Issue: February/March 2006
Broad Based BEE
Knickers in a knot
Supposedly “final” codes of good practice on B-B BEE ownership appeared to recognise black membership of retirement funds for scorecard purposes, despite protestations to the contrary from the Department of Trade & Industry (DTI). Many funds can easily meet the defined criteria. But now the DTI wants submissions on whether, and how, “indirect ownership” should be recognised.
Somebody, somewhere high up in the Department of Trade & Industry (DTI), is having a big rethink. What had seemed clear as crystal from the first phase of the “final” good practice codes for the broad-based black economic empowerment (B-B BEE) scorecard, released last November, turns out to be clear as mud.
Back into the melting pot is whether shares held by black members of retirement funds – and various other categories of indirect shareholding, such as private equity – should be recognised for purposes of the ownership scorecard. Responsibility for the anomalies must be laid squarely at the door of DTI for having sidestepped share ownership via retirement funds. A perfectly legitimate interpretation, vigorously disputed by the DTI, is that the first phase implicitly recognises this ownership.
In December, however, the DTI released the second phase, which deals with a set of different issues such as preferential procurement, employment equity and skills development. At the same time, it returned to the first phase by the ministry requesting “public submissions and recommendations as to appropriate recognition of ownership contributions to B-B BEE facilitated through indirect ownership”. Because of urgency, says DTI, the submissions must be made by March.
“From the various public responses received,” the DTI noted in December, “there are extremely divergent views among stakeholders . . . as to whether indirect ownership should be recognised and as to the basis upon which it may be recognised”. Did higher authorities intervene? “Government,” says the latest statement, “recognises the important role that indirect ownership can play in advancing the objectives of BEE”.
Let’s stop playing with words. Even the term “indirect ownership” invites ambiguity. The crux of this matter has to do with beneficial ownership, irrespective of the vehicle, and not indirect ownership. Shares held by black individuals through companies such as Safika and Wiphold, for instance, are no less beneficial and no more indirect than shares held by retirement funds and collective investment schemes managed by financial institutions. Or so it should be, unless the codes are allowed to undermine the principle of shareholder equality.
The first phase of the codes, issued in November, was intended for gazetting under the B-B BEE Act. Unlike the drafts, it omitted any mention of pension or provident funds. From this absence of exclusion it can be inferred that retirement funds meeting the codes’ criteria in fact qualify for inclusion. In other words, the ownership of shares in companies by black people through retirement funds is recognised.
FIRST PHASE FINE AS IT STANDS
As such, the first phase is fine as it stands. There is ostensibly no need for further submissions except as a ploy for DTI’s nose to be put back in joint.
Taking the codes for what they say, as opposed to what the drafters might have intended, the consequences are profound. At one level, it will become easier for companies to reach their 25 percent ownership targets. At another, it can advance the role of black fund members in B-B BEE transaction financing rather than cause them sacrifice. At a third, by bringing black members to the fore, it should stimulate the shareholder activism that National Treasury wants to encourage and that the Financial Sector Charter commits institutions to pursue as the fiduciary managers of retirement funds (see box).
This is as it must surely be. There are no ownership vehicles more broadly based than retirement funds. They house over R1 trillion of assets for almost 10 million members.
Cosatu, with significant business support, has vigorously argued that retirement funds frequently represent the only savings of black workers and often are the sole means by which masses of people share in companies’ ownership. Exclusion of long-term black savers would therefore be illogical. It would also be unfair.
Historically, from introduction of a new labour dispensation in the 1980s, unions sought to use black members’ assets for anti-apartheid pressure on corporate behaviour. Later, under the democratic dispensation, the intent to empower workers gained momentum with the 1996 Pension Funds Act amendment entitling fund members to 50 percent representation on trustee boards.
THE ONGOING TIDE OF B-B BEE
More than this, the ongoing tide of B-B BEE transactions requires that somebody pays. Usually, it is existing shareholders. Especially with public companies listed on the JSE, by no means are these shareholders exclusively or even predominantly white. Invariably and substantially, they include financial institutions on behalf of retirement funds.
So, when new shares are issued by companies to B-B BEE consortia, the retirement funds’ shareholdings in those companies are diluted; fund members’ proportion of shareholding is reduced, which means they will receive a lower proportion of dividends and hence lower retirement benefits. It also means their share of ownership is reduced, resulting in them having fewer votes at shareholder meetings.
Particularly when new shares are issued at a discount to the prevailing market price, broadly based retirement funds additionally subsidise a transfer of wealth to consortia that are less broadly based. This is perverse.
Then, when the favoured consortia want to exit from JSE-listed shares, inevitably the prospective buyers include retirement funds. So the consortia get in earlier at a special price and the funds later at a full price, the difference being the profit to the consortia at the expense of the funds. This is elitist.
A main argument against inclusion of retirement funds in the B-B BEE codes is that black members cannot be separately identified. This is false.
Although funds tend not to profile members on the basis of colour, they have records enabling them to do so with similar efficacy to companies filing reports under the Employment Equity Act. It simply requires effort, for which the “follow-through” principle in the codes provides. The principle is used to determine “the entitlement of any category of black people to participate in an economic interest or exercisable voting right of a measured enterprise”.
The codes’ definitions clearly embrace retirement funds’ black members, or at least set out criteria that these funds can meet. For example:
The first step should be for a fund, wanting its black members recognised for B-B BEE purposes, to identify and quantify them. It will put them in line for B-B BEE benefits.
Or a company, wanting scorecard credits for black members of retirement funds holding its shares, can conduct the exercise. Say Company X is 20 percent owned by a retirement fund of whose members are 50 percent black. The scorecard credit for this company would be 10 percent B-B BEE ownership. The more black members in the more funds that are beneficial shareholders, irrespective of the number of institutions that nominally represent them, the faster the company effectively reaches its 25 percent scorecard target for black ownership.
There are conditions to be met. Among them:
To the extent that funds don’t comply already, they have the capacity to readily do so. All this seems sufficiently evident, but it does leave certain questions:
What’s the position of the Public Investment Corporation (PIC), given that “capital invested by an organ of state” is excluded? The PIC manages the Government Employees Pension Fund, by far the largest investor on the JSE. Arguably, the fund is a separate legal entity whose assets are owned by its members; while the PIC is owned by the state, the fund’s assets aren’t.
Will it be possible for companies to increase the shareholdings of their employees’ retirement funds for maximum scorecard credit? No. By regulation, a fund may not invest more than five percent of its assets in the sponsoring employer. Also, an increase in the fund’s shareholding will require approval from its employee-elected trustees.
How are multi-managers, who invest large pools of funds and whose portfolios are fluid, to keep track of beneficial shareholders? That’s a real problem for multi-managers to resolve.
On this interpretation of the final codes, the earlier drafts are eclipsed for equity and excitement.