The great SOE (liability) vanishing act

“I’m on a mission to fix my own mistake,” jokes Ismail Momoniat, the acting director-general of the National Treasury. “Before I leave the public service, I want to have finished the review of the Public Finance Management Act (PFMA), so that we can fix the minor problems in it.”

Momoniat, a former maths lecturer who studied at the London School of Economics, was one of the architects of that law, implemented in April 2000, which was meant to introduce far greater accountability in how taxpayer money is spent.

But while every lacklustre state-owned entity (SOE) is now blaming the PFMA for just about everything — their inability to compete, their sluggishness in implementing reforms, Steve Hofmeyr’s sensibilities — Momoniat is perhaps being too harsh on himself.

After all, the PFMA was hardly a “mistake”, but rather a system of accounting for spending that perhaps didn’t evolve as it should have done over the past two decades.

Says Momoniat: “For the first 10 years of its existence, the PFMA wasn’t a problem. But over the next 10 years, the way it was implemented differed from the original spirit of the law, especially as it related to government procurement, and the auditors became far more technical in implementing it too.”

The result was that while the PFMA remained in place, a litany of new Treasury regulations (often issued as “instructions”) were bolted on, making it unwieldy.

Rather than going for the cumbersome process of overhauling the legislation, the Treasury opted for Band-Aids to close the gaping holes that opened up as state corruption exploded during Jacob Zuma’s tenure as president. “Irregular expenditure” in firms such as Eskom, Denel and Transnet began to resemble telephone numbers.

Today, Momoniat is philosophical over how this well-intentioned law, designed to provide more comfort to taxpayers that their money was being well-spent, seems to have spiralled out of control.

“If the PFMA wasn’t a problem in the first 10 years, you have to ask what happened to change that. Perhaps it’s that the auditors responded to the waves of corruption by becoming far more technical about interpreting it,” he says.

Either way, Momoniat is sympathetic to the view (emanating, vociferously, from firms such as Transnet) that this cascade of PFMA regulations “have made it impossible for honest accounting officers to do business”.

But if it’s confusing to the auditors, imagine how baffling the public finds it.

Essentially, the PFMA rules require SOEs to report “any material losses through criminal conduct and any irregular expenditure” in their audited accounts. Spending that fails to meet a technical requirement — if a state firm fails to get three quotes to buy so much as a paper clip, for example — is deemed “irregular”. Last year, Eskom had “irregular spending” of R67bn, but while some of this was certainly due to fraud , much of it related to mundane technicalities.

In the public eye, however, “irregular” expenditure is often depicted as “stolen money”, which isn’t the full picture.

Despite all the fuss over the PFMA, what irks Momoniat is that the carping about minor technical irregularities has shifted the focus away from whether the law is doing its job in flagging corrupt transactions. After all, just about every state-owned company was robbed blind between 2010 and 2017 — and auditors hardly raised a red flag.

“Given what happened during state capture, we need to review how our auditing system works. I’m very sceptical of the auditors,” he says. “We could see the corruption happening during state capture, and yet the accounts of Transnet, Eskom, SAA and others were never qualified. So, despite the PFMA, they missed the big stuff, and ended up obsessing about small irregularities.”

Conveniently, every basket-case SOE, flailing strategically, has been quick to blame the PFMA for all its ills. And while there is a sliver of truth to their complaints, it’s hardly the whole truth.

Notoriously, Eskom was granted a “partial exemption” by finance minister Enoch Godongwana on March 31 to exempt it from disclosing “irregular, fruitless and wasteful expenditure” in its accounts for the next three years.

It caused an almighty fuss. The DA’s Dion George and Ghaleb Cachalia called it a “hare-brained scheme aimed at hiding critical financial information from auditors, hoping to achieve a better audit outcome to enhance the utility’s credit ratings and make it appear more attractive to investors”.

In the end, with MPs baying for blood, Godongwana withdrew that exemption in June.

Only, now, the FM has learnt that the National Treasury implemented a new “instruction” earlier this year that snuck through under the radar — and that regulation does almost the same thing as that now withdrawn Eskom “exemption”.

