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Is Corporate South Africa using employees to set up trusts for fronting purposes?

By 18th April 2018September 28th, 2020No Comments

The Commissioner of the Broad Based Black Economic Empowerment (“B-BBEE”) Commission, Ms Zodwa Ntuli, said in Parliament this week that more and more companies are fronting their employees through trusts. She reported that 83% of the 334 complaints that the Commission handled as part of its objective of implementing corrective enforcement to achieve compliance with the B-BBEE Act, related to fronting practices.

“Although complaints decreased slightly this year, fronting practice remains constant. We find more and more companies’ schemes fronting workers through trusts”, said Ntuli.

Dr Rob Davies, the Minister of Trade and Industry (“dti”), said at the end of last year that over 50% of the trusts registered so far as part of a major B-BBEE ownership transaction, are not compliant with the Broad Based Black Economic Empowerment requirements.

Shane de Villiers, Associate at Bravura, an independent investment banking firm specialising in corporate finance and structured solutions with specialist expertise in B-BBEE ownership transactions, comments that these sweeping accusations are not necessarily supported by the current B-BBEE legislation.

He explained that all major B-BBEE ownership transactions concluded on or after 24 October 2014, must be registered with the B-BBEE Commission. The comments that companies are using employees for fronting and that more than 50% of the trusts registered are not compliant with B-BBEE requirements are obviously of great concern to market participants.

Where black shareholding is held through a trust, the B-BBEE Codes require trusts 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. Davies commented last year that in most instances, the trusts do not provide guidance on how they would record information relating to the identity of each black participant. “The transactions are structured in a manner where the beneficiaries will only be selected each year to receive benefits for education etc., or it is stated that a portion of dividends will go towards projects.”

Davies concluded that most of the trusts do not satisfy the requirements of the ownership scorecard because the trusts are dedicated to skills development and community projects but not ownership, which means Black participants are treated as beneficiaries and not shareholders.

The Commission clamps down on fronting

In August 2017, the B-BBEE Commission announced that it was investigating a number of companies and entities for allegedly violating the B-BBEE Act. The commission also said it would look into fronting practices, including the use of trusts in B-BBEE ownership structures.

Ms Ntuli commented this week that there were opportunistic intermediaries and existing entities creating new 51% black-owned entities through which they do business. “We have issued 45 companies with findings and most are being referred for prosecution and criminal investigation. We issued 63 non-investigations on lack of jurisdiction and no merit, but these have shown us fronting practices date back as early as 2003. Companies such as Servest, Tempest Fire, Mammoet SA, Kearley Transport, Colentrade and Zimele Broadcasting resolved their complaints through the Alternative Dispute Resolution process that is allowed for in the Act,” said Ntuli.

The B-BBEE Commission’s view on trusts

Fronting is the practice whereby companies claim the benefits of B-BBEE ownership points for transactions that do not really benefit participants as claimed.

Since the B-BBEE Commission became active last year it has taken a strong stance on stamping out fronting, which is now a criminal offence. The B-BBEE Commission is particularly concerned with B-BBEE trusts that place restrictions on how beneficiaries of the trust should use the money they receive. This is a feature of many community trusts which are drafted for specific purposes, such as community upliftment and education. The B-BBEE Commission discourages companies from taking this route, to prevent the “abuse” of trusts as a fronting vehicle.

The B-BBEE Commission expressed its views in public and also in its Whistleblower Newsletter released in September 2017. De Villiers summarises the viewpoints held by the Commission as follows:

Beneficiaries as shareholders

• An ownership vehicle must be created to facilitate B-BBEE ownership and must not focus on initiatives that may qualify under Socio-Economic Development (“SED”).

• Where black participants are reduced to mere beneficiaries of a bursary scheme and not direct black shareholders, the transaction does not qualify as ownership but should rather be claimed as skills development.

• Beneficiaries must be specifically identified – a broad description of beneficiaries is not sufficient to qualify for B-BBEE ownership status.

Voting Rights

• A Trust or Broad-Based Ownership Scheme must transfer exercisable voting rights to beneficiaries, similar to a shareholder’s right to vote in shareholders meetings.

• Black participants should be treated as (indirect) shareholders and not mere beneficiaries.

• Trustees of the Trust must not be employees of the company.

