Corporate Governance Report:Briefing by Public Protector; Public Finance Management Act: Briefing by Public Service and Administ

Meeting report

PUBLIC ENTERPRISE PORTFOLIO COMMITTEE; PUBLIC SERVICE & ADMINISTRATION PORTFOLIO COMMITTEE: JOINT MEETING
13 June 2001
CORPORATE GOVERNANCE REPORT: BRIEFING BY PUBLIC PROTECTOR; PUBLIC FINANCE MANAGEMENT ACT: BRIEFING BY PUBLIC SERVICE & ADMINISTRATION DEPARTMENT

Chairperson: Mr S Belot and Mr N Nhleko

Documents handed out
Office of the Public Protector briefing on Special Report No 13 (see Appendix)
Public Finance Management Act presentation

SUMMARY
The Public Protector office gave background to how recommendations of Report Number 13 came about and pointed out which areas in the report the Committees should focus on, namely, the mixed board of executive and non-executive directors, and fraud prevention strategies.

The Department of Public Service and Administration elaborated on the Public Finance Management Act and some of the projects being pursued by the Department, namely, remuneration and accountability frameworks, and anti-corruption strategies to culminate in a National Anti-Corruption Forum.

MINUTES
Mr Nhleko explained that Dr Schutte of the Office of the Public Protector was to brief the Committees on corporate governance issues as they arise out of the Public Protector’s Report No 13 with specific reference to its Recommendations. Corporate governance issues affect the public service in general as well as the Department of Public Enterprises in terms of the state-owned enterprises (SOEs).

The Public Protector’s Report
Dr Schutte said the recommendations in the report stemmed from when in 1996 the then Minister of Minerals and Energy Affairs raised certain concerns with the General Manager and Chairman of the Board of the Strategic Fuel Fund Association (SFF). This is a statutory body which provides corporate and support services for the stockpiling and trading of oil for South Africa.

SFF was originally established to secure fuel supplies by circumventing oil embargoes. When the United Nations lifted the oil embargoes in December 1993, the SFF continued to trade in oil internationally and to make themselves independent of state funding and to get some money for the state coffers.

Dr Schutte said the specific issues, which raised the suspicions of the Minister initially, concerned certain payments made by the SFF after the oil embargo had been lifted to a certain company called Interstate. These payments were made over and above the purchase price of the oil acquired by the SFF. He said there was obviously some kind of commission paid to Interstate and the concern at that time were these payments could be irregular or even fraudulently made.

Early in 1997 the Minister appointed a private firm of chartered accountants to investigate. On 18 June 1997 the Minister then responded in Parliament to certain questions put by opposition party members concerning the SFF.

The issue that caught public attention was that he queried why a loss of R170 million described as a transfer was not disclosed in the Auditor-General’s Report to Parliament in 1993 of the SFF annual financial statements which brought in another element of suspicion.

The Minister’s remarks led to some unpleasantness between himself and the Auditor-General. This led to Parliament requesting the Public Protector to investigate the allegations of irregularities on the part of the SFF and also to investigate the Auditor-General’s Report to Parliament regarding the Annual Financial Statements.

Two recommendations in the Public Protector’s Report No 13 as the result of that investigation are relevant to this meeting. The first is that the SFF and other similar state organisations should have a board of directors consisting of executive and non-executive directors as suggested by the King Report on corporate governance.

The second recommendation was that all state institutions should have a formalized fraud strategy which should include how fraud risk would be assessed on an on-going basis, an on-going methodology for ensuring that the controls in place correctly identify, detect and prevent fraud; that there is a fraud response plan to ensure that fraud detected is responded to appropriately, and specific responsibilities for ensuring that fraud strategy is implemented and followed up on an on-going basis.

Basis for recommending the board of directors
Dr Schutte said one of the allegations investigated by the Public Protector was that the General Manager of the SFF acted without appropriate authority and without the knowledge of the Board and did not provide the Board with adequate information on key issues, particularly the extraordinary payments to Interstate.