However, this regulation — known as “Instruction No 4 of 2022/23” — doesn’t just apply to Eskom; it applies to all state-owned companies and provincial treasuries. And, as one worried auditor tells the FM, it has the potential to “badly mislead” the public about what’s happening in the accounts of South Africa’s beleaguered state sector.

Vanishing ‘irregular expenditure’

So what does Instruction 4 actually do?

In the sort of brain-curdling language you’d expect from accountants, the notice sent to “accounting officers” of public entities two days before Christmas last year dramatically overhauls the way “irregular expenditure” is accounted for.

Until now, all “irregular expenditure” had to be reported in the annual financial statements and be verified by that state company’s auditor and reported in the annual financial statements. And if the “irregular spending” dating back years wasn’t addressed, it carried forward to the next set of accounts too.

Instruction 4 changes that, at the stroke of a pen.

Now, “irregular expenditure” will still have to be included somewhere in the wider annual report, but it won’t have to be audited. For example, a casual member of the public who picks up an Eskom annual report will only see “irregular expenditure” from the past two years, and will have zero idea about whether money stolen years ago by, say, the Guptas, has been recovered.

Instruction 4 also allows the  board of the SOE to “condone” or pardon previous expenditure that contravened the PFMA, which means the historical numbers can shrink dramatically too.

Another practical example: if Transnet had bought trains from China under a dodgy irregular contract in, say, 2013, you now wouldn’t see this number in the audited financial statements. And Transnet’s board could “condone” this past spending, presumably on the basis they know they’ll never recover the money. (It’s important to say, however, that losses from criminal conduct will remain in the audited financial statements.)

In other words, the stain of much past misconduct can be entirely erased.

Bernard Agulhas, the former head of the Independent Regulatory Board for Auditors and now professor in auditing at the University of the Free State, says it’s deeply concerning.

“Irregular expenditure will effectively be hidden from members of the public who deserve to know how their tax money is spent,” he says. “And if the board condones past irregular expenditure, management effectively gets away with past misconduct.”

Auditors of SOEs are also deeply worried.

“This takes a full audit of irregular expenditure away from the auditors, and gives management a lot more discretion over how much detail they do provide over this to the public,” says one auditor, who spoke to the FM on condition of anonymity.

He says it’s the wrong move — especially so soon after chief justice Raymond Zondo’s inquiry into state capture underscored the importance of putting in place strong controls and accountability for public spending.

“A year ago, a member of the public would have looked at these accounts, and seen, say, R40bn of irregular expenditure. Now, they’ll look at this year’s accounts and see far less, and have no idea what happened,” he says.

Besides potentially misleading the public, there’s another reason it’s dangerous: if SOEs don’t have to disclose the full extent of irregular spending, it could deter them from trying to recover money stolen in years gone past.

“If those numbers just disappear from the accounts, the danger is that nothing happens in terms of trying to recover money, and holding people accountable for what went missing,” he says.

So, he asks, will the public understand what happened? Will investors who buy bonds from firms such as Eskom, effectively lending money to them, understand they’re looking at accounts that have been sanitised in this way?

“The fact is, the disclosure won’t be what it was before. And if irregular spending isn’t audited, there’s probably likely to be less rigour in management on this number. So you could see this number dwindle because nobody is checking it.”

It’s a disturbing shift in an era in which auditors have been roundly flayed for missing all sorts of shenanigans at the likes of Eskom and Transnet in the public sector, as well as VBS Mutual Bank, Steinhoff and Tongaat in the private sector.

But instead of obliging them to do more, this rule gives auditors fewer openings to raise the red flag.

Says Agulhas: “Auditors’ hands are tied, as they won’t be able to report on noncompliance when it comes to irregular expenditure, as this will only be disclosed in the annual report, which is not technicaly audited.”

It’s a big risk for auditors, as they’ll likely still be blamed for not reporting on irregular expenditure anyway. Even if, as Agulhas says, it won’t even be their fault this time around.

Auditor-general Tsakani Maluleke will probably be the person most affected by this change because her office audits most public entities, except for Eskom (audited by Deloitte) and the Industrial Development Corp (audited by Nexia SAB&T and Deloitte).

