Denel forensic investigations

Meeting report

Denel forensic investigations

Ms Monhla Hlahla, Chairperson: Denel Board, thanked the Committee for welcoming the Denel delegation to the meeting, and admitted that this presentation should have been given earlier in the year. She introduced the members of her delegation, including the Acting Group Executive Officer, Mr Ismail Dockrat, who had started on 1 December.  She declared that with a new board and management now at Denel, there was a belief that the future of Denel was bright.

Mr Dockrat gave a general overview of the challenges faced by Denel. Since the appointment of the new board, the focus had been on dealing with the core business of Denel and cleaning up the inherited mess. The company was now being repositioned and a new strategy devised. The board had resolved a number of key interventions to deal with the group’s inflated cost structure, its loss-making contracts/businesses and limited access to export markets, to return the group to market related profitability within the term afforded to the board. These interventions included:

• Establishing a commercial mind-set within the company; 
• The appointment of the right calibre of leadership on the highest level;
• Exploiting Denel’s property portfolio, including actions to reduce space occupation and optimisation/sale of properties.
• Investigating options to exit from loss-making and non-core businesses.
• Restructuring and optimising its fixed cost base.
• Resetting the Hoefyster contract by March 2019 and determining the way forward.
• Implementing a supply chain optimisation programme.
• A complete governance and compliance turnaround.
• Establishing a strategy by January 2019 regarding the future Denel footprint, with consideration given to introducing strategic partners in selected Denel products, capabilities and business units.

Mr Talib Sadik. Denel board member and chairperson of the audit committee, said that during the external audit, the following prior period errors had been identified:

• Revenue - the incorrect application of International Accounting Standards (IAS) 11 and IAS 18, and incorrect translation of prepayments received on invoicing;
• Property, plant and equipment (PPE) – the understatement of assets valued at zero balances and the non-capitalisation of the site restoration cost of leased space.
• Revaluation reserve – the PPE accounted for using the revaluation model and transferred to investment properties in the prior years was accounted for in profit or loss, instead of the revaluation surplus;
• Post retirement benefit – the net defined benefit asset had not been accounted for as an asset in the books of Denel.
• Investment in subsidiaries – inadequate evidence was provided to the auditors for the accounting of the investment in associates, with regard to the purchase of Turbomeca Africa.
• Deferred tax and income tax – tax implications due to the prior year period could not quantified at the conclusion of the audit.
• Irregular and fruitless and wasteful expenditure – inadequate disclosure was identified, as there was additional expenditure not identified by management..

Governance investigations

Award of Bursary to Mr Mahumapelo

A pilot bursary agreement had been entered into with Mr Oarabile Mahumapelo. In terms of the agreement, the total bursary paid to Mr Mahumapelo would not exceed R1,156,378.20.

The summary conclusions were that:

• The Air School was not an approved study institution in terms of Denel’s Bursary policy;
• The pilot bursaries were not advertised in terms of Denel’s Bursary policy;
• The pilot bursaries were not approved by the Group Bursary Committee in terms of Denel’s bursary policy;
• The pilot bursaries were granted without following the proper selection process as set out in Denel’s bursary policy.

Mr Mahumapelo’s bursary agreement had been terminated, with Denel reserving its right to recover the monies paid.

Irregular expenditure

Ms Thandeka Sabela, Group Financial Controller: Denel, referred to the irregular expenditure, and said that enhanced processes including the establishment of a central team to investigate and recommend appropriate consequence management, and control improvements to ensure accountability. It was in the process of identifying areas that required exemption, where compliance was not feasible

It was updating the supply chain procedure to ensure that in instances involving original equipment manufacturers (OEMs), industrialised suppliers, accredited local agents and client prescribed suppliers, prior approval had to be obtained from the Group Supply Chain Executive before an order was placed.

The open tender threshold of R1m stipulated in the supply chair policy had been confirmed with National Treasury as compliant, based on the process that had been followed to change it from the normal R500 000 stipulated in the Preferential Procurement Policy Framework Act (PPPFA) regulations

Denel had commenced with the process of investigating the possible irregular expenditure figures for the 2017/18 financial year. The completion date for the process was set for 6 December 2018. The process would identify genuine root causes for the different categories of irregular expenditure, and would result in corrective steps taken to prevent its recurrence.

Discussion

The Chairperson proposed that Member’s questions in the first instance should be focused on challenges and interventions, financial results, audit opinions and irregular expenditure. In the second part, the questions should be on governance and forensic investigations.

Dr Z Luyenge (ANC) highlighted the issue of corruption at Denel. He asked if the board and executives came across individuals who were corrupt at Denel, both from the previous board and executives. If investigations were in place, how far was the process at this moment? On monies that were lost, was any determination made on the amount lost in the last few years? Were there any plans to investigate internal and external contracts? On management involvement in corruption, were there existing disciplinary cases? Had any suspensions been invoked by the present board, and how had that affected operations? How was the number of acting executives affecting the company’s operations? On the issue of VR Laser and other contracts, how much was found to be irregular? If found, had it been stopped, and how was Denel dealing with the services already rendered? The new board now had the responsibility to put things right at the new Denel and ensure that the company participated in the economic development of the country.