Although no substance could be found in these allegations, it became clear that the General Manager, who is a man of very strong personality that had made his subordinates rather wary of him, was a linchpin between management and the non-executive board. Potentially he could have manipulated the information going through the Board should he have wished to do so. If the SFF Board had had both the executive and non-executive directors on it, the flow of information between management and Board would not have been open to potential limitation by one person. This in turn would have prevented the perception leading to the allegations.

Dr Schutte said the King Report when dealing with corporate governance, looks at the issue of executive and non-executives in Chapter 4 sections 6-9 and concludes that the board needs to be balanced by executive and non-executive members and recommends that public entities also follow these recommendations.

The Public Protector was of the opinion, in his Report, that appointing the General Manager and the Deputy General Managers to the Board as executive directors would prevent the Board being dominated by an individual or individuals whilst ensuring that it is fully informed. He said the senior managers would then report directly to the Board as opposed to reporting through the General Manager with the result that the General Manager would not have had that vetting opportunity.

A problem with this is that most of the Boards are statutory boards and that legislation prescribed who should be members of the Board. To rectify that one would have to amend the legislation to make provision for the General Manager and Deputy General Managers to become executive members of the Board.

Formalised fraud strategy
Dr Schutte said one of the key allegations before the Public Protector was that the SFF and therefore the State lost money due to fraudulent activities or irregular payments. They were all aware that fraud was of great concern not only around the world but also particularly in South Africa. He said it was vital that fraud was specifically addressed. Some state institutions in the past worked under a veil of secrecy such as the SFF due to the nature of its activities in circumventing the oil embargo.

He said secrecy heightens the potential for fraud and similar crimes. State institutions previously working in secrecy have to adopt a transparent environment and ensure that all matters are above reproach, especially when contracts concluded in the era of secrecy continue into the era of transparency.

He said an appropriate fraud response plan might have mitigated the problems that arose when Minister became suspicious. There was no formal policy in place on which the Minister could base his actions. That was one of the reasons why "things went not as they should have".

Dr Schutte said although the recommendations in Report No 13 were made against a background of an investigation dealing with a business entity in the public sector, they equally find application in the state departments.

In their view, comprehensive fraud strategy should include:
- A policy statement by top management setting out clearly that there would be a no-tolerance approach to economic crime offences and acts of dishonesty.
- A policy document on how fraud would be dealt with should be made available to the staff.
- A risk assessment of all areas of operations to make sure that one knows where areas of risk are. He said it would be a confidential document, only meant for management and board.
- A fraud prevention and the response plan. The emphasis should be on prevention but response is just as important and this point would be included in the confidential document. He said if these confidential documents get out they would forewarn the potential fraudster who would know what would happen if he does something. This was not necessarily a bad thing but if the frauster knows how the investigative techniques are going to take place he might be able to evade those techniques. Thus the fraud prevention response plan should be a confidential document.
- A code of conduct
- Training on fraud prevention is necessary as staff must know what it is all about
- Instruments to prevent and detect fraud, for example reporting structures, a hotline, surprise inspections, staff vetting and rewards.
It was important to regard the fraud prevention strategy as an on-going strategy rather than a once-off exercise.

Dr Schutte noted that shortly after the Report was tabled, Treasury Regulations were issued in April 2001 in terms of the Public Finance Management Act (PFMA) and these regulations went a long way towards obtaining exactly what the Public Protector recommended. Regulation 3.2.1 provides that an accounting officer must make sure that a fraud prevention plan is developed for his/her institution. In terms of Treasury Regulation 3.2.2, fraud prevention plans should be fully operational by 30 June 2001.
Discussion
Mr M Sikakane (ANC) asked for clarity on the appointment of the General Manager and Deputy General Managers on the Board as executive individuals and asked, "Where does this put the General Manager?"

