As South Africa enters its third wave of empowerment deals, the use of trusts as an ownership vehicle continues to rankle the Broad-Based Black Economic Empowerment (B-BBEE) Commission. With a third of all major B-BBEE transactions using this model, it seems that for Corporate South Africa the model is here to stay. However, a recent roundtable discussion hosted by the B-BBEE Commission signalled that using a trust as a vehicle for broad-based ownership has outstayed its welcome.
Since the inception of the Commission three years ago, the issue of fronting has remained front and centre as a critical impediment to transformation. Commissioner Zodwa Ntuli reported to Parliament in 2017 that a growing number of companies were believed to be engaged in fronting their employees through trusts. That same year Department of Trade and Industry (dti) Minister Rob Davies, said that over 50% of the trusts registered as part of a major B-BBEE ownership transaction had been found to be non-compliant with B-BBEE requirements.
In the Commission’s first financial year of 2016/17 it received 191 complaints of fronting. Although this had dropped to 92 a year later, by the end of August 2018 the numbers of complaints related to fronting had risen to 125.
The Commission has so far issued 55 preliminary and 14 final reports. Some cases are being referred for criminal processes.
A roundtable session was hosted by the Commission in early 2019 to discuss strategies for ramping up of black ownership, particularly in South Africa’s township and rural economies. At the meeting the dti said that black ownership has declined across the country’s key economic sectors. Additionally, it said that the ongoing abuse of trusts has kept black people at arm’s length from the real, operational ownership of a business. A member of the BEE Advisory Council suggested that trusts and empowerment transactions were not the answers to true empowerment.
Evon Jeewan, Associate Principal at Bravura, an independent investment banking firm specialising in corporate finance and structured solutions with specialist expertise in B-BBEE ownership transactions, says that the existing B-BBEE Codes make specific provision for trusts to be used as an indirect form of B-BBEE ownership. Code Series 100 has specific rules that relate to broad-based ownership schemes (B-BOS) and employee share ownership programmes (ESOPs).
A report by capital markets and financial services research firm, Intellidex, indicates that the 25 trusts included in the report hold R37 billion in endowments, with spend to date on projects benefitting black participants totalling R3.3 billion.
Criticisms of trusts
Jeewan says that there are two main criticisms aimed at trust ownership structures. “Firstly, they lean towards ‘passive’ shareholding which refers to the fact that there are no specific black individuals able to drive transformation in the company. Secondly, black participants of a trust do not own the shares in their personal names – the shares are rather held by trustees on behalf of the beneficiaries. This is a feature of South African trust law and is expressly permitted within the Codes.”
Where black shareholding is held through a trust, the B-BBEE Codes require the trust deed to define both the participants in the trust, as well as the portion of their entitlement to receive distribution of the economic interest from the trust.
Dti Minister Davies says that in most instances trusts do not provide guidance on how they record information relating to the identity of each black participant. Additionally, certain transactions are structured in a manner where the beneficiaries are only selected each year (to receive benefits for education and so on), or it is broadly stated that a portion of dividends will go towards projects.
This is at odds with the Code requirements, according to Jeewan. “There is no stipulation that trusts, B-BOS and ESOPs list the detail of participants. On the other hand, there are detailed requirements that seek to protect participating groups against fronting. For instance, the Codes ascertain that black participants in an employee trust must take part in appointing at least 50% of the trustees and in managing the trust at a level similar to the management role of shareholders in a company. There should also be articulation of the participants having vested rights to distributions. As well as this, the Codes require the trustees to provide an annual financial report to participants at an annual general meeting. If the trust does not comply with the requirements, the ESOP B-BBEE ownership points cannot be scored.”
The B-BBEE Commission’s view on trusts
B-BBEE Commissioner Ntuli’s concern is that there has been little certainty around whether broad-based ownership is benefiting the intended participants. In a recent interview she remarked that in the first wave of empowerment deals, there had been no monitoring to ascertain whether B-BBEE had been implemented and whether members were effectively participating as shareholders. “This is when the Commission was established and it became our role to step in. We need to make sure that these vulnerable groupings really are going to benefit from those deals.”
Jeewan says that this view foregrounds points raised during the last roundtable session. “It has been proposed that the Companies Act Regulations be amended to require that the Companies and Intellectual Property Commission (CIPC) records data specifically to track black ownership, and that this be broken down by race and gender. It is anticipated that this amendment may go through Parliament to be promulgated in the Companies Act after the general elections in May. Apparently, the Commission has already begun the amendment of its registration forms so that it can gather race and gender information when companies are registered. To date the Commission has gathered this information from 6 000 of South Africa’s larger businesses.”
Ntuli says that as of December last year, a total of 341 major B-BBEE transactions (deals over R25 million) had been registered with the Commission, as per the requirement of the amended Codes. In assessing these, the Commission has found that over a third of the deals made use of the trust model in their ownership structures. Prior to concluding B-BBEE deals, companies are able to take advantage of the Commission’s service to assess the transaction upfront prior to registration, and provide non-binding confidential advice. Ntuli says, “We are able to look at the transaction and highlight where there will potentially be a problem, for example with regards to the proposed ownership structure.
“We have advised certain companies who have approached us specifically to provide input on transactions variables, for instance where a repayment of a loan is dependent on dividends and on the achievement of a particular share price in a particular year. When looking at the track record of the company, we’ve been able to assess whether this is going to be probable or not.”
“In such instances, we advise companies to remove those provisions and structure in a way that clearly shows the intention to pass ownership, and not to prolong ownership vesting while the company continues to be recognised for black ownership through the very credentials of those people who may not be getting anything.”
Ntuli says that for those deals already registered, the Commission assesses and advises on the need for remedial action where necessary. “We see a number of companies heeding the Commission’s instructions. But for those that inform us that there will be no remedial action taken, we will follow through to check that they are recognising black ownership. Our view is that you cannot recognise ownership which does not meet the requirements in terms of vesting, exercisable voting rights and all of those other rights that should flow naturally to a shareholder.”
The roundtable session’s findings will be gathered into a report with the purpose of advising government, although Jeewan says no time frame has been provided for this. “The findings could have an impact on the utilisation of B-BBOS and ESOP schemes. Although Commissioner Ntuli has stated that the trust model can be used to facilitate broad-based ownership, she has cautioned that ‘at the end of the day we must be able to look for the black person and find the black person in the deal.’ So far both the Dti and the Commission do not seem convinced that this is being achieved in many of the transactions utilising the trust model.”