Maluleke tells the FM that state-owned companies will still be responsible for putting measures in place to ensure that the historical numbers of fruitless, wasteful and irregular spending are “reliable”. “To ensure accountability, those charged with governance will have to institute measures to increase the transparency and reliability of these registers,” she says.

Despite Instruction 4, Maluleke will go the extra mile to ensure “transparency and accountability” isn’t diminished.

“We will continue to test the historical irregular, and fruitless and wasteful expenditure included in the separate registers. Where we identify material issues, we are able to communicate such issues in the audit report without modifying the audit opinion,” she says.

But you can expect some state-owned companies, which have barely tolerated the PFMA rules, won’t be keen to invite any extra scrutiny.

‘This isn’t new’

You can, of course, understand the reasoning behind it. In many cases, there’s pretty much no chance SOEs such as Denel or Transnet will recover the billions stolen years before, which have been frittered away on apartments in Dubai, sports cars or PR contracts for Bell Pottinger.

As one private sector auditor tells the FM, maybe it’s best to draw a line under the past. “Pragmatically, we probably won’t get to the bottom of what happened with all the historical misspending. So maybe they have a point,” he says.

Take Transnet. The Zondo commission found that contracts worth R41.2bn were “irregularly” awarded by the freight company during that particular era — amounting to 72% of all state contracts linked to state capture. Yet the odds of recovering all of that money is vanishingly slim.

It’s the same at Eskom. The power utility’s accounts carry forward the previous balance of irregular expenditure dating back many years; it’s surely alarming for any lender to see this clock in at a gargantuan R67bn for the year to  March 2022.

In its annual financial statements, Eskom says most of this R67bn “relates to prior year transgressions”, adding that “regrettably, the process of obtaining condonations from National Treasury has shown little progress for several years”.

It adds: “Eskom is working with the department of public enterprises and the National Treasury to ring-fence historical irregular expenditure to minimise the continued impact on the annual financial statements.”

This was why it wanted that controversial “exemption”. Now it’ll be able to make use of Instruction  4 to alter the complexion of its financials.

In response to questions from the FM, Eskom acting CFO Martin Buys says that the withdrawn exemption would have given the utility far more flexibility than Instruction 4 ever will.

“The request was to be exempted from disclosure in the annual financial statements, and instead to disclose the current and prior year irregular expenses, fruitless and wasteful expenditure and losses due to criminal conduct in the integrated report. The application was similar to what has been granted to Transnet [for] three years, to allow Eskom to clean up the past,” Buys says.

He adds that Instruction 4 didn’t introduce the concept of pardoning irregular expenditure; that “process has been well into existence for numerous years”.

But he rejects the view that this will allow Eskom to get away with past misconduct, free from auditing oversight.

“The auditors are required to issue an opinion on the audited financial statements, and Instruction Note 4 requires disclosure of expenditure incurred in the current financial year with comparative information on irregular expenditure, fruitless and wasteful expenditure and losses due to criminal conduct,” he says.

Anyway, the auditors’ responsibility “is to read other information, including the integrated annual report which will contain all the PFMA information that was previously included in the annual financial statements”. And if they see inconsistencies, or material misstatements, they must report these.

But, tellingly, Eskom wouldn’t say if Deloitte has raised any reservations about this. Nor would Deloitte give anything away about its work on Eskom, when asked by the FM.

It’s about ‘competitive neutrality’

There’s no company that has been more outspoken about its desire to shake off the “shackles” of the PFMA than Transnet.

In extensive interviews with the FM last week on this subject, CEO Portia Derby and her executive team railed against the strictures of the law which, she says, are “making us uncompetitive”.

Derby says it was never about “getting around our obligations under the PFMA”, but rather about reducing the “differential reporting requirements for Transnet relative to our competitors, customers, lenders and suppliers”.

She says being forced to report on multiple prior years, and on spending that didn’t necessarily even cause Transnet a loss, creates a misleading view of “massive and ongoing wrongdoing in the public sector”.

That’s why Transnet asked for an exemption (the same one that Eskom got), which now expires in March next year.

