The devil is in the detail when trying to fathom the figures in the audit report on the Strategic Defence Package, writes Ivor Powell

The conversion used an arcane system of ‘multipliers’

GOVERNMENT audits are, by nature, cautious and circumspect, constrained by the letter of the mandate they are required to execute, and slow to apportion blame or exercise judgement.

THUMB-SUCK: Former trade and industry minister Alec Erwin might have some hard explaining to do when – if the programme goes ahead as scheduled – he takes the witness stand at Judge Willie Seriti’s Arms Procurement Commission in Pretoria tomorrow.

But the truth lies in the numbers. And the numbers crunched by a Department of Trade and Industry (DTI) audit team to produce a final internal audit report on the Strategic Defence Package Phase 1 – the performance of arms deal manufacturers in so-called National Industrial Participation (NIP) projects – require a lot of secondguessing to even begin to add up.

The offsets agreements were concluded under the umbrella of the 1999 arms deal. They bound successful contractors to make investments in the South African economy to offset the huge cost incurred in buying the weapons in the first place. As sold by proponents of the deal, offsets would generate more than twice the cost of the materiel, leaving South Africa richer rather than poorer for having bought the hi-tech weaponry.

That was the theory, but, to quote authors Paul Holden and Hennie van Vuuren in the title of their book on the arms deal, the devil was lurking in the detail.

To start with the big number: in 2012 Trade and Industry Minister Rob Davies submitted a report to Parliament’s trade and industry portfolio committee revealing a staggering shortfall of more than R100 billion in what successful bidders in the notorious 1999 arms deal committed themselves to invest in the South African economy (about R110bn) and what was actually invested (about R6bn).

But an inter-departmental industrial participation control committee – made up of officials from DTI, the Department of Defence, the National Treasury and the Department of International Relations and Co-operation, and charged with evaluating the performance of NIP investments – by 2012 saw fit to sign off all NIP commitments as having been fulfilled. The conversion of six to 110 had been effected by using an arcane system of “multipliers” supposedly quantifying the benefit to the South African of investments in strategic sectors of the economy.

Crucially, though, it meant that the weapons manufacturers – the BAE/Saab consortium, the German Frigate and Submarine Consortia, French supplier Thales and the Italian company Agusta – would finally get paid in hard cash for the materiel the South African government had purchased.

Another number: by this time (2012), given fluctuations in the value of the rand among other factors, the payout would lighten the South African fiscus by about R70bn, more than double the about R30bn the deal had been worth at the turn of the century. And here are more numbers: BAE/Saab are recorded as having invested $35 million in a project designated as Gemco Laboratories and involving the manufacture, sale and distribution of dental prostheses. Though no sales or other benefits to the economy are recorded, the consortium was awarded offset credits to the value of $350m – that is, on the basis of a multiplier of 10.

Meanwhile, as is recorded on Gemco’s website, the company’s foreign investors sold their shareholding in 2010. The sum realised is not immediately to hand, but there are no indications it was reinvested in South Africa.

Another BAE/Saab project awarded seemingly particularly generous offset credits was one designated as Carbotech Carbon Manufacture. Here an investment of $14 460 000 was transformed into a credit of $110 404 336 – despite the project failing in its entirety.

One project that did not fail in its entirety was producer Anant Singh’s Mandela movie, Long Walk to Freedom, into which the German Submarine Consortium pumped € 5 691 952, achieving offset credits to the value of € 300m – broken down as € 180m against sales and € 120m credited against the € 5.9m investment. Assuming that the German Submarine Consortium investment accounted for one-fifth of the total investment in the film, these numbers would project Long Walk as one of the top 10-grossing movies in history, up there with Titanic and way above Star Wars. Even more startling, though, is the fact that these credits were awarded before the film was even made.

Dryly, the DTI internal audit report notes a pattern in the awarding of offsets to the arms deal obligors in which investment credits were awarded “up front” on the basis of projections in the business plans submitted by the various obligors, rather than according to what was actually achieved.

In some cases this led, as the audit records show, to situations like that where the French manufacturer Thales achieved offset credits worth $171 213 256 – on a tangible investment of $1 100 065 in a project designated as Evertrade Medical Waste. As part of the justification for the more than 15 000 percent escalation in credit value, the control committee awarded $107 590 000 against sales. Curiously, though, as the audit notes, the project failed before getting properly off the ground, and “there is currently no evidence that the conditions for awarding the credits were eventually met”.