Dr Schutte replied that instead of the General Manager appearing before the Board as General Manager, this person actually has a seat on the Board as an executive director member of the Board. In other words, one person would have two roles. Instead of merely attending the meetings and appearing before the Board, they would be part of the Board as executive members. The non-executive members would balance the Board.

Instead of the general manager being a conduit through which all the information goes to the Board, he would be one of many people on the Board that would get in the information directly from senior managers. This avoids placing a single person in a position where he would manipulate the information going to the Board.

Mr R Heine (DP) was concerned about the implementation of the recommendations as the Portfolio Committees was not going to be part of overseeing this. They do not drive it nor are responsible for monitoring all the departments and getting feedback from them.

Dr Schutte agreed that implementation was essential but pointed out that together with the work done by the Public Service Department and the National Treasury there are many deadlines in place already for accounting officers to implement recommendations such as getting their fraud prevention plans in place. The difficulty was the monitoring role to ensure that the fraud prevention plan was happening.

Mr B Bell (DP) referred to the confidentiality aspect and asked to what level would the documents be confidential. What happens if it is actually at the top that fraud was taking place? He added that he did not see the whistle blower being protected which he thought should be included.

Dr Schutte replied that this was a difficult question because in ideal circumstances your management people would be the ones against fraud in the environment they are managing. When one talks about these documents being confidential, one thinks about keeping them confidential to the level of management and up. However, it was a real concern that some top managers are involved in fraud-related activities. For that reason the fraud prevention plan should address that.

There should be a hotline, for example, where individuals could phone in on an anonymous basis giving the tip-off and in that way fraud could be detected. The whistle blower was very important and the treatment of the whistle blower should be part of the policy document. Staff should know if they blow the whistle, they will not be victimized.

An IFP member asked for clarity as to whether the policy statement would be part of the policy document or would they be separate?

Dr Schutte said the ‘policy statement’ was part of the fraud prevention policy and that people at work should be told that fraud would not be tolerated by signing a document, especially managers and up.

He said the ‘policy document’ was about informing the staff that strong action will be taken if one was found involved in fraudulent activities. The policy document sets out policies such as what one needs to do when reporting fraudulent activities in order for the staff to buy into this document.

Mr M Baloyi (ANC) asked also for clarity on the Public Protector’s recommendations especially when it comes to formalised fraud prevention strategy. He queried the assumptions of the Public Protector when making these recommendations.

Dr Schutte answered that the recommendations by the Public Protector are not new and that the PFMA went a long way to cover the ground. He said the recommendations should be seen as further impetus to curtail this problem and for Departments to get their act together.

Department of Public Service and Administration on Anti-Corruption Policy
Mr R Kitshoff (DPSA Manager: Anti-Corruption and High Profile Cases) said already in 1997 the Department of Public Enterprise had presented a protocol on corporate governance of public entities and has a unit which looks at performance and monitoring of public entities against stated objectives, budgets, and so forth.

When public entities and statutory bodies are established, there is close co-operation between the relevant overseeing Department, the Department of Public Enterprise and the Department of Public Service and Administration to ensure that matters such as good governance are captured.

Public Finance and Management Act
Mr Kitshoff said the PFMA has four objectives:
- To modernise the system of financial management
- To enable public sector managers to manage but at the same time to be accountable for that management
- To ensure timely provision of quality information, and
- To eliminate waste and corruption in the use of public assets

Section 6 of the PMFA provides National Treasury with the specific role to promote and enforce transparency in management, revenue, expenditure, assets and liabilities. National Treasury must prescribe uniform treasury norms and standards and must enforce the PFMA. Treasury may assist Departments with capacity-building for efficient, effective and transparent financial management.

The Act puts similar responsibilities on the accounting officers of Departments (Section 38) and public entities (Chapter 6). The accounting officer must ensure that the Department has and maintains an efficient system of financial and risk management, and internal control, a system of internal audit under the control of an audit committee, and an appropriate procurement system, which is fair, transparent, and cost effective.

The accounting officers must take effective and appropriate steps to prevent unauthorized, irregular, fruitless and wasteful expenditure and losses resulting from criminal conduct.

