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Private sector corruption

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Issue date: 
14 February 2012
Publisher Name: 
The Africa Report
Sarah Bracking
Author e-Mail: 
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What is private sector corruption? A flippant answer would be anything that the losing party in a job or tender selection process says it is, since there is that old saying that one person's corruption (or patronage, nepotism) is another's rightful meritocracy!1

Time for a re-evaluation and new market rules?

Of course the meritocratic selection based on 'natural intelligence' and 'expertise' is always cited by the winner - but perhaps generally more vociferously by male winners! Certainly with tender processes so complex, and firm structures so opaque, it is hard to work out what corruption is these days. One thing is clear, whatever it constitutes, its outcome is inequity, since people who navigate well the public/private sector 'revolving door' are getting very rich. But are we to worry? No, as the World Bank repeatedly tells us, or at least not very much, since according to them since 19972, corruption only happens in the public sector when public sector workers, those most devious of pathologised creatures in World Bank texts, take from the public purse for private gain. The action is one way, implying that you have to be in the public sector to be able to 'do' corruption. But a quick review of corruption scandals in South Africa this past year shows many firms doing just that – taking public subsidy which then 'disappears' into private accounts!

Traditional ways of looking at corruption in the private sector also blame the public sector. If you look at the US Foreign Corrupt Practices Act (1977), the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (even the title gives it away) or the soft law Extractive Industries Transparency Initiative you get the sense that private sector corruption only happens at the boundary of the firm when it interacts with - yes, you have it - those devious public sector people, who won't do their job without a bribe. A good example of this genre of [LINK=http://siteresources.worldbank.org/AFRICAEXT/Resources/english_essay_adi2010.pdf]World Bank storytelling is Silent and Lethal[/LINK] (referring to 'quiet corruption') whose main villains are absentee teachers and doctors. Thus corruption, for the World Bank, does not appear to actually exist between two private actors (rather like the first British Queen Victoria's view of lesbianism when she outlawed sex between men, allegedly), or within the firm itself. How convenient. And yet, taking money from the public sector by capturing a subsidy or a bailout – the banks on a grander scale in 2008 – seems to be the order of the day.

The climate policy scam

Take for example, the public effort to reduce carbon emissions, flawed as the policy is in [LINK=http://www.youtube.com/watch?v=pA6FSy6EKrM]its stupid reliance on markets and cap and trade schemes[/LINK]. The logic behind the Kyoto protocol cap and trade scheme of 1997 is that Carbon Emissions Reductions (CERs) can be traded in carbon markets, principally in Europe, acting like permits to pollute. Firms who have reached their carbon cap, that is the government imposed limit on their emissions, can then buy these 'credits' in order to carry on emitting. The supply of CERs, in a properly functioning market, would be scarce relative to the demand for them, thus pushing their price up, and acting as an incentive to firms to reduce emissions (or that is the supposed logic).

"rather like the first British Queen Victoria's view of lesbianism when she outlawed sex between men, allegedly"

However, the European Union oversupplied permits at the beginning of the recession, so industry doesn't need any credits, while the supply of them just keeps growing under the Carbon Development Mechanism (CDM) and Reducing Emissions from Deforestation and Forest Degradation (REDD+), leaving their price languishing and approaching zero. Indeed the European Carbon Trading Scheme was recently [LINK=http://www.bloomberg.com/news/2012-02-07/europe-s-emissions-trading-system-is-dead-eon-ceo-teyssen-s... 'dead' by EON CEO Tayssen[/LINK]. But firms in the South are still fighting to get a slice of the carbon market through CDM accreditation.

In South Africa, the Designated National Authority (DNA) manages South African Clean Development Mechanism (CDM) projects and valuable, tradable CERs under the provision of the Kyoto Protocol. These are gratefully received by shareholders of Omnia, Sasol, PetroSA, South African Breweries, Mondi and the Beatrix Mine - for polluting a little bit less. International companies also benefit, despite their healthy balance sheets, such as Denham Capital Management's (US$ 4.3 billion), who [LINK=http://www.counterbalance-eib.org/wp-content/uploads/2011/12/BANKING-ON-CARBON-MARKETS.pdf]despite their dirty energy portfolio[/LINK] and bad reputation, nets hundreds of thousands of lucrative CERs for itself and PetroSA by[LINK=http://www.thecornerhouse.org.uk/sites/thecornerhouse.org.uk/files/EU-ETS_briefing_april2011.pdf] investing in BioTherm Energy and MethCap[/LINK]. Many [LINK=http://www.thecornerhouse.org.uk/sites/thecornerhouse.org.uk/files/UpsettingtheOffset.pdf]carbon capture and offset projects globally are anemic, disappeared, or fictional[/LINK]3

