Conducting sanctions due diligence

In today's episode of Integrity Insights I talk to Verena Horne, a senior consultant at Berlin Risk. We discuss the latest developments in the field of sanctions enforcement in the United States and the European Union. Verena explains why sanctions risk is top of the agenda for many internationally active companies, and talks about how this type of risk can be mitigated with the help of sanctions due diligence. 

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Transcript

Hi Verena. Welcome on the podcast. Hi, Philip. Thanks for having me.

My pleasure. Um, okay, so before we start, can you maybe tell our listeners a little bit about your background? Uh, yeah. Well, I'm senior consultant at Berlin Risk, and, um, I'll keep it short. I trained as a financial journalist and then I worked for many years in political and security risk, um, working. In most parts of the world, but also, uh, specializing in India.

And then I at some point found my way into integrity due diligence and corporate investigations where I found my home. So interesting. Thank you for this, Verna. And, uh, yeah, I, I mean, I, as I outlined in the. Introduction to this episode, I invited you today specifically to talk about sanctions because I know that you've recent, relatively recently written an, uh, an interesting article on the subject.

And I was also actually recently at a conference in Berlin with a, a lot of compliance people from various big German companies, and I've heard something really interesting there. One of the. Um, compliance officer was basically saying that the companies these days worry mostly about sanctions, not so much maybe about supply chains or ESG.

That was something that really struck me and, uh, I was, I thought this would be a good opening question, like, why, why is this the case? Why, why do, uh, companies worry about the sanctions so much these days? Yeah. Really good question. Well, um, I guess just. Purely technically, um, sanctions are, uh, under strict liability in most jurisdictions.

Companies are legally liable for their sanctions violations, even if they're unaware that they are violating those sanctions. This really makes it a compliance priority, and I mean, economic sanctions have been developing into one. The west kind of primary foreign policy tools for a long time now. We've had long running sanctions on pariah states like Iran and Syria, um, and sectoral sanctions on Russia after its annexation of, uh, illegal annexation of the Crimea in 2014.

But I mean, what we really had over the past year and a half is a quite an unprecedented, unprecedented situation where Russia, which is really an integral part of the global economy, has been, um. Targeted and really quite sweeping sanctions. Um. That, um, mean that there's just on top of the sheer number of different sanctions regimes that we have globally, we also have these sanctions on Russia, which are targeting a record number of individuals and entities.

And those entities are, like I said, often part of the global economy. Um. You know, Russia's an exporter of certain important raw materials. So what we have is the risk of kind of collateral impact on the, on, um, for companies and entities all over the world is much higher. Um, so yeah. I guess that's the, the main answer.

Hmm. I mean, I guess what I have been really wondering mostly about is the, is the fact that, I mean, you all have all these different sanctions, I dunno how many different sanctions, regimes, different countries imposing sanctions, but at the same time, I have been reading a lot about. I mean, this concerns Europe mostly.

I mean, that's, that's where we are based. But the fact that there's so many sanctions individuals and sanctioning companies that still continue doing their business without very little kind of limitations, very little restrictions. So the sanction enforcement, at least in Europe, seems to be really kind of ineffective.

So, uh, I guess in that context, I was thinking, okay, why, why do we actually fear this company's sanctions? Yeah, yeah, that's a good point. I mean, uh, I think. Any company that is involved in transnational business will be concerned about sanctions primarily because of the US Treasuries, office of Foreign Assets Control, which has really been the kind of primary official entities that companies need to be concerned about.

In terms of sanctions enforcement, we saw, for example, earlier this year, I think it was in June, the British American Tobacco, um, was. Made a settlement with the US authorities in US OFAC for sanctions violations with regard to North Korea. It, it, it, between 2007 and 2017, it was exporting cigarettes to North Korea, um, in violation of sanctions and it made a settlement payment of nearly 600 million, or perhaps it was just a little over 600 million.

So you can see that there are really, really quite substantial penalties, um, to be. Paid, perhaps you are right, that in the EU that enforcement of sanctions violations and circumvention has been pretty, um. Patchy to say the least. And I'm not sure that there is a lot going on, but we've seen some changes, um, in the EU in recent months, I think in response to, um, debates over actually how effective the sanctions have been in, um, affecting the Russian economy and kind of, um, hampering the Kremlin's war efforts in Ukraine.

Um. So, uh, yeah. We've seen a move in the EU towards increased enforcement, especially with, I mean, the EU Council in June settled on an approach for an EU wide law criminalizing and imposing penalties for violations of EU sanctions, which probably will means that we're moving towards a situation where sanctions violations will be prosecuted on an EU wide level, which perhaps is, will mean that Europe.

Will be more of a concern in terms of enforcements for companies going forward. I mean, if there, so that means Go ahead. Sorry. That, that means, that means Verna that at, at, at, at, at the moment. Uh, in the European context, it's the individual member states that are responsible for the enforcement. But you are basically saying that there is a.

Pushed towards centralization of this. Yes, exactly. Sorry, that, sorry if that wasn't clