How to deal with fronting in the context of BBBEE
These structures are usually, although not always in the forms of Trusts. Educational Ownership, Trusts, even Community Ownership Trusts are easy vehicles for fronting practices. The black fiduciaries are led to believe that they are doing good by assisting the “black beneficiaries” of these trusts who will never own any shares in these companies due to the structure of the transactions. Effectively, it only amounts to TRANSFORMATION on paper, designed to ensure maximum B-BBEE points for the company and a pittance for the beneficiaries who are left the remnants of the dividends declared after the company pays of the never-ending debt of the shares that the trust acquired in the company.
The victims are led to believe that they fronting company is a saviour sent to throw them a life-line out of poverty. Worse is that these fronting companies actually believe that too. The fundamental existence of fronting has always been premised on intransigent white-owned companies as the villains and unsuspecting black people as victims.
Conversely, the B-BBEE Commissioner has recently discussed the insurgence of a new obstacle to the objectives of TRANSFORMATION. According to the B-BBEE Commissioner, some black people are using their “blackness” as a commodity and are now willingly entering into fronting transactions with the intention of getting quick rich quick. This is counter-productive to the struggle for true transformation.
With the new sanctions imposed on fronting practices which include hefty fines and jail time, it is imperative to ensure that you do not get caught up with wolves in sheep’s clothing, regardless of their race.
The following guidelines from the DTI will assist you in identifying obscure fronting transactions:
- The black people identified by an enterprise as its shareholders, executives or management are unaware or uncertain of their role within an enterprise;
- The black people identified by an enterprise as its shareholders, executives or management have roles of responsibility that differ significantly from those of their non-black peers;
- The black people who serve in executive or management positions in an enterprise are paid significantly lower than the market norm, unless all executives or management of an enterprise are paid at a similar level;
- There is no significant indication of active participation by black people identified as top management at strategic decision making level;
- An enterprise only conducts peripheral functions and does not perform the core functions reasonably expected of other, similar enterprises;
- An enterprise relies on a third-party to conduct most core functions normally conducted by enterprises similar to it;
- An enterprise cannot operate independently without a third-party, because of contractual obligations or the lack of technical or operational competence;
- The enterprise displays evidence of circumvention or attempted circumvention;
- An enterprise buys goods or services at a significantly different rate that the market from a related person or shareholder;
- An enterprise obtains loans, not linked to the good faith share purchases or enterprise development initiatives, from a related person at an excessive rate; and
- An enterprise shares all premises and infrastructure with a related person, or with a shareholder with no B-BBEE status or a third-party operating in the same industry where the cost of such premises and infrastructure is disproportionate to market-related costs.
In addition to the above, red flags should be raised if it is noted that the Black shareholder does not get unrestricted access to the financial statements of the company and also if the repayment of the shares is structured in a manner that imposes hefty interest rates and the dividends declared to towards paying off the interest and never the capital debt.
The difficulty in combating the scourge of the self-seeking practice is that perpetrators do not seem to be deterred by the consequences of being exposed. It is unclear whether this is a result of ignorance being bliss or just an attitude of basic defiance to legislation. For the sake of clarity and to annul the former defense, the penalties for a person convicted of fronting as per the Amended B-BBEE Act 46 of 2013 includes a fine or a maximum prison sentence of 10 years, or in the case of a juristic person, a fine of up to 10% of its annual turnover.
Also, any person convicted of an offence in terms of the B-BBEE Act may not contract or, transact any business with any organ of state or public entity for a period of ten years from the date of conviction and will be registered in a register of tender defaulter with the National Treasury. Any contract awarded to the company found guilty of fronting may also be cancelled due to misrepresentation.