The recently established BEE Commission has been tasked to oversee the implementation of the BEE Act, and to ensure compliance by entities seeking to gain recognition for black empowerment. The Commission has prioritised the eradication of the scourge in fronting practice, and to refer offenders for prosecution accordingly. Fronting practice is now a criminal offence as per the recent amendments to the BEE Act. Offenders may face serious penalties such as fines of up to 10% of annual revenue, imprisonment, or even being prevented from doing business with the government.
Overstatement Of Black Beneficial Ownership
A large number of companies have chosen to establish broad based ownership schemes as part of compliance with the ownership element of the BEE scorecard. The DTI has indicated that broad based ownership schemes are susceptible to fronting. The most significant risk is the overstatement of black beneficial ownership, which is a fronting practice as defined in the BEE Act. Companies choosing to implement BEE ownership through broad based ownership schemes need to be aware of the related risks of fronting. One way of doing that is to ensure that broad based ownership schemes are properly structured, governed and managed.
Beneficial ownership by black people is measured in three main pillars:
- Economic interest
- Exercisable voting rights
- And the net equity value that accrues to black people in the measured entity
It is important to understand how black beneficial interest is measured. Below is a discussion on each of these pillars and how Transcend Capital can help you to govern your scheme such that it complies with good corporate governance and with the spirit of BEE.
Economic interest is similar in nature to a dividend right in the measured entity. A potential fronting risk is the abuse of this definition, since it does not accommodate payments outside distributions directly linked to ownership in a sufficient manner. For instance, economic interest may be diluted through excessive management fees, partner drawings, and profit share agreements, which may leave a black participant with a diluted return on ownership. In determining whether a measured entity meets the criteria for economic interest, a verification agency may review and take into account the memorandum of incorporation of the measured entity to determine the economic interest attached to each class of equity instruments, trace the economic interest in the hands of black participants through a shareholders’ agreement or similar document, or through share certificates or security certificates held by black participants, as the case may be, and interviewing black participants to determine whether they understand their rights to economic interest.
Voting rights are rights attached to an equity instrument which allow a black participant meaningful participation in the measured entity at shareholder level. A verification agency must determine whether these rights factually exist, whether the black participants are fully aware of them, and whether they can actually exercise them. The verification agency should trace the voting rights to some or other relevant documents such as the measured entity’s memorandum of incorporation, and any shareholders’ agreement, as the case may be, to inspect clauses that grant or restrict voting rights of black shareholders.
Net value is measured according to the unencumbered value of assets in the hands of black participants. A verification agency takes into account all outstanding debt, including notional debt associated with the acquisition of the shares by black participants, and if there are any third party rights attached to the equity held by black participants. In structuring their ownership transactions, measured entities must be mindful of the rate at which net value will be created through the servicing of outstanding debt. This will have a direct bearing on the ability of the measured entity to earn net value points and to meet its sub-minimum requirements pertaining to ownership.
The verification process for a measured entity can be an elaborate and time-consuming process. The introduction of the definition of fronting practice in the amended BEE Act together with guidance from the BEE Commissioner provides a good framework for measured entities to ensure that their broad based ownership schemes are compliant. If a broad based ownership scheme is not properly managed and governed, measured entities will run the risk of non-compliance. Furthermore, the BEE Commission has the authority to challenge measured entities that overstate black beneficial ownership in order to gain BEE recognition.
Many broad based ownership schemes are appropriately implemented, however, measured entities frequently underestimate the amount of time and resources required to ensure good governance in the administration of those schemes. As a result, Transcend Capital has recently established a trust administration unit, a team of experts who are fully qualified to provide guidance on all the relevant legal and regulatory compliance issues related to broad based ownership schemes, to provide administrative support to schemes where necessary.
Should you be interested in additional information on how we can assist you, please do not hesitate to contact our team.