Silindile Kubheka, Transnet’s GM for loss control, tells the FM that when she arrived in 2020, she was greeted with an “irregular expenditure” legacy that clocked in at a mind-blowing R114bn.

“This sort of irregular expenditure isn’t something you’d find in the IFRS accounting standards, and international lenders won’t find this either. It only exists in South Africa, and was implemented so that National Treasury could see that if you were allocated money, you followed the prescripts,” she says.

Kubheka says much of this was technical, relating to small breaches of the 1,001 laws that govern the parastatal.

“If the Treasury instruction says you must advertise for 14 days, and you only advertise for 11, that becomes ‘irregular’. Even though you receive the goods properly, you get value for money, and there’s no loss to the fiscus,” she says. “This has nothing to do with fraud and corruption, which we deal with separately.”

Sandra Coetzee, Transnet’s legal counsel, says that in 2021 the utility got a legal opinion that said its reporting obligations were too onerous. In 2022, the Treasury agreed, and granted Transnet that “exemption”.

Coetzee says Transnet was worried that after Eskom’s exemption was withdrawn, the Treasury might do the same thing to Transnet, so it got another legal opinion saying its exemption had to remain in place, if only to placate the bondholders.

“When we asked for our exemption, we ensured we weren’t in a more beneficial position than a publicly listed company, and that we at least comply with exactly the same regulatory regime [as other companies],” she says.

Coetzee adds that exemption doesn’t mean it is spared having to report losses due to criminal conduct or fruitless and wasteful expenditure; “it’s only the irregular expenditure that has been carved out, which didn’t result in fraud”.

As a result, in Transnet’s financials for the year to March 2022, Maluleke cites this “exemption” as an “emphasis of matter”.

“Irregular, fruitless and wasteful expenditure is no longer included as part of the annual financial statements, and is now included [in the] integrated report. Accordingly, I do not express an opinion on this disclosure,” she says.

But is this doing taxpayers, and the public, any favours?

Derby says she feels sorry for Eskom, given the fracas around its own exemption.

“It’s about competitive neutrality. You cannot have state-owned enterprises, which are supposed to compete in the private sector, and also borrow money from the private sector, where the reporting requirements aren’t the same. How do we ensure that there’s competitiveness between the state and the private sector? At the rate at which we’re going, we’re going to kill state companies.”

Critics might consider that a self-serving argument. After all, if a company gets the benefit of the state apparatus, the luxury of a monopoly position and the financial backing of the state, it seems only right that it accounts for that money with more rigour than a private company.

And in any event, is it not just an excuse to moan about the PFMA when the problems bedevilling state-owned companies aren’t about that, but rather about the financial and strategic chaos?

On this point, Coetzee argues the problem isn’t the PFMA at all; it’s the smorgasbord of Treasury rules that have been tacked on over the years.

“We need to fix the law rather than seeking repetitive or multiple exemptions. What we’re saying is the PFMA was fine, but it’s these multiple instruction notes and regulations that flip-flop all the time and become overly restrictive,” she says.

Moral hazard

One former CEO of a state-owned company, who spoke to the FM on condition of anonymity, agrees with Derby’s argument.

“The logic behind Instruction 4 is that significant fruitless and wasteful expenditure was incurred in the past, particularly during state capture. The way the PFMA works is that the items are repeated as findings every year by the auditor-general, even though the present management has no hope of ever clearing the decks,” he says.

As a result, lenders, the public and parliament get a skewed perception of how much of a mess the institution is, and how much it has actually been cleaned up.

“The emphasis should be on getting exemptions for historical fruitless and irregular expenditure — not that affecting the current year or future,” he says.

That was the mistake made in the previous (withdrawn) Eskom exemption, which would have given the power utility a free pass from reporting irregular spending in its current year.

It’s a beguiling argument but surely, as Agulhas argues, this would create a degree of moral hazard, as state companies would not then bother to go and scrap for the billions misspent in the past?

The anonymous CEO agrees it’s a risk, but says we need to be realistic about what can be recovered from thieves. “Cynically, this move may simply be acknowledging the reality of all the money stolen during state capture,” he says.

Eskom’s Buys disagrees with the moral hazard argument, saying there’s still a fiduciary and legal duty on executives to recover any money due to a company, no matter how far back it goes.