They must take effective and appropriate disciplinary steps against any official who commits an act that undermines the financial, management, and internal control system; who makes and commits an unauthorized or irregular, fruitless, and wasteful expenditure.

The responsibility of other officers within the Department (Section 45) is to ensure that they also take effective steps to prevent unauthorized irregular and wasteful expenditure. Management must also safeguard the assets within the area of their responsibility.

Treasury Regulations describes extensively the Department’s requirement for setting up audit committees and orders committees to inform the Auditor-General not later than 30 June 2001 of any determination to share audit committees between the Departments.

Treasury Regulation 3.2.1 on Internal Control and Internal Audit states that the accounting officers must facilitate a risk assessment to determine the material risk to which the institution may be exposed and to evaluate the strategy for containing risks. Suffice to say that the accounting officer must include the fraud prevention plans in this, The strategy must be used to direct internal audit efforts and to determine the skills required to manage these risks.

He said by the end of this month heads of Departments must inform the National Treasury that they have done the risk assessment and that their fraud prevention plans are fully operational. He said according to the regulations, the accounting officers must provide certificates to the National Treasury by 30 June on the above requirements.

He said the regulations differentiate between public entities and Departments. There are specific regulations around internal control and corporate management issues that affect public entities and require them to establish internal committees and requires accounting officers to facilitate risk management and to establish fraud prevention plans similar to Public Service ones.

There is no determined time line for reporting by public entites but this is because public entities have greater flexibility than the Departments. Most of the public entities operate on an advanced accounting system which complies with generally accepted accounting practices (GAAP) which is different from the accounting practices generally used by the Public Service.

In terms of the law, regulations and monitoring compliance is contained in the law and is happening. He repeated that by the end of this month, National Treasury would be able to assess exactly how operational the fraud prevention plans of the Departments are.

Mr Kitshoff said he thought it was important to point out that the fraud prevention plan is an element of good governance and anti-corruption and a corner stone for anti-corruption efforts.

He said international practice indicates that fighting corruption must be a very good balance between preventive action and taking hard action such as investigating, prosecuting, and resolving matters by sanctions. The fraud plan is not only geared towards sanctions but is also geared towards prevention. He said it is a powerful tool but is part of a bigger strategy.

The Minister of Public Service and Administration, in her budget speech, mentioned two major projects:
- The public entities project which encompasses a remuneration and accountability framework and whose objective is to develop a proper database on remuneration and and an accountability.
- The Public Service anti-corruption strategy. It was hoped that by July they will start a consultation and presentation process on this forum which is going to have a strong focus on the prevention side.

Mr Kitshoff concluded by saying that the National Anti-Corruption Forum is a national strategy where the public sector anti-corruption strategy, business anti-corruption strategy, and civic society anti-corruption strategy would culminate within this forum into a national strategy.

Discussion
Mr M Sikakane (ANC) asked Dr Schutte whether this presentation addresses the questions that were put to him.

Dr Schutte answered that to a large extent they do and that the Report by the Public Protector was published in 1999 and that since then a lot has happened to overtake those recommendations.

He said the new legislation makes provision for a balanced board. The old legislation that prescribed statutory boards has not been revisited. He said there are many statutory bodies that do not have the mixed board of executives and non-executives.

He went on to say that it is true there has to be certificates coming from various Departments stating whether they are complying with various indications but conceded that the civil service is a big body, which makes it difficult to implement these directives.

Ms C September (ANC) asked how one balances good governance mentioned in the King Report with the PFMA? She said the King Report talks about salary disclosure while the PFMA is silent on that.

Mr Kitshoff answered that the PFMA, which is about financial reporting, has incorporated a lot of good practices proposed by the King Report and that they were now working on remuneration frameworks to deal with inconsistencies emanating around that area in the public entities.

Mr D Sithole (ANC) observed that instead of every Department issuing certificates, how about the Public Protector revamping the Corruption Act to avoid generating policy and documentation that could be cumbersome?

