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BEE fronting legislation has serious implications

August 20, 2013

By Keith Levenstein a director of EconoBEE, a BEE advisory firm, discusses various types of fronting.

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: 


EME Fronting: 


An exempt micro enterprise (EME) automatically has a level 4 certification. An EME is defined as having an annual turnover of less than R5m (depending on industry and sector code), or is a startup enterprise.

In an extreme example, a 50-year-old company 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 R100m, 2,200 employees and nine branches. The codes define a startup 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 the new enterprise is small and an EME, or sometimes a Qualifying Small Enterprise (QSE) defined as having an annual turnover of between R5m and R35m. Requests 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 the head office overseas. The income is less than R5m, and two independent verification agencies have issued 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 a BEE certificate. Neither of the verification agencies asked why the main operating business did not have a BEE certificate. There are 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 they created a new business.

The company 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 R100m. 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 (turnover R5m to R35m) showing 51% black ownership. The only difference is they added the letters ‘SA‘ onto the end of the name. The main operating business turnover is well over R500m. When reported to their verification agency, the agency approached them. The company then moved to another SANAS accredited agency that was prepared to continue this practice. SANAS took no action.

Holding Company Fronting


Many companies are owned by a holding company. 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 R35m, while the entire group has a turnover of billions. An extreme example is a listed company with a turnover of R1,3bn that had a lean head office – with a turnover of less than R5m. This company produced and used an EME certificate.

Forged Certificates

We still see forged certificates bearing names of well-known verification agencies. The companies involved always blame their “verification agency”. But they know this is untrue. 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 are not a verification agency.

Unaccredited agencies

There are still businesses that 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 http://www.sanas.co.za or http://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 which they know to be invalid. This also meets the definition of fronting, but companies try 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, some companies still use the codes of good practice rather than following a sector code, even thoughthey 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 R2,5m. Many companies, especially guesthouses issue a BEE certificates/accountants letter showing that their turnover is less than R5m. This practice works 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 often 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 R1,5m. They also have a QSE threshold of only R11,5m, so many chose to ignore the sector code and use the more lenient codes of good practice.

Future turnover

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 R5m 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 certificate 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 how agencies allow the financial year-end to be verified up to 4 years 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. 



Ownership Fronting

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. The important issue is that businesses can earn a high BEE rating without having to have a black shareholder. 



Trusts


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 the agency only checked the rules of the trust and awarded the points. The following year, the company argued with its new agency that 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 agency should have attached 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”.


Skills Development


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 itcould be Enterprise Development but in most cases would be for a white-owned business so does not count.



– Procurement

Many mistakes are made with procurement, which will unwittingly misrepresent a company’s score. Common ways to front are:



– Imports:


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.


– Different invoices: 
Some suppliers will collude with their customers to give them an invoice from “their BEE company” if the customer wants a BEE certificate. 



Enterprise Development (ED)
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 manycases any ED spend is recovered from the ED supplier in some other way so no actual spend takes place.



Socio-Economic Development (SED)
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 butvastly overvalue them. For example, IT systems such as CCTV or computers lose value after a couple of years, it would be fronting to value the cameras orcomputers 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.


Fronting Indicators
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 their invoice.

·       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 awrong/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 



About EconoBEE

BEE is a complex business task, which consumes a considerable amount of time and resources. It needs a strategy planned with commercial logic, which is then properly implemented and monitored in a way that makes complete business sense.

Choosing the appropriate competitive B-BBEE strategy is a sophisticated endeavor requiring knowledge and familiarity with the minute intricacies of the B-BBEE Act and Codes of Good practice. The lack of expertise in many companies countrywide hampers the successful implementation of the B-BBEE Codes in their operations.

EconoBEE’s managed services offer a high quality streamlined step-by-step approach to becoming BEE compliant.

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