Dividends and Capital Growth

• Black participants must have the equivalent right as a shareholder to receive both dividends as well as capital gains and growth.

A high-profile corporate publicly challenged the views of the B-BBEE Commission

In October 2017 Sasol announced its new Khanyisa BEE scheme to its shareholders. The supporting circular noted significant differences in opinion with the B-BBEE Commissioner regarding the treatment of the Khanyisa Employee Share Option (“ESOP”) scheme as well as the Inzalo Trust.

The B-BBEE Commission had raised concerns about Sasol’s entitlement to claim ownership points in respect of the proposed holding of shares by the Sasol Khanyisa ESOP and Inzalo trusts based on the B-BBEE Commission’s interpretation of what constitutes ownership. As such, the Commission said that it would not recognise the holding of Sasol Shares by the Sasol Inzalo Foundation and ESOP trusts as eligible for ownership points. Sasol begged to differ with the Commission’s interpretation of what constitutes ownership, pointing out that the structure of the Sasol Khanyisa ESOP and Inzalo Trusts was materially no different to structures adopted by other South African corporates in their B-BBEE schemes. Currently, the Commission is apparently considering arguments put forward by Sasol, and the company is engaging with the Commission in this regard.

This was the most high-profile instance of a corporate publicly disagreeing with the Commission on its interpretation of the B-BBEE requirements relating to trusts to-date.

What does the current B-BBEE Codes say about the use of Trusts?

Code 100 of the B-BBEE Codes deals with the requirements of the Ownership element of the B-BBEE scorecard. The requirements state, in clause 12, that measurement of ownership of trusts should adhere to the following in order to be recognized as such:

12.1 the entitlement of a black beneficiary to receive distributions or benefits from the trustee(s) of the trust must vest, provided that if such entitlement does not vest, but the trust deed is so structured as to allow the trustee(s) no discretion as to the identity of the black beneficiaries and as to the proportions in which such black beneficiaries will share in Economic Interest received by the trustee(s), this requirement will be deemed to have been met in the absence of vesting;

12.2 the identity of black beneficiaries may be expressed either by reference to

12.2.1 the person’s name; or

12.2.2 the person’s membership in a specified class of natural persons;

12.3 the proportion in which black beneficiaries will share in the Economic Interest flowing from a trust may be expressed either:

12.3.1 as fixed percentages; or

12.3.2 as the result of a formula against which that proportion may be determined.”

Clause 12 clearly uses the term “beneficiaries”, implying that the dti designed the B-BBEE Codes to be used in this manner.

It would seem clear from the legislation, that there is no compulsory requirement to list beneficiary names, or to maintain the same beneficiaries year-on-year. It has also been accepted practice over the last fifteen years that B-BBEE trusts generally do not distribute cash handouts to individuals, but rather invest in specific programmes to create specific impact.

Impact of trusts and broad-based schemes on B-BBEE in South Africa

Financial research house Intellidex issued a report in 2017 which found that since 2002, R51.6bn in value has been created specifically for charitable recipients through B-BBEE deals, including community trusts, existing charities and newly established foundations. Of the JSE’s top 100 companies, 87 had conducted B-BBEE deals and 35 of these included public benefit organisations as beneficiaries.

The report challenged the widely held view that empowerment deals have benefited only a handful of politically connected elites and had little to no broad-based effect on the majority of black South Africans. The stated spending priorities of newly created foundations were overwhelmingly education, with 67% going to this cause. Community projects followed at 10.6%, with entrepreneurship at 8.4%. Other priorities included children and youth, women and skills development.

Way forward to ensure certainty with regards to ownership of trusts

De Villiers said that the value created for beneficiaries through trusts and broad-based ownership schemes was potentially a game changer that could help alter South Africa’s history of inequality and unemployment if the money was well spent. However, the current uncertainty with regards to the requirements for trusts is becoming a potential minefield for corporates seeking to implement carefully structured B-BBEE ownership transactions.

De Villiers comments that both the dti and the B-BBEE Commission are required to operate within a defined regulatory environment, as defined by the B-BBEE Act and the B-BBEE Codes. At the moment there does not seem to be alignment with the legislation. De Villiers suggests that the dti should consider amending the B-BBEE laws rather than implying a lack of compliance in practice, as it will ensure regulatory certainty.
Categories: B-BBEE, News

Published: 18 April 2018