Research and Policy Brief: Changes to BEE: Present and Proposed

"On 7th December 2011 the Government brought new BEE procurement regulations into law. It also unveiled a BEE amendment bill intended to prohibit fronting and lay down prison and other penalties for misrepresenting BEE status. If the Bill is adopted in its current form, this will be the first time since 1994 that jail terms will be available for failure to comply with affirmative action laws."

BEE CHANGES: PRESENT AND PROPOSED

Procurement

• New procurement regulations under the Preferential Procurement Policy Framework Act of 2000 came into force on 7th December last year.
• The regulations widen the scope for preferential procurement by requiring the State to assess the black economic empowerment (BEE) status of firms tendering for government business on the basis of the seven BEE elements in the generic codes of 2007, rather than on black ownership alone.
• The new regulations also specify a number of sectors (locomotives, rolling stock, and canned foods, for instance) in which the State must increase its local procurement of goods and services to boost the domestic manufacturing sector.
• The regulations show that the determination of the Department of Trade and Industry (DTI) to tighten BEE rules has triumphed over the National Treasury's concerns about increasing the scope and costs of BEE procurement.

"Fronting" and "incubation"

• Also on 7th December 2011, the minister of trade and industry, Dr Rob Davies, released the Broad-Based Black Economic Empowerment Amendment Bill of 2011 (the Bill), which is intended to proceed through Parliament this year. 
• The Bill's main purpose is to prohibit and punish ‘fronting' by firms seeking to win state contracts or licences by artificially inflating and so misrepresenting their BEE credentials. The Bill defines fronting in an extraordinarily wide way and gives discretionary investigative and other powers to a new BEE commission operating under the minister's control. 
• Penalties for misrepresenting BEE status include the cancellation of contracts, the blacklisting of culprits, prison terms of up to ten years, and a fine of 10% of turnover for enterprises.
• Established companies will be expected to ‘incubate' new businesses and could be seen to be fronting - with all the penalties flowing from such misrepresentation - if they fail to turn their BEE start-ups into successful firms.
• If the Bill is enacted in these terms, it will be the first time since 1994 that jail sentences will be available for failing to comply with racial laws.
• Private firms, irrespective of how small they are, will have to report to the commission on their BEE compliance, along with stage agencies and parastatals.
• All organs of state and public entities will have the right ‘to determine their own transformation policies' with the minister's consent. Such policies will override the generic BEE codes and probably sectoral charters as well. This could throw existing BEE rules into a quagmire of conflicting obligations.

Introduction 

The Broad-Based Black Economic Empowerment Act of 2003 (the 2003 BEE Act) seeks to give black South Africans greater ownership and control of the economy and increased access to economic activities. The statute, though adopted in 2003, became fully operative only in August 2008 when codes of good conduct gazetted by the Department of Trade and Industry (DTI) the previous year were finally brought into effect.

The codes set out seven different elements of black economic empowerment (BEE), these being ownership, management control, employment equity, skills development, preferential procurement, enterprise development, and socio-economic development. Large companies, defined by the DTI as those with annual turnover exceeding R35m, are expected to comply with all seven elements. Smaller companies - those with annual turnover between R5m and R35m - may choose four out of the seven to pursue. Micro businesses, with turnover of less than R5m, are officially exempt.

From the Government's perspective, two problems have come sharply to the fore since the codes took effect. The first was the conflict between the codes and the Preferential Procurement Policy Framework Act of 2000 (the 2000 Procurement Act), which obliged organs of state to give preference in procurement to firms which were black-owned. The 2000 Procurement Act thus assessed empowerment on the basis of black ownership alone, while the codes had seven elements for measuring BEE status. The 2000 Procurement Act thus reflected a ‘narrow' approach to empowerment while the codes were broader in their focus.

The second problem was that many firms began resorting to ‘fronting' - colloquially dubbed ‘the renting of black faces' - to gain an unmerited preferential access to state contracts or other benefits. (Before the codes took effect in 2008, fronting was aimed mainly at appearing to satisfy the ownership requirements of the 2000 Procurement Act without actually doing so. After the codes came in, the pressure on firms to gain good BEE scores increased, creating incentives for businesses to overstate their BEE credentials in other spheres and for other purposes too.)

Fronting techniques became increasingly sophisticated, prompting Dr Rob Davies, minister of trade and industry, to comment in 2010: ‘It is not just as crude as a gardener becoming a managing director... It's now beginning to involve accountants, lawyers, and verification agencies that are giving people ideas of more sophisticated ways to front... It's becoming analogous to tax avoidance and tax evasion.'

