Sectoral sanctions and 50 percent rule add risk and costs to transactions.
Multinational corporates have always had to comply with US sanctions around the world. However, new “sectoral sanctions” issued last year against Russia following its annexation of the Crimea, combined with recent guidelines to determine company ownership, have made dealing with companies in Russia and elsewhere much more complex. And this is happening just as regulators are levying record fines for violations.
Sanctions traditionally have stemmed from embargoes and levied on countries including Cuba, Iran, North Korea, Sudan, and more recently Syria. To help companies, the US Treasury’s Office of Foreign Assets Control (OFAC) publishes a specially designated nationals (SDN) list, comprising sanctioned individuals and companies that are controlled by, or act on behalf of, targeted countries and individuals such as terrorist that are not country specific.
Sectoral sanctions issued by OFAC, on the other hand, prohibit transactions with individuals and organizations on the sectoral sanctions identification (SSI) list, which in the case of Russia are fine-tuned to apply only within specific sectors: energy, defense and financial. That raises the possibility of a multinational entering a business or financial contract with one non-sanctioned affiliate of a Russian company, and then finding itself in violation of a sectoral sanction because the product or service it sold is also used by another affiliate subject to sanctions.
Lindsay Meyer, co-managing partner at Venable LLP and head of the law firm’s international trade practice, noted a US company could sell software to non-sanctioned subsidiary of a large Russian state-owned company to make back-office operations more efficient. Given the fluid nature of software, however, if it is used by a sanctioned financial or energy subsidiary, the company could find US regulators knocking at its door.
A common approach to deal with this risk is to ask the counterparties in business and financial transactions to certify that the activities in question are not in violation of sectoral sanctions. However, said Ms. Meyer, regulators have yet to clarify how they would handle that situation, or whether such certifications are a safe harbor.
So far, the impact on multinationals has been more direct. Exxon Mobil Corp. was involved in a major project with Russian state-owned oil company Rosneft, and after the sanctions were issued last spring—and later amended in September—it withdrew exploration teams preparing for future work. Given the size of the project, however, Exxon sought a waiver from OFAC to extend the 14-day period authorized under General License 2 to wind down that business.
“That’s one where clearly the impact of US government sanctions was acutely felt by that large US company, but they were able to work out an accommodation,” Ms. Meyer said.
French oil-services giant Schlumberger has also shut down business in Russia, given the risk of violating US and European Union sanctions.
Fanning the fire, OFAC last August issue guidance saying companies must look at a potential counterparty’s owners in aggregate, and if more than 50 percent of that ownership is by folks on the SSI or SDN lists, transacting with that company is prohibited.
“So now companies have a higher standard of due diligence, because they can’t just look at a list and say, ‘I know I’m not dealing with this person on the list,’ and move on,” Ms. Meyer said. She added that Russia’s many oligarchs, often closely associated with Russian President Vladimir Putin, may appear on the SSI or SDN lists, and if two or more of them exert ownership in a company that exceeds 50 percent, then selling goods and services to the company is prohibited. For example, brothers Boris and Arkady Rotenberg both appear on the SSI list. The billionaire co-owners of SMP Bank and SGM Group, a large Russian supplier of construction services, also own pieces of many other companies, in and outside of Russia.
“If I have a contract with ABC Co., but I find out the Rotenberg brothers, and perhaps another person on the SSI or SDN list, co-own an interest in the company that’s more than 50 percent, then dealing with that company is prohibited,” Ms. Meyer said, highlighting that that’s true “even if the company itself isn’t on an OFAC list.”
This new interpretation of majority ownership greatly increases the importance of careful due diligence in such transactions, which is already quite challenging due to issues of translation, opaque ownership, and shifting interests.
“In many jurisdictions there’s a lack of transparency around beneficial ownership, or there’s the use of nominees hiding the true ownership,” said Pekka Dare, director of anti-money laundering (AML) and financial crime prevention at International Compliance Training (ICT).
So far there haven’t been any violations of sectoral sanctions, at least publicly announced ones, but regulators have displayed new intensity in terms of enforcement. The Association of Certified Anti-Money Laundering Specialists (ACAMS) found that enforcement actions decreased by 11 percent, but the US Justice Department reached a record $9 billion settlement last June with France’s BNP Paribas for violating US sanctions against four nations. Most sanctions have been issued by US regulators, and they apply to any transaction in US dollars, regardless of the nationality of the persons or companies involved.
Companies must also consider sanctions issued by other jurisdictions, if they do business in those currencies, Mr. Dare noted. The due diligence to prevent sanction violations can be costly, but violations and remedial steps that follow are typically far worse.
Financial institutions and especially banks face the greatest scrutiny from regulators, if only because they have so many. However, non-financial corporates may face questions from examiners from the Securities and Exchange Commission or other regulators. And even though less than gigantic corporates may not have the resources internally to do complete due diligence on their own and must rely on third parties, they are still legally responsible.
Mr. Dare said they must be able to demonstrate to examiners that they are regularly updating their systems used to scour data and weed through misleading results, since that software degrades if not attended to. Or they must show regulators their third parties are proactively doing so.
Many questions today may be clarified when regulators in the US and EU finalize proposals requiring financial institutions to understand who the beneficial owners are of companies they’re doing business with. Although the proposals only apply to financial institutions, they will serve as guidance for other type of companies. Ms. Meyer said she expects the rules to refine current requirements and emphasize the need for companies to demonstrate they are doing as much due diligence as possible.
It’s currently unclear whether sectoral sanctions will be limited to Russia or represent a new sanction regime. In the Russia, however, those sanctions combined with the oligarchs, the rich energy sector, and the new guidance on the 50 percent ownership rule create a challenge for multinationals doing business there and just about any other jurisdiction where the ownership laws are less than clear and/or the bureaucracies are complicated.
“It’s tricky, because you have to peel back layers of the onion to understand the ownership, and that can be difficult because ownership interests can be opaque,” Ms. Meyer said. “A company has to do the best due diligence possible. Many were trying to get publicly available information, often from third-party entities that gather and report such information. But it’s not a perfect science, and that’s why many companies to the conservative route and decided to disengage from contracts.”