choosing to use the codes because they did not have the required accreditation for the sector code. There are some good reasons to use the wrong sector code or codes of good practice:
· Certain sector codes are harsher for EMEs and QSEs. For example, entities in the tourism sector are defined as EMEs only if their turnover is less than R2.5 million. Many companies, especially guesthouses issue BEE certificates/accountants letter showing that their turnover is less than R5million. This practice works very well, especially if the tourist business has a name that does not describe the industry. Many auditors are guilty of this practice and when approached feign ignorance. However they don’t retract the certificate. We regularly report this to the dept of tourism, but they have little interest.
· In the construction sector, BEPs (built environment professionals such as quantity surveyors and architects) have an EME threshold of only R1,5-million. They also have a QSE threshold of only R11,5 million, so many chose to ignore the sector code and use the more lenient codes of good practice.
By either reducing the company turnover or verifying a projected future turnover a company is able to lower their turnover and use an easier scorecard. We often see letters signed by accountants that state “This is to certify that the turnover for Company X will not exceed R5 million rand per annum in the next financial year”.
The old financial year front
The more distant the financial year the more likely the company is to be small. If you were to get a verification for a past year you could go to another agency and use that same financial years’ data to get a new verification (this time valid for the current period). We have seen agencies allow a financial year end to be verified up to 4 previously. This would mean that you could be verified based on your February 2009 financial year end and have that certificate valid ending in February 2014.
Obviously the most well-known form of fronting is putting a “black name” onto a share register. Very often a company will “give/transfer” shares to a black person, who is not even aware of this. The company will also obtain a signature from the black person agreeing to sell the shares back to the company at the same price as the purchase price. Effectively the black person will be used to warehouse the shares.
Many companies are setting up valid employee trusts, but some have recognised that this is an ideal way to pretend to do an ownership deal. One company set up a trust, defined the class of person entitled to purchase shares as being “all black senior management”. The trust was allocated 25% of the shares, but there were no beneficiaries, as the company has no black senior managers.
The codes are clear that the verification agency must check the ultimate beneficiary, but all the agency did was check the rules of the trust and awarded the points. The following year, the company argued with its new agency who did not want to award the points. There was the threat of moving the entire company’s business away if the “right” points were not awarded.
We have a certificate from a large company showing it to be 59% black-owned with 29% of the shares in the hands of black women. On the face of it, this is fine. However the company earned zero points on management. This implies that the company has 100% white directors, executive and non-executive, and all top managers are white – not one black top manager.
Since BEE is all about opportunities for black people, and it is a very sensitive issue, it is highly unlikely that the majority black owners would only appoint white directors. The implication is that the black owners have chosen to have no one representing them at board level – or have chosen a white director. This should have highlighted the ownership as a fronting indicator. The least that the agency should have done is attach a report to the verified certificate showing that they applied their minds to this potential problem.
Management and Employment Equity Fronting
This refers to putting people into positions where they do not hold similar responsibilities or get similar rewards to white people in the same positions. If a verification agency performs proper interviews they can manage this risk. However companies are realising that they can earn more points by removing whites from official positions and letting them “pull the strings” remotely. Some companies show mainly black managers, but the real managers are those who officially have no job title. Verification agencies do not interview whites who could be more senior than their job title dictates.
Manipulated sample selection
Agencies are supposed to select a random sample, however since some employees are not available on the day or are in other towns not serviced by the agency it becomes very easy to suggest to the agency to pick another sample. SANAS does not allow telephonic interviews which leaves the agency no choice but to allow a “company selected random sample”.
This is a complex code, with multiple interpretations such as the “no training” front. Data that is verified is based on spend rather than skills learnt. A company could create an expense. The learner then either does not attend or has a fabricated invoice spend. The questions asked of a learner are generally very vague. The audit process does not allow for detailed interrogations and as a result spend that does not exist is included.
Someone else paid for the training
SETA’s often give grants to companies for training purposes. The company therefore receives an invoice which it passes onto the SETA for payment but does not actually incur the expense themselves.
Labour broker skills spend
Labour broker staff are not included on the company EE reports but include time and money spent training those people. This is not skills spend, at best it could be Enterprise Development but in most cases would be for a white-owned business so does not count.
Many mistakes are made with procurement, which will unwittingly misrepresent a company’s score. Common ways to front are:
Imports can be excluded from the procurement calculation if they carry a brand or specification different to one available locally. Some companies will attempt to ignore all imports, even if they do not meet this definition. This is an area where verification agencies do try to check, but it is still possible to increase the procurement score substantially. This is why the draft codes are attempting to disallow imports as an exclusion for procurement.
3rd party procurement.
If you spend money with a company who acts as a third party supplier, your true spend is with the actual supplier, not the third party. The most extreme case, and we’ve seen it a lot, is a company that spends money on its credit card applies the bank’s BEE status. They should look at each individual spend, eg restaurant, hotel, air flights, and apply the BEE status of each supplier. They often get away with using the specific bank’s BEE status because it is too “difficult to break down the credit card spend”. We believe it is mainly because banks tend to have a very good BEE score.
Some suppliers will collude with their customers to give them an invoice from “their BEE company” if the customer wants a BEE certificate.
This remains controversial due to multiple interpretations. One way that a company fronts is to perform early payment of invoices but then deduct a service fee, or early payment discount from the supplier’s invoice. In many cases any ED spend is recovered from the ED supplier in some other way so no actual spend takes place.
Some SED beneficiaries tell their donors that they meet the requirements for the codes when they do not. In some cases a company will offer products but vastly overvalue them. For example IT systems such as CCTV or computers lose value after a couple of years, so it would be fronting to value the cameras or computers as at the date of purchase. The right way to do so would to get an expert valuation, but it is easy to overvalue equipment.
All BEE certificates issued should include fronting indicators however most certificates report no fronting risk and the rest give a low or no risk indicator. We have not ever received a certificate with a fronting risk of high.
How to Spot Fronting
The best people to spot fronting are the customers of the business:
· Look at your invoice from them.
· Look at the company registration number
· Look at their VAT number
· If the registration and VAT numbers do not match, then the company has submitted a wrong/invalid/front certificate.
· Use a logic test to make sure that the elements they are earning points on makes sense. Is the turnover correct? Do they have black ownership?
· Consult an expert and give them your concerns.
Why is it so Important to Stop Fronting?
A B-BBEE certificate is used to get business. In the private sector some companies are insisting on a particular level before they do business with you. If your competition is fronting and reaches the required level, you will lose business.
Keith Levenstein is CEO of EconoBEE – a B-BBEE advisory firm