Procurement regulations aimed at bringing the 2000 Procurement Act into line with the codes have long been in the pipeline. So too have new rules against fronting. On 7th December 2011 the regulations came into effect, while on the same day the DTI tabled a BEE amendment bill intended, among other things, to prohibit fronting in all its diverse forms.

The regulations, with their various changes to BEE rules, are thus already operative. The BEE amendment bill is scheduled for adoption by Parliament in 2012. Both the present and proposed new rules have wide-ranging ramifications for the private sector and the economy.

Present changes to BEE rules

Widening the basis for preferential procurement

The coming into operation of the codes in 2008 immediately raised the question whether the preferential awarding of state contracts should in future be governed by the codes or the 2000 Procurement Act. For three years the National Treasury insisted that the 2000 Procurement Act, with its emphasis on black ownership alone, was the only law with which state officials had to comply in awarding government contracts.

This stance reflected its concern (as the minister of finance, Mr Trevor Manuel, said in 2008) that an expanded system of preferential procurement under the codes would ‘compromise price-competitiveness', as many more state contracts might then be awarded on a preferential basis to BEE firms whose prices were higher than those of non-empowered businesses.

However, the DTI was determined that the 2000 Procurement Act should be brought into line with the codes - and it is this policy which has prevailed. The new regulations, which were gazetted in June 2011 and brought into effect on 7th December 2011, thus make it clear that the BEE status of firms tendering for state contracts must in future be assessed on the basis of the seven elements laid down in the codes. In addition, the empowerment status of any firm tending for government business will have to be confirmed by accredited verification agencies and not via self-assessment alone.

Local procurement

The new procurement regulations are also intended to buttress the revised Industrial Policy Action Plan (IPAP2) announced by Dr Davies in 2010. In the words of Mr Nimrod Zalk, deputy director general of trade and industry, they thus require ‘all government entities to buy locally manufactured goods, rather than imported ones, in designated sectors'. An initial list of such sectors was published in December 2011, at the same time as the regulations took effect. The current listed sectors include locomotives, rail rolling stock, buses, and power pylons, along with canned vegetables, clothing, and footwear.

The DTI says its aim is to counter the de-industrialisation of South Africa. However, it has yet to recognise the Government's own role in the declining competitiveness of the manufacturing sector, which has much to do with flawed labour and BEE policies, along with the State's failure to improve education and skills, curb crime, and provide essential infrastructure. The DTI's ‘solution' simply adds to the bureaucratic burden and will increase production costs in instances where imported goods would be cheaper and better.

The local-content requirements will also push up procurement costs for the public sector. According to Mr Zalk, ‘the Government is prepared to pay some price premium for buying locally, as long as this doesn't exceed the...broader economic benefit [in] preventing further de-industrialisation'. However, since the Government is not prepared to pay ‘twice as much' for a local product as a Chinese one, the DTI is busy drawing up guidelines to prevent public entities from paying ‘excessive premiums' for buying locally. The designated sectors are also expected to improve their productivity to keep costs in check. However, increased productivity is unlikely to be achieved via government fiat.

Proposed changes to BEE rules

Also on 7th December 2011, the DTI published the Broad-Based Black Economic Empowerment Amendment Bill (the Bill) for public comment. One of the main purposes of the Bill is to prohibit ‘fronting' with the help of a new BEE commission.

‘Fronting' and a new BEE commission

The Bill defines fronting in extraordinarily broad terms to encompass any ‘transaction' or even ‘any conduct' that ‘directly or indirectly undermines or frustrates the achievement of the objectives' of the 2003 BEE Act. Certain fronting practices are expressly barred. These include: 

• appointing a black person to an enterprise and then ‘discouraging or inhibiting him from substantially participating in its core activities'; and 
• entering into a legal relationship with a black person for the purposes of enhancing BEE compliance without granting the individual ‘the economic benefits that are reasonably to be expected'.

The Bill also seeks to establish a Broad-Based Black Economic Empowerment Commission (the commission) to investigate fronting, among other things. (This will be a new body, in addition to the Broad-Based Black Economic Empowerment Advisory Council for which the 2003 BEE Act provided from the start but which was only established in December 2009, with President Jacob Zuma as its chairman.

The functions of this advisory council, as its name suggests, are to advise the Government on BEE, review progress in achieving it, and facilitate partnerships between the State and the private sector to promote black empowerment.)

The new commission will operate under significant ministerial control, for its head will be appointed by the minister of trade and industry for a (renewable) five-year term, and will be paid such amount as the minister (in conjunction with the National Treasury) may decide. In addition, the commission will be subject to the minister's ‘policy statements or directives' in the performance of its functions. In practice, these provisions are likely to trump a clause stating that the commission ‘must be impartial and perform its functions without fear, favour, or prejudice'.