So what has this got to do with private sector corruption? After all this is all completely legal, if a foolhardy policy instrument. But it doesn't pass the 'sniff test' as an old lawyer friend of mine once said in terms of knowing what is corrupt and what is not, and it certainly seems to fit the classic definition of corruption provided for the public sector, of the private use of public money, and to some very rich firms.

Corruption in the Boardroom proper

But private sector corruption must be seen as more than this public to private transfer, however novel it is already to apply the classic definition more broadly. Beginning with the 1980s idea of 'asset stripping' where one firm bought another to steal bits of it and bankrupt the rest, dirty tricks seem to have grown in the corporate world, alongside the rise of the private equity fund. Asset stripping began a trend of company takeovers where the longevity and sustainability of the bought up firm was only secondary to the interests of the hawkish new parent. For private equity the largest source of profit is to invest in a liquid firm with good assets, and then drain it and indebt it to the parent, take management fees besides and then exit leaving a weaker and unstable firm [LINK=http://www.newyorker.com/talk/financial/2012/01/30/120130ta_talk_surowiecki?fb_ref=social_fblike&fb_... may then go bankrupt[/LINK].

Given that parents can use transfer pricing to cause this 'thin capitalization' of their young, and given that management and technical fees are a fairly arbitrary flow, it is quite easy to prey on the future of others, workers and pensions included. This model is the one that Julius, or 'JuJu', Malema uses with a 'family trust' holding in an outsourced 'programme management unit', a firm called On-Point, which is paid R52 million in management fees from the Limpopo road and transport department, to manage contracts on their behalf. On-Point then allegedly demands to be a silent partner with the company who 'wins', demanding [LINK=http://amabhungane.co.za/article/2011-08-19-mechanics-of-the-silent-partner]'management and design fees' [/LINK]of up to 70 per cent of profits. While Malema is being investigated, [LINK=http://mg.co.za/zapiro/fullcartoon/3521]the trust fund structure seems to be working for him[/LINK].

"fees paid into Directors accounts, to close an already closed mine"

This all makes those accused in the R144 million "Three Amigos" government racketeering, fraud and corruption trial look very old fashioned, and relatively weakly 'rewarded' for their malfeasance. In this trial, KwaZulu-Natal legislature speaker Peggy Nkonyeni and Economic Development MEC Mike Mabuyakhulu are accused of taking a R1-million "donation" from South American businessman Gaston Savoi to the ANC in 2007, allegedly [LINK=http://mg.co.za/article/2011-08-01-tender-case-anc-leaders-get-r100nbsp000-bail]in exchange for a R45-million government tender[/LINK], \[Nkonyeni had been previously accused of a personal kickback from Savoi in 2009 of R20,000, but the case was dropped].

Overall the Amigos trial involves mispriced, over inflated procurement contracts for hospital equipment which stack up the value of the scam. But why did Nkonyeni and Mabuyakhulu receive only smallish old fashioned bribes when they could have had a management service contract with a trust company (aka Malema) to do the procurement for the department, and make much more? In fact the way to go to super riches is to have a number of management companies all layered on top of one another and with the 'top' one offshore - and all eating from a single productive entity.

For example, one bankrupt mining company, Pamodzi Gold, has seemingly numerous management companies, Aurora Empowerment systems, who themselves are managed by Zondwa Mandela's Kaunda Global Mining Resources, all needing lucrative management fees paid into Directors accounts, [LINK=http://mg.co.za/article/2011-11-18-aurora-bosses-diverted-millions]to close an already closed mine[/LINK]. Interesting here is also that Pamodzi was bankrupt in October 2009, when Aurora took over. Were these directors copying habits of prior owners, and how does the Pamodzi Resources Fund, Harmony Gold (and their joint investment in Rand Uranium), and their foreign partners American Metals & Coal International (AMCI) Capital Fund and First Reserve Corporation fit in to this story of thin capitalization and bankruptcy? After all, you can hardly blame the soaring gold price for the failure of Pamodzi!