Derby agrees. “For any contract that is ‘live’, there is still an obligation to review them. We’ve not walked away from any of that historical stuff. But when it’s dispensed with, it should be out of the system — why the hell do you want to go back to that?”

Momoniat concedes some of these arguments.

“In government, blame shifting is something of a national sport. But I am sympathetic to the view that much of the historical irregular expenditure is totally meaningless in the current context, and tells you nothing about corruption. So, to that extent, we’re reviewing it.” 

He says “irregular expenditure” is a uniquely South African concept, and not part of any international accounting standard. As a result, it tends to confuse investors.

Still, he has set himself the goal of fixing the PFMA before he leaves government. As it is, his contract as the interim director-general is almost up, and will probably come to an end when a new permanent appointment (likely Duncan Pieterse) is made. “I will then focus on some projects like the PFMA,” he says.

Surely it’ll take years to change the PFMA?

“It can be done far quicker than that as it only requires a few tweaks. We don’t want to open the door for people with corrupt intentions, or enable those politicians who feel they should be allowed to do anything they want. But there are some small things we can fix so it works better,” he says.

Crossed signals

Hlaudi Motsoeneng might have been the high watermark, but there are few people who’ve inhabited the SABC’s C-suite who haven’t met a scapegoat they don’t like.

Last month it was the turn of the SABC’s outgoing CEO Madoda Mxakwe, who argued that the reason the public broadcaster is battling financially has to do with the Public Finance Management Act (PFMA) rules about accounting.

Mxakwe, who became the first SABC CEO in 15 years to complete his full five-year term, told Business Times: “If you want this organisation to be financially sustainable, remove all the restrictions of the PFMA.”

He cited an example of the Reserve Bank apparently wanting to spend R50m buying “advertising space”.  He said: “It took us close to six weeks just to register it as a client, because we had to go through regulations, policies and bureaucratic processes,” he says.

These “unnecessary regulations” hurt the broadcaster because “we compete in a very stiff market in which our competitors don’t have the same restrictions”.

Mxakwe complained about how “a rush by government” to switch off the analogue signal led to a 40% drop in viewership in five provinces, causing the public broadcaster to lose millions in advertising revenue.

While there are elements of truth to this, his picture is a distortion.

First, there’s been no “rush” to switch to analogue; digital migration was first raised two decades ago, in 2000. Second, the SABC, unlike its commercial rivals, last year got the benefit of R815m in licence fees as well as another R163m from government grants.

 This contributed to its overall R5.04bn revenue (a slight increase of 2%), even though it made an overall R200m loss.

Still, Mxakwe is at least partly right that some of the National Treasury rules relating to the PFMA are time consuming and stifling for a company trying to operate commercially.

But as one auditor tells the FM: “There are state-owned companies that haven’t shown much appetite to operate as businesses, but now they turn around and say, ‘Ah, yes, it’s the legislation that’s the problem’.”

Bernard Agulhas, the former head of the audit regulator and now professor in auditing at the University of the Free State, believes the PFMA is world class; it just needs to be applied properly.

“The PFMA might need some revision to ensure the obligations placed on smaller entities in the public sector are not as onerous as for larger entities, and [to ensure it] provides the right balance between good governance and controls [on the one hand] and being sufficiently practical [on the other],” he says.

According to Agulhas, the goal should be to examine the PFMA properly and fix any flaws rather than grant exemptions. “Exemptions would defeat the principles of good governance. Even in the private sector, entities can’t be exempted from the principles of good governance, transparency and accountability,” he says.

One former SABC executive tells the FM it’s disingenuous for the broadcaster to moan about the PFMA now, as it got an exemption from Treasury on content commissioning months back.

“The PFMA can never be seen as the sole reason for the current situation. I’d start with it not having a board for six months. And there are multiple other reasons — including poor management and the lack of strong commercial leadership in certain respects,” he says.

It’ll be no consolation to the SABC’s new acting CEO, Nada Wotshela, knowing that if she had a TV licence fee-payer for every time someone at the broadcaster complained about the PFMA, her financial headaches would have been long gone.