State seeks to criminalise 'fronting' with new B-BBEE bill

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State seeks to criminalise ‘fronting’ with new empowerment bill
 

Draft legislation proposes severe penalties for both individuals and companies who misrepresent equity credentials, writes Linda Ensor
Published: 2011/12/05 07:05:42 AM

THERE are only two options for white-owned businesses wanting to win a government contract — accept the rules on black economic empowerment and transform, or cheat.

Cheating by misrepresenting the true nature of one’s enterprise, called "fronting", has been used to obtain certification as a black-empowered company as defined in the Broad-Based Black Economic Empowerment Act (BBBEE) and the codes of good practice in order to get state contracts.

Fronting is also used in the local content requirements frequently laid down by the government for some of its tenders, with companies falsely claiming to be local manufacturers when in fact they plan to import the products tendered for.

The practice has become so widespread it has spawned an industry of lawyers and accountants who Trade and Industry Minister Rob Davies says are involved in structuring complex deals in order to achieve it.

A number of fronting incidents reported over the years have described how the truck driver, tea lady or some other low-level employee has been cited as chairman or CEO or part owner of the company without their knowledge and without benefiting from such claims of employment or ownership.

This type of window-dressing is a relatively simple form of fronting which, like tax evasion, has become increasingly sophisticated. For example, "black- owned" companies are set up for the specific purpose of acting as the front for a white-owned one operating in the background.

The government now plans to criminalise fronting, which subverts the attainment of its aim to change the ownership structure of the economy, promote local industry and stimulate job creation. The BBBEE Bill adopted by the Cabinet proposes a fine or imprisonment of up to 10 years or both for individuals and 10% of annual turnover for companies.

Those convicted will be banned from doing business with any organ of the state, and the state will be able to cancel unilaterally a contract awarded on the basis of false information.

The MD of the black economic empowerment rating agency Empowerdex, Lerato Ratsoma, says a common form of fronting is where companies form "BEE" subsidiaries. "These companies tend not to have any capacity to deliver and rely solely on the parent company to fulfil their contractual duties."

Smaller firms tend to be guilty of the window-dressing type of fronting, while the more prominent ones use complex ownership structures, she says.

"The lesser-known type of fronting is benefit diversion, where everything seems correct, but upon closer analysis you find there are amounts being paid to other shareholders through, say, management fees or other fees that the black shareholder, if not financially literate, may not pick up on. This leads to their economic interest being reduced or to decisions being made that he should have been a part of, but is excluded from through some technicalities.

"Sometimes the share agreements the black shareholders sign are extremely skewed against them. That is a serious form of fronting that is normally picked up by verification agencies," Ms Ratsoma says.

The bill — due to be gazetted this week — defines fronting as that which "directly or indirectly undermines or frustrates the achievement of the objectives" of the act. It outlaws four types.

One is where black people who are appointed to an enterprise "are discouraged or inhibited from substantially participating in the core activities of that enterprise".

The second is where the economic benefits received as a result of a company having empowerment status do not flow to black people in the ratio specified in the relevant documents.

The third practice involves "the conclusion of a legal relationship with a black person for the purpose of that enterprise achieving a certain level of BBBEE compliance without granting that black person the economic benefits that would reasonably be expected to be associated with the status or position held by that black person".

Finally, the bill says fronting involves "the conclusion of an agreement with another enterprise in order to achieve and enhance BBBEE status in circumstances in which a) there are significant limitations on the identity of suppliers, service providers, clients or customers; b) the maintenance of business operations in a context reasonably considered to be improbable having regard to resources; and c) the terms and conditions were not negotiated at arm’s length on a fair and reasonable basis".

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