He also asked the DPSA how does it envisages coordinating all the certificates in terms of saying this is where the Public Service is now?

Dr Schutte replied on the matter of revamping the Act, saying he had attended a training course conducted by the South African Institute for Government Auditors (SAIGA) on the PFMA. SAIGA was of the opinion that the PFMA is an excellent document and that the public sector was ahead of the private sector because of the PFMA.

He said the problem was not so much with the documentation, policies and legislation but with implementation. The new PFMA approach is to allow the managers to manage, doing away with the old Treasury Regulations that were prescribing; first do this, second do that. The new approach says this is what you have to achieve now go and do it, which can be a good thing if a manager knows what s/he is doing.

Obviously the managers have to go for training which is available and added that the new regulations give guidelines rather than prescriptions. The problems he foresees especially from provinces is the lack of expertise to implement this, especially with the regulations which say this is a general idea now you go and do it.

He said there should be systems to help managers to get to the level of being able to implement this.

Mr Kitshoff said the Public Service Review Report published last year realized that the one size fits all approach does not work. That Departments are not exactly the same and if it comes to fraud prevention strategy, one size will not fit all, as there are small Departments in terms of manpower and bigger Departments on the other hand. But it does not preclude the fact that there should be sharing between the Departments, helping each other to curtail fraud and corruption, and that trends needs to be adapted and tailor-made for specific Departments.

The meeting was concluded.

Appendix:
SUBMISSION TO THE PORTFOLIO COMMITTEE ON PUBLIC SERVICE AND ADMINISTRATION: 13 JUNE 2001

Briefing on special Report No 13 of the Public Protector: Dr M Schutte (Assistant to the Public Protector)

Introduction
1. The Portfolio Committee on Public Service and Administration invited the Public Protector to attend their meeting of 13 June 2001. The purpose of the meeting would be for the Public Protector to brief the Committee on the recommendations made in the Public Protector's Special Report No 13. The Committee indicated that they would like the Public Protector to specify what the basis was for making the recommendations, with specific reference to paragraph 7.59 on page 166 of Report No 13, which makes mention of a formalised fraud strategy.

2. Regrettably the Public Protector will be presiding at the public phase of the "arms deal" investigation on 13 June 2001. Dr M Schutte, Assistant to the Public Protector, will therefore represent the Public Protector, if this would be acceptable to the Committee.

Background to Report No 13 of the Public Protector

3. The Public Protector reported in Report No 13 on his investigation into the alleged irregularities with regard to the affairs and financial statements of the Strategic Fuel Fund Association (SFF), and on the relevant reports of the Auditor-General to Parliament.

4. A brief summary of the history leading to the investigation, is given below:

- During 1996 the then Minister of Mineral and Energy Affairs, Dr P M Maduna, raised certain concerns with the General Manager and Chairman of the Board of the SFF.

- The SFF was originally established to secure fuel supplies by circumventing oil embargoes. When the United Nations embargo was lifted on 9 December 1993, the SFF continued to trade oil internationally.

- The issue which raised suspicions, concerned certain payments made by the SFF after 1993 to a company called Interstate, over and above the purchase price of oil acquired by the SFF. The concern was that these payments could be irregular, or fraudulently made.

- Early in 1997, the Minister appointed a private firm of chartered accountants to investigate the above. (Their mandate was later extended to cover the issue dealt with in the paragraph directly below).

- On 18 June 1997 the Minister responded in Parliament to questions concerning the SFF. In summary he queried why a loss of R170 million described as the transfer of oil stock, was not disclosed in the Auditor's report to Parliament on the 1993 annual financial statements of the SFF

- The above resulted in some unpleasantness between the Minister and the Auditor-General, and led to Parliament requesting the Public Protector to investigate the allegations of irregularities on the part of the SFF, and on the Auditor-General's reports.