Ms N Mazzone (DA) said that in 2017, a Denel spokesperson had reported that the government of Qatar had approached Denel with the possibility of providing a loan package, and this was followed by the signing of a memorandum of understanding (MOU) in October 2017 by representatives of Denel and the governments of RSA and Qatar, based on what seemed to be strange conditions. It was a $350m loan facility for a five-year term, which Denel could draw from as needed. There was a six-month exclusivity period, a confidentiality clause, the desire of Qatar to obtain an equity share in Denel, and everything about the loan was shrouded in secrecy. The only thing SA citizens saw was a photo of a Qatar government official and his SA counterpart, and the chief financial officer (CFO) of Denel at the time, who had since resigned. The problem was that the National Arms Control Committee and the Vetting Council of South Africa should have been involved in the contract negotiations in both this and the Saudi deal. The new board, though not involved in signings these deals, was now left with the burden of implementing deals that were deemed illegal.  How does one go forward with this, knowing that SA was now a member of the Security Council of UN? Does one now continue with these deals, knowing that if SA reneges it would amount to breaking international treaties? A big worry for any Denel worker was the uncertainty of not receiving their salaries. Was there enough money left to pay employee salaries? She recalled that the former board had been thrown out of Parliament by this Committee because of their lies. Had people been forewarned that there would be retrenchments?

Mr N Kwankwa (UDM) was worried with the trend of interacting with the new boards of state-owned enterprises (SOEs), when the former had orchestrated a wide scale mess. What was the loss to Denel as a result of the activities of the previous board, in quantitative terms? What were the consequence management measures put in place for state looters?  Could the Committee be told who were involved in the looting and how much was involved? In as much as it was difficult to in interrogate the new board members, who were not part of looting, the Committee wished the current board success in cleaning up this inherited mess.

Mr R Tseli (ANC) appreciated the progress made by the new board in following up on important issues affecting Denel. What was the state of affairs in respect of questionable salary increases? What was the financial health of Denel? Could Denel update the Committee on the ongoing litigation regarding some of the contracts signed by the former Denel executives?

Denel’s response

Ms Hlahla confirmed that there was currently no loan agreement between Denel and Qatar, or any other country for that matter. All Denel’s loans were with South African banks. If ever it arose that Denel would borrow, it would follow the diligence required by the Public Finance Management Act (PFMA), the shareholder and the Treasury. Members should be comforted that the MOUs of the past had been scrutinised by the board.

On financials, Denel had liquidity challenges but it had to be said that the SOE culture in SA was predicated on the premise that employees think the state -- thus the taxpayer -- owed them a salary when in actual fact they were producing and doing nothing. Even in this precarious economic crunch, the politicians were privy to this outlandish narrative. The question had to be asked, what is the workers’ output? Even the politicians expect the SOEs to pay salaries that were above inflation when employees produce nothing commensurate to that expectation.  And the people expecting to stay in those cosy jobs without producing anything, had found a way of going to politicians to say they were not being paid by the SOEs, and yet you see none of them resigning.

This situation was not limited to Denel alone, but extended to Eskom, Transnet and others. One was seeing that partisan and political interests were now entrenched and these interests were being played up ahead of the 2019 elections, even if the PFMA was meant to ensure effective and efficient spending of tax rands within a framework of good governance and fiduciary responsibility. SOEs and government had to work together to build a good revenue base for the country. Right now, Denel had a bit of revenue, but suppliers had to be paid first and then other critical stakeholders so that the company could be restored to the black. It was all hard work, and the board and executives have no silver bullet to do it. The issue of extraordinary salary increases was receiving the attention of the audit committee, and their reports were being awaited. There was hope and excitement that things would turn around for good, and that value would be added to the company.

Mr Sadik said that Denel remained solvent and had good relationships with the banks. It had a commitment to be giving the banks regular updates, and all stakeholders were committed to fixing all the issues raised by the auditors. Denel had had a disclaimer audit opinion, and the banks would be brought up to speed on the company’s true financial health. It had not breached any agreements around that audit opinion. The salary spending was being prioritised, and the company meets weekly to review its financials and ability to pay suppliers and contractors. Denel was not only worried about salaries, but it had scarce skills in its employ which consisted of engineers with sought after skills, and when they join Denel it is often for more than salaries. 

Mr Thamsanqa Magazi, Denel Board member, added that the company did not want to depend on the government all the time, and was working hard to break even. The company was balancing between paying the suppliers and employee salaries. Concentrating only on salary payments meant that Denel would just continue to borrow, without any production.

Further discussion

Dr Luyenge asked if Denel had the names, either from the board or executives, of those who had participated in the looting of the resources of Denel. If that was the case, were there criminal charges that Denel was contemplating to lay against them? When would this take place? Relating to contract management; the company rendering services to Denel – had there been inappropriate collaboration with staff members, board members and executives? Was there any chance of charging them criminally? 