In investigating fronting, along with any ‘complaints relating to BEE', the commission will be able (with ministerial permission) to delegate ‘its duties and functions' either to the Special Investigating Unit (a unit within the National Prosecuting Authority, whose mandate is primarily to probe corruption) or to ‘any other person or organ of state'. These powers of delegation are very broad.

As for the commission's investigative powers, the Bill gives it discretion to decide for itself ‘the format and procedure to be followed in conducting any investigation'. The Bill is silent as to what evidentiary rules (if any) should be followed and what standard of proof will be required. It does, however, give the minister the power to make regulations regarding ‘the conduct of investigations' by the commission. Though such regulations could lay down a clear set of sound principles with which the commission must comply, there is no guarantee that the minister will use his discretionary power to that end.

Based on such evidence as it decides to muster, the commission will be able to ‘make a finding as to whether any BEE transaction involves fronting practices'. It may also institute proceedings in a court to restrain any conduct in breach of the 2003 BEE Act, and will be entitled to refer any contravention of taxation or other regulatory requirements to either the South African Revenue Service or the appropriate regulatory authority.

If the commission thinks that any matter it has investigated may involve the commission of a criminal offence, it ‘must refer the matter to the National Prosecuting Authority or...the South African Police Service' (emphasis supplied). This mandatory obligation indicates that the normal requirements of criminal law and procedure, along with the Constitution's guarantees of due process, will have to be fulfilled before the bill's draconian criminal penalties for misrepresenting BEE status can be applied.

Penalties for fronting

According to the Bill, a person ‘is guilty of an offence' if he ‘knowingly misrepresents...the BEE status of an enterprise' or ‘provides false information' to a BEE verification agency, organ of state, or other enterprise. ‘Knowingly' is defined as meaning either that a person has ‘actual knowledge' of a particular matter or ‘ought reasonably' to have had such knowledge.

Any person convicted of such misrepresentation will be punishable by a fine, imprisonment for up to ten years, or both. If the person convicted is ‘an enterprise', then ‘a fine of 10% of that enterprise's annual turnover' will also apply. No provision for a lesser fine is included in the Bill. Any contract concluded (or licence granted) on the basis of such misrepresentation may be cancelled by the Government, while those responsible for providing false information will be prohibited (without any specified time limit) from contracting with any organ of state.

At present, there is no explicit legal prohibition of fronting, though it could be considered a form of fraud punishable under common law rules. At common law, however, such draconian penalties would be unlikely to apply. If the Bill is adopted in its current form, this will be the first time since 1994 that jail sentences will be available for failure to meet BEE targets that shortages of skills, capital, and business experience among black South Africans make difficult to fulfil.

If people working for verification agencies or organs of state become aware of any attempt to misrepresent a firm's BEE status, they must report the matter ‘to an appropriate law enforcement agency'. Failure to do so is also an offence, for which the penalty on conviction is a fine, imprisonment for up to a year, or both.

Other functions of the commission

In addition to acting against fronting, the new commission will have a range of other functions. It must ‘supervise and promote' adherence to BEE rules, maintain a registry of ‘major BEE transactions', and ‘receive and analyse' the reports on BEE compliance which will have to be submitted to it by ‘organs of state, public entities, and private sector enterprises'.

All organs of state and public entities will have to report on their progress in meeting BEE requirements, not only to the commission, but also in their audited annual financial statements and annual reports under the Public Finance Management Act of 1999. All private sector firms - including firms officially exempt from BEE, or too small to qualify as designated employers under the Employment Equity Act of 1998 - will also have to report on their BEE compliance to the commission. Listed companies will have to provide such further information as the commission may prescribe. The minister will be empowered to increase reporting obligations by means of regulation.

These new reporting obligations will significantly increase the compliance burden on the private sector. However, this will not be the worst of it for the private sector will find it yet more difficult to cope with the additional uncertainty the Bill will generate. Much of this will stem from the Bill's overly broad definition of fronting, coupled with the commission's discretionary investigative powers. Still more unsettling, however, are two further provisions in the Bill which could generate great confusion over the content of BEE requirements.

Increased uncertainty over BEE requirements

The Bill gives all organs of state and public entities the right ‘to determine their own transformation policies' provided they have ministerial consent. It also says that such transformation policies will take precedence over the generic BEE codes gazetted by the minister. Hence, if Eskom, a public entity, were to adopt its own transformation policies, all firms seeking to contract with it would thereafter have to align their BEE efforts to these new policies rather than the 2007 codes. Moreover, if a number of parastatals or government departments were to develop their own (differing) transformation policies, this would negate a key purpose of the 2003 BEE act - to introduce some uniformity into empowerment requirements - and turn BEE compliance into a quagmire of conflicting rules.

