THIS week, the Department of Trade and Industry held a conference to
discuss the illicit practice of “fronting” in broad-based BEE transactions.
“Fronting” refers to a deliberate circumvention of broad-based BEE
whereby an entity claims BEE credentials by misrepresenting facts. In short, it
is lying about one’s BEE credentials.
Its most common practice is having black people registered as
shareholders and directors but with no beneficial ownership of their equity and
no say in running the company.
In a typical broad-based BEE fronting deal, the economic benefits of
the purported ownership or directorships would flow disproportionately to the
black people, if at all, and the lion’s share would be pocketed by their white
counterparts.
Over the years, we have seen many reports of cases in which domestic
workers and gardeners discovered they were BEE partners of their unscrupulous
white “masters ”. These have never been investigated and prosecuted. Well,
until now.
Recent amendments to the Broad-Based BEE Act make “knowingly
engaging in a fronting practice” a criminal offence, the penalty for which is a
fine, or up to 10 years’ imprisonment, or both.
In addition, a person convicted of fronting will be disqualified
from business with any organ of state for 10 years.
The “domestic worker” cases are the obvious ones, and it’s easy to
see the injustice and accept that those who engage in such practices should
indeed be jailed and never be allowed to do business with the state, or any one
else for that matter.
However, the truth is that fronting has been happening for many
years, in a much more sophisticated manner and by much more sophisticated
people than some scruffy, khaki-wearing “master ” hoodwinking his unsuspecting
gardener.
In the late ’90s and early 2000s, every major South African company
was under tremendous pressure to do a BEE deal. CEOs and chairmen had accepted
there was no way to stop or even slow down the government’s transformation agenda.
To prosper in the new South Africa, one had to introduce broad-based black
shareholding.
But there was a problem. These companies were worth billions, and
“selling” 26% to black people with no money, on commercial terms, appeared near
impossible. The popular view was that markets and shareholders would hate it,
because whichever way you looked at it, a BEE deal would be dilutionary.
So these billion-rand companies had to think of ways to tick the BEE
box without giving away the crown jewels. They had to appease a Pretoria that
was unwavering on economic transformation, but they also had to retain the
support of Stellenbosch and Cape Town, the capital cities of South African
asset managers.
A number of CEOs at the time would call BEE “giving away value to
black people”. Of course, this was never said in public, with every major
company CEO singing the praises of BEE and how it was the “right thing to do”.
The truth is that many resented it and worked hard to devise ways to be seen to
be doing the right thing without really doing it.
Enter the investment bankers, in those days the smartest guys in the
room with their double-cuff shirts and Porsche 911s. Their job was to come up
with structures that looked like bona fide BEE deals with minimal value leakage
for white shareholders and, where there was a gap, an opportunity to profit
from this BEE thing.
As you can imagine, most of the mergers and acquisitions at this
time involved BEE deals, and lots of effort went into devising BEE schemes that
could be sold to clients. Hundreds of millions of rands in fees were earned by
lawyers and bankers for designing and implementing structures for the optimal
BEE deal for their clients.
One of the popular schemes was the special purpose vehicle structure.
It had two variations.
The first was to introduce black shareholders, through a special
purpose vehicle, at the level of the mother company.
The white company’s shareholders would “lend” the black shareholders
funds to acquire the shares. The black shareholders would cede their dividends
to service the loan and interest and, at some point, the share price would have
increased so much that a partial sale of the shares would settle the original
loan plus interest.
The upside was that the BEE shareholders were the rightful owners of
the equity at the mother company level on day one. Tick. The downside was that
the equity was obviously encumbered, and the settlement of the debt depended on
a consistently growing dividend income that outpaced the interest charge and,
of course, also a flourishing share price.
As we now know, many such structures fell apart mainly because the
shares didn’t perform as anticipated, dividends were not consistent and, as
investment bankers say, the deals eventually went “under water”.
The second SPV variation involved setting up a new company. This was
initially a shell that issued 26% shareholding to the BEE shareholders at no
cost, with the balance of the shares owned by the white mother company .
The “newco ” would then be the official BEE company of the group.
The original mother company, or crown jewel, would remain 100% white-owned and
the BEE company, with its 26% black shareholding, would be the vehicle used for
all government-related business.
One could recognise the products of these BEE deals by their names —
often some mixture of the mother company’s name and some African verb, like “siyaya”,
“siyakhula” or “ses’fikile”.
This was a great deal for the white company. It got to do a BEE deal
and got a cool black name without giving away any share of the mother company.
The white company didn’t have to fund the BEE shareholders or wait
for them to raise capital to conclude the deal. Best of all, the group had a
new subsidiary, with politically correct credentials and an incentivised team dedicated
to securing government business.
The white companies didn’t stop there. They would often charge the
BEE company a management fee for back-office services — sales support,
marketing support, office space and so on — and this would often be a
percentage of the revenue generated by the BEE company,
which further undermined its margins from whatever government business
it secured.
The white companies also recognised they had to sustain the facade
that the BEE deal was a group-wide transaction. There had to be a link of sorts
between the mother company, which remained lily-white-owned, and the BEE
company.
To achieve this, the mother company would appoint to its board the
key person in the BEE consortium, who was often a politician or struggle
stalwart.
His job, other than ticking the box of being a black director, would
be to report to the main board all the “business development and stakeholder
management” tasks being carried out by the BEE company on behalf of the group —
further entrenching the facade that a group-wide BEE deal had been concluded.
He would earn board fees, the status of being on a listed company
board, in return for protecting the group’s interests with the government and
regulators.
We never called this a front; we called it a partnership.
As I mentioned, in a typical broad-based BEE fronting deal, economic
benefits attached to the purported ownership or directorships would
disproportionately flow to black people, if at all, and the lion’s share would be
pocketed by their white counterparts.
The reality is that the mother company never transformed. Instead, it
pocketed most of the economic value created by the toil of the black
shareholders in the BEE company.
So how was this not fronting?