Confronted with seemingly anomalous accounting like this – and there are hosts of examples recorded in the 37-page document – the audit draws attention to a major deviation from DTI’s usual practice in administering investment offsets, and insists on the essential simplicity of formulas adopted by the department.

As noted, established DTI procedure specifies that “one (1)” offset credit is to be awarded according to each of three criteria – actual investment, local sales realised and net exports generated as these are recorded. In other words, the equivalent of each dollar in local sales, or export earnings, would be credited with one dollar in offset credit and added on to actual investment to calculate offset credits.

But this is not how the arms deal offsets were calculated. Instead, the interdepartmental committees negotiating the offsets in the first place – made up of DTI, the Department of Defence and Armscor officials – chose to introduce a new system of calculation, whereby offsets would be calculated as “package deals”.

The rationale for the deviation was stated as being designed to encourage the obligors to invest in sectors of the economy where interventions were required – like training – but immediate profits would not be forthcoming. At the same time a new differential was introduced – though not directly calculated for offset credits – in the field of creating and sustaining jobs through the obligors’ investment interventions. To “balance the books”, as it were, as regards perceived benefit to the economy, the industrial participation control committee introduced a system of multipliers whereby actual investment would be brought into line with economic benefit – but without any guidelines on how this was to be calculated. On this basis, multipliers of up to 150 were employed – as in an item designated as “SAMES loan grant” where a sum of € 1.5m was transformed into an offset credit of € 217.8m.

Responding to such startling – not otherwise explained – value escalations, in one of a series of such interventions, policy interventions initiated by the DTI’s audit specifies that future offsets will not be allowed to exceed a ratio of two credit units to one investment unit.

But the audit acknowledges its own limits. Though other agencies – Swedish investigations into the conduct of Saab and BAE, German probes into the German Submarine Consortium and the UK’s Serious Fraud Office probe into alleged bribery by BAE, among others – have highlighted alleged corruption in the programme of offsets, the DTI audit notes that procedures it has followed “do not guarantee that fraud will be detected”.

It does note that not all money the obligors were credited for actually found its way into the various projects. It also notes that in relation to several projects documentation supporting the awarding of offset credits – more than $50m in the case of BAE/Saab alone – could simply not be found.

DTI’s immediate job has been to ensure that procedures are rationalised to prevent possible abuse in future. Other agencies will have to decide on how the information gleaned from the report is to be used.

But for a start, former trade and industry minister Alec Erwin might have some hard explaining to do when – if the programme goes ahead as scheduled – he takes the witness stand at Judge Willie Seriti’s Arms Procurement Commission in Pretoria tomorrow.

Commission spokesman William Baloyi confirmed this week that the final audit report reviewing the performance of NIP investments on the part of successful contractors in South Africa’s 1999 Strategic Defence Package – the arms deal – had been formally handed over to the commission along with a substantial body of detailed evidence.

But, while the beleaguered commission will be closely watched in relation to the way it uses or fails to use the DTI audit, its real force might be felt elsewhere. Arms deal critic Terry Crawford-Browne – whose application to the Constitutional Court led to the establishing of the commission in late 2011 – is in the process of reactivating his challenge before the highest court in the land. Key to his argument is a contention that the offset programme could not be justified under constitutional injunctions for public officials to act rationally, in good faith, and in the best interests of the country.

Whether the offset programme as it played out will satisfy such criteria remains to be seen.

With acknowledgement to Ivor Powell and Sunday Argus.

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This is simply staggering.

Even for me who has been immersed in this bilge for 15 years.

Larceny at its grandest.

Not that there was ever the slightest doubt from the onset, it is now so stark why Grand Larceneer Mbeki smiled relievedly when his stooge Dr Penuell Maduna that he was recommending to him circa 20 January 2001 that Judge Willem Heath's SIU not be granted a proclamation to investigate the SDPs.

The contracts would all have been cancelled that year' with only the 20% advance payments having been made and not a single stitch of equipment having been delivered.

Now it is a simple matter of incarcerating the natural persons and blacklisting the juristic ones.

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I just read the two DTI Reports.

In my view they are both incomplete and very soft.