Other provisions in the Bill suggest these new transformation policies might also prevail over the sectoral charters previously adopted by the mining sector, the finance sector, the agricultural sector, and so on. On this basis, a new transformation policy adopted by the Department of Mineral Resources, for instance, would trump the mining charter earlier adopted by the mining industry under the Mineral and Petroleum Resources Development Act (MPRDA) of 2002. But this would contradict all the Government's promises not to change the goalposts for the mining sector, while opening the door to arbitrary shifts in BEE ownership and other requirements. This in turn would further erode South Africa's capacity to attract mining investment. This problem would, of course, extend beyond the mining sector to other spheres of the economy.

A new obligation to ‘incubate' small businesses

The Bill also reflects the Government's determination that established companies must become more proactive in fostering the growth of small ‘black' businesses (black being defined under the 2003 BEE Act as meaning ‘Africans, Coloureds, and Indians'). Under the current codes, firms are expected to put 3% of net after-tax income a year into enterprise development, but they do not have to go further than injecting these funds. Under the Bill, however, firms will be expected to incubate small enterprises, by giving them both ‘financial and non-financial support', and thus ‘increasing effective black-owned and -managed enterprises'.

Any failure to provide such support will not only result in the loss of BEE points but could also expose firms to accusations of fronting. For the Bill expressly defines fronting as including ‘the conclusion of an agreement with another enterprise in order to achieve and enhance B-BEE status in circumstances in which...the maintenance of business operations...[is] reasonably considered to be improbable having regard to resources'.

Hence, if an established business (company A) agrees with a small black firm (company B) to put 3% of company A's after-tax profit into company B to help it grow (which will enhance company A's BEE status), then company A must also make sure that company B has sufficient resources, both human and financial, for it to be able to ‘maintain its business operations'.

For if company B is unlikely to be able to remain in business in the light of its available resources, then company's A agreement to help it could be seen as ‘fronting'. Under the Bill, the penalties for misrepresenting BEE status in this way could start with a fine of 10% of turnover and could include imprisonment for directors too. The best way for company A to avoid this risk will be to put great effort into incubating company B and turning it an ‘effective black-owned and -managed business'.

Other powers

The minister will also be empowered to entrust the commission with ‘such other powers' as he may think fit. According to the DTI, the commission will thus be ‘a champion for BEE, especially in parts of the economy where there has been very little empowerment, such as retail, manufacturing, and agriculture'.

Conclusion

In September 2011, in a speech to the Confederation of Black Business Organisations, President Jacob Zuma lamented the lack of ‘visible black industrialists' after a decade or more of BEE deals and expanding BEE policies. He also assured his black business audience that mooted changes to empowerment rules would help to ‘build up a generation of black industrialists': a rising number of ‘authentic black entrepreneurs who own factories and...produce whatever the market requires'.

 The Government seems to assume that increasing the BEE burden on established business will somehow make for more - and more successful - black entrepreneurs. Yet BEE is an important part of the reason for the paucity of black industrialists, for it encourages a sense of entitlement rather than entrepreneurial drive.

Mr Moeletsi Mbeki has repeatedly urged an end to BEE because it creates a culture of ‘cronyism' and discourages black entrepreneurship. What South Africa needs is an entrepreneurial middle class capable of creating wealth and expanding the economy, he says. Instead, BEE is generating an entitlement culture, ‘whereby black people who want to go into business think they should acquire assets free, and that somebody else is there to make them rich, rather than that they should build enterprises from the ground'.

Present and proposed new BEE rules will do little to inject fresh vigour into black business. Instead, they are likely to:

• increase the scope for costly and often inefficient preferential procurement at the expense of both taxpayers and poor people reliant on state delivery;
• give protection from foreign competition to inefficient local producers;
• burden the struggling criminal justice system with ‘fronting' prosecutions;
• threaten firms and businessmen with penalties out of all proportion to their supposed ‘crimes';
• erode the rule of law by giving yet more discretionary powers to ministers and officials; 
• add to the regulatory burden and the costs of doing business; and 
• make it still harder to generate investment, growth, and jobs.

Before enacting the Bill into law, the Government should remember the words of a French entrepreneur who recently said (regarding the regulatory burden in his country): ‘You can't play football with a sack full of rocks on your back.'

Dr Anthea Jeffery, Head of Special Research and Dick Gawith Fellow. This article was first published as an opinion piece in Business Day.

Click here to sign up to receive our free daily headline email newsletter