Ms Mazzone said she was not convinced and not at ease regarding the answers given about Qatar and the Saudi deals. If there was something confidential about those contracts that could not be revealed immediately, Denel should tell the Committee so that they could be confidentially primed. This Committee needed to know more about what was going on, because it had the constitutional responsibility of oversight. Denel used to set a benchmark for a well-run state entity, but was a shadow of itself because of state capture. The consolation was that those who had orchestrated state capture were being held to account. The former board had erroneously told this Committee that Denel Asia was a legitimate enterprise to expand and have a Denel footprint in Asia, but the Committee argued then that there was absolutely no need for Denel Asia, because Denel’s foot was already entrenched in the Asian market. It was now known why Denel Asia was set up. This Committee wanted the board to confirm that Denel Asia was set up as a scam and a sham to enable state capture. This assertion would supplement an affidavit to be sent to the Zondo Commission. This was the time to put politics aside and fight for South Africa. Was the government getting rent from the Fireblade terminal?

Mr Kwankwa was saddened that officials come and deliberately lie to Parliament. The time had come for consequences to be meted out to those who deliberately mislead Parliament.

Mr Tseli was worried with the new trend of SOEs going to government to request bailouts. SOEs, by their very nature, were supposed to contribute to the economic development of the country. Consequence management must be dealt with squarely, otherwise they would be faced with a situation where everyone did as they pleased. Those who caused the company to receive a disclaimer must surely face consequences. The disciplinary processes were taking a long time to be finalised. Even when people were suspended for a year or two, they continued to draw salaries, and this was unacceptable.

Denel’s response

Ms Hhlahla responded by saying that they were governed by the PFMA, which also compelled the board to provide all the answers sought by Parliament on how it conducts business. On the relationships with the unions, every whistle blower issue received by the board came from the unions. Denel had about five unions, and the professionalism with which they had engaged on all the difficult issues had been commendable. They had been practical in pointing out areas the board should focus on, indicating that they all love this company and were all working towards a sustainable outcome. They were the best partner in management trying to find a way forward for Denel. 

There were no contracts between Qatar and Denel. The board would go back to find out what the two companies were trying to do, and summarise it in a memo so that this issue would come to a close. The fact that Denel was not for sale did not mean Qatar and the Saudis did not want to buy certain products from it. Denel had made it clear that it was open for business, with a commercial outcome in mind. In this regard, a level of transparency was a must on contracts from now onwards. As recently as last week, Denel had disagreed with the Saudi’s assumption that Denel was for sale, and this board was determined to show that there was so much value SA would derive from Denel.

 Regarding Denel Asia, Denel had various divisions and the audit committee was presently analysing the entire web. They were seeing that it was even larger than previously thought, so they were working towards giving this Committee the facts. Investigations were ongoing and when they were completed, they would revert to the Committee.

On consequence management, the board was very clear, especially with regard to the dismissed CFO. Though it was painful to be paying him a salary every month while the allegations were piling up, the reality was that the process would have proven to be thorough and dealt with effectively.

On determining the level of losses, looking at 2015 financial year to date, one could see that Denel was a company that one day makes billions, and on another was sitting with a deficit of R200m. The board was digging to find out where that gap went to. Other issues being dealt with included the brokerage fee paid fee paid by Denel to technical assistants. In Europe, they were paid 2.5%, while Denel pays 10%. Even before Denel invests and deliver the projects, the brokers have already received their money. All these reviews were being done to understand where the company went wrong. This would help the board to make informed policy positions.

Mr Sadik referred to consequence management, and said the board was looking not only at current employees, but also those that had left Denel. There could be criminal charges and civil claims instituted against them, and the process the board was looking at was proscribing former officers as delinquent. This was not limited only to employees, but would be extended to suppliers.

Denel had not received any cash from Qatar. After the forensic audit, and the names that come out through that process, appropriate action would be taken and the board was working closely with the Special Investigating Unit (SIU) to achieve that.

Denel’s total irregular expenditure had been over R500m, including the R108m for VR Laser. On governance, even though Denel had government guarantees, banks may still not be keen to work with Denel because of reputational risk.

Mr Mangazi said that the company had an existing policy on misconduct, and it would be strengthened. Members should be reassured that where there was a clear case of misconduct, there would be a summary dismissal. A few weeks ago, there had been case of lower level management extracting confidential company information out of the system, which had led to the summary dismissal of those involved.

The Chairperson appreciated the efforts being made by the new board and executives to clean up and stabilise Denel. The issues raised by Members on outputs should come out in the key performance indicators. The Committee was happy that no strikes had been embarked on by workers, and all their grievances were being attended to. The committee would call Denel back to Parliament in the New Year to present its annual report.

On the legacy report, Members of the Committee were asked to forward their submissions to the office of the Chairperson.

The meeting was adjourned.