Recommendations made in Report No 13 relevant for present purposes

5. The following recommendations made by the Public Protector do not only apply to the SFF, but concern State institutions in general:

5.1 The SFF and other similar State organisations should have a board of directors consisting of executive and non-executive directors, as suggested by the King Report on Corporate Governance, 1994. The chairperson should be independent and non-executive (paragraphs 7.37, 11.12, 11.13).

5.2 All State institutions should have a formalised fraud strategy as part of their overall strategy, which should include:

* How fraud risks will be assessed on an ongoing basis;

* An ongoing methodology for ensuring that the controls in place correctly identify, detect and prevent fraud;

* A fraud response plan to ensure that any fraud detected is responded to appropriately;

* Specific responsibilities for ensuring that the fraud strategy is implemented and followed up on an ongoing basis (paragraphs 7.59 to 7.61, 11.14).

Basis for recommendation on board of directors

6. One of the allegations investigated by the Public Protector, was that the General Manager of the SFF acted without the appropriate authority and knowledge of the Board, and did not provide the Board with adequate information regarding key issues, particularly with regard to the mentioned payments to Interstate.

7. Although no substance was found in the allegations, it became clear that the General Manager, a man of strong personality which made his subordinates wary of him, was the lynch pin between Management and the non-executive Board. This potentially led to the situation where he could have manipulated information going through to the Board, should he have wished to do so. It became clear that if the SFF had had both executive and non-executive directors, the flow of information between Management and Board would not have been open to potential limitations by one person. This in turn would have prevented perceptions leading to the allegation made in this regard.

8. The King Report deals with the issue of executive and non-executive directors in chapter 4 (section 6 to 9), and draws the conclusion that a board needs to be balanced by executive and non-executive members.

9. The Public Protector was of the opinion that appointing the General Manager and the Deputy General Managers to the Board as executive directors would prevent the Board being dominated by an individual or individuals, whilst ensuring that it is fully informed. The senior managers would then report to the Board directly, as opposed to reporting through the General Manager.

10. The Public Protector thought it fit to make this recommendation of general application, since adherence to the King report in this regard can only benefit other state institutions with boards not consisting of both executive and non-executive directors.

Basis for recommendation on a formalised fraud strategy

11. One of the key allegations before the Public Protector was that the SFF, and therefore the state, lost money due to fraudulent or irregular payments.

12. Fraud and similar crimes is of grave concern around the world, and particularly in South Africa. Given the highlighting of fraud in business today, it is vital that fraud is specifically addressed when looking at the corporate governance of State institutions.

13. In South Africa we have the added concern that some state institutions worked under a veil of secrecy, of which the SFF is a prime example due to the nature of its activities (circumventing the oil embargo). Secrecy heightens the potential for fraud and similar crimes. State institutions previously working in secret have to adapt to a transparent environment. It is necessary for such institutions to review themselves to ensure that all matters are above reproach, especially where contracts concluded in the era of secrecy continue into the era of transparency.

14. An appropriate fraud response plan may have mitigated the problems that arose when the Minister became suspicious. There was no formal policy in place on which he could base his actions.

15. Although these recommendations were made against the background of an investigation dealing with a business entity in the public sector, they equally find application in State administration.

16. A comprehensive fraud prevention strategy should include:

* A policy statement by top management;

* A policy document on how fraud will be dealt with;

* A risk assessment of all areas of operations;

* A fraud prevention and response plan;

* A code of conduct;

* Training on the fraud prevention strategy;

* Instruments to prevent and detect fraud, for example reporting structures, a hotline, surprise inspections, staff vetting and rewards.

17. A fraud prevention strategy should be regarded as an ongoing process rather than a once-off exercise.

18. It should be noted that the Treasury Regulations dated 31 May 2000, issued in terms of the Public Finance Management Act 1 of 1999, indeed underpins the recommendation of the Public Protector. Regulation 3.2.1 provides that an accounting officer must ensure that a fraud prevention plan be developed

DR M SCHUTTE ASSISTANT TO THE PUBLIC PROTECTOR