/ 5 October 2012

Compliance is not black and white

Loopholes in the new codes on broad-based black economic empowerment make it easy toget a good rating with no real transformation.
Loopholes in the new codes on broad-based black economic empowerment make it easy toget a good rating with no real transformation.

The minister of trade and industry, Rob Davies, on October 2 unveiled the key changes in the draft revised broad-based black economic empowerment (BEE) codes. The draft codes are intended to amend the existing regime, which took effect in 2007. Under this regime, incentives have been offered to businesses in South Africa to optimise their broad-based BEE compliance levels. The immediate potential upside for such businesses is access to government work, public-private partnerships and state assets.

Broad-based BEE compliance levels are currently measured across seven different elements: black ownership, black management, black employees, skills development of black employees, the procurement of goods and services from broad-based BEE-compliant suppliers, support provided to black ­enterprises and socioeconomic development contributions.

Despite the very sophisticated rating regime and industry of verification agents established under the existing laws, broad-based BEE in its current form has been subject to myriad criticisms. The more prominent of these have been that broad-based BEE has benefited only a ­limited pool of beneficiaries and it has not achieved real transformation of corporate South Africa and, ultimately, the economy.

From a purely technical perspective, what has become obliquely clear is that through careful and clever structuring, businesses are able to achieve high compliance levels without real transformation ­having necessarily happened.

Many companies and foreign investors have also chosen to ignore what they consider the more expensive or risky element of broad-based BEE – black shareholding – and have focused on the other elements to achieve high compliance levels. These companies will under the proposed new regime be at risk of being downgraded by up to two levels if they do not have a minimum of 10% black shareholding. For example, a large company has 7% black ownership, but is a level three contributor, may be automatically reduced to a level five contributor because it does not meet the 10% minimum black ownership target.

Tick-box approach
According to Davies, the main rationale for the proposed amendments is to deal with the formalistic tick-box approach to broad-based BEE that corporates in South Africa have generally adopted and to ultimately achieve real empowerment. The amendments are also intended to align with the economic trajectory of the country so that productive black businesses are created and supported. Passive black shareholding and ownership may no longer be enough.

However, despite the intention of the government to encourage active and productive black shareholding in companies, loopholes remain that appear not to have been addressed in the draft codes. One such loophole is the Companies Act, which came into effect in 2011, also under the custody of the trade and industry department.

The maximum overall target for black ownership is 25%+1 vote. The 25%+1 vote was a sufficiently weighty target for voting rights, because black shareholders who had that level of voting power were in a position to block the passing of special resolutions under the old Companies Act. Under that law, at least 75% of the votes of shareholders were required to adopt a special resolution. Although the 75% rule is still possible under the new Companies Act, the new regime offers levels of flexibility so that the 75% rule may no longer apply for the adoption of special resolutions.

The new Companies Act allows companies to lower – or increase – the 75% rule, provided that there always remains a 10% differential between the percentage of shareholder votes required for an ordinary resolution and the percentage of shareholder votes required for a special resolution.

The lowest percentage required for an ordinary resolution is more than 50%. This means that a company could determine in its memorandum of incorporation that more than 60% of shareholders votes are required to adopt a special resolution. In such a case the company, if it has BEE shareholders who have 25%+1 of the voting rights, may claim maximum points for voting rights on the ownership element of the BEE scorecard, despite the fact that the BEE shareholders would not be entitled to block a special resolution.

Different classes
The potential to undermine does not stop there. The new Companies Act contemplates the ability of a company to authorise different classes of shares such that each class may potentially have assigned to it different voting rights in respect of different categories of matters. So a class of shares issued, for example, to BEE shareholders could potentially be assigned 25%+1 of the total voting rights in respect of most matters. But in some excluded specified matters, the same class could be assigned 15% of the total voting rights and yet 10% in respect of the few remaining but crucial matters. What, in such a scenario, would the actual voting rights of the BEE shareholders amount to for purposes of determining the BEE ownership score to be assigned to that company?

The BEE codes do not cater for schemes likely to be devised for BEE transactions under the new Companies Act and the draft codes have not addressed this issue either. More disconcerting is that many employees of the BEE verification agencies who evaluate these schemes are not lawyers, or have no or little understanding of the companies legislation. As it is, they constantly battle among themselves over interpretational issues pertaining to the current BEE legislation.

Another proposed amendment is that the number of elements of the generic scorecard will be reduced from seven to five. The total score across all the elements will increase from 100 to 105 points. Ownership will count for 25 of those points and enterprise and supplier development will be the highest contributing element, counting 40 points.

Another key shift is that the thresholds for exempted micro-enterprises and qualifying small enterprises have been increased. Entities with a turnover of less than R10-million (currently R5-million) will now qualify as exempted micro-enterprises and enterprises with a turnover of between R10-million to R50-million (currently R5-million to R35-million) will qualify as qualifying small enterprises. Exempted micro-enterprises that are 100% black-owned will automatically qualify as level one broad-based BEE contributors. If they are more than 50% black-owned, they will automatically qualify as level two contributors.

Safiyya Patel is a partner at Webber Wentzel