And while we are on a roll, there is also a new variant of private sector corruption which seems to be inspired by Directors and CEOs taking no long term view over the sustainability of the firm that they manage! For example, in the case of the BEE offset projects and firms generated by the submarine deal in South Africa in 1998, there is a pattern of excessive executive 'reward', and subsequent bankruptcy of the firms and projects within a few years, generally after the initial public subsidy has been 'spent'. [I]The Mail and Guardian[/I] reported that the submarine deal, worth R30 billion in 1998, [LINK=http://mg.co.za/article/2011-10-28-the-great-submarine-ripoff/]was touted to deliver R110 billion in offset benefits[/LINK]. But by October 2011, four of the six projects had collapsed into insolvency or bankruptcy, and two were stalled.

Bringing moral values back into business

Given these new forms of private sector corruption - which 'smell' wrong even if they are not properly legislated for in corporate law - I propose some new principles to underlie corporate and financial regulation.

Proposal One

CEOs and business directors should be disallowed by law from adopting a corporate strategy that heightens their own personal gain from profit shares and bonuses, while risking the sustainability or longevity of a venture through over-extraction of funds. While this behaviour doesn't involve a traditional bribe, facilitation payment, or dash money, it is profiteering from the hardship of others, (the workers at Pamodzi who were not paid for two years and who lost their pensions) and most religions, if not corporate law, [LINK=http://mg.co.za/article/2011-12-12-broke-aurora-miners-plead-for-help-ahead-of-christmas/]would say that was a bad thing[/LINK].

Proposal Two

Second, and related but directed to the financial sector, fund managers and traders should be disallowed from gambling on the misfortune of another, be it human, non-human, firm or country. This is basic morality. If you see an elderly person crossing a road, do you gamble that they will be run over by a truck? No, but you can gamble on the collapse of societies, or species becoming extinct (in the noxious species banking). If you couldn't gamble on another's misfortune the futures and derivatives market would shrink back to its central historical role of insuring people against misfortune, essentially a mutual insurance market.

Proposal Three

Additionally, for financiers, a firm owning a derivative must, at least in part, have an equity state in the asset from which the derivate income stream is generated. This would prevent the securitization of derivatives in packages that caused the 2007 bubble to burst, when it was realized that no one really knew the value of the underlying asset, which in the case of subprime mortgages, was, well, very low. Toxic debt and junk bonds resulted. This rule would make financiers take better responsibility for the health of real assets. As it stands, the income from the tollbooth on a public private partnership (PPP) road is a derivative owned by a different firm than the one that actually owns the asset, the road, so what incentive has the firm with the income to maintain the road?

Proposal Four

And finally, while we are on a roll, private equity funds should only be able to domicile in a country where at least 10 per cent of their portfolio is invested – that should help close the tax havens4.

Some readers might be uncomfortable about such speculative fashioning of economic morality, but I would counter that there has been realms written about the global economy since the 2007 Crash which takes the form of backward facing critique. But, there has been comparatively little penned about how to design a future economy that would be better, and about how to take us there. Design is all - well nearly; we will still need to muster a critical mass of class-based power to get the rules into effect! (a detraction I have from Callon, 1998). It is useful to begin with the principles and rules of the (new) game. After all, our political regimes have constitutions to lay down their foundational mediating values and principles: so should our economies.


[I]1) Szeftel, M (1998), "Misunderstanding African Politics: Corruption and the Governance Agenda", Review of African Political Economy, 76, 221-240 [/I]

[I]2) World Bank (1997), World Development Report 1997: The State in a Changing World, New Yotk, Oxford University Press[/I]

[I]3) Bond, P (2011), Durban's Climate Gamble, playing the carbon markets, betting the earth, Unisa Press[/I]

[I]4) Bracking, S, Hulme D, Lawson, D, Sen K and Wickramasinghe, D (2010) The Future of Norwegian Development Finance, Government of Norway official document no: 0902364-55 (The Report), Callon, M ed. (1998), The Laws of the Markets, Oxford, Blackwell

Dr Sarah Bracking attended York and Leeds Universities in the UK and now works as a Senior Lecturer in the School of Environment and Development, University of Manchester. She is editor of Corruption and Development (Palgrave, 2007) and author of Money and Power (Pluto, 2009). Sarah is currently completing a book on The Financialisation of Power in Africa (Routledge, 2012).


Extpub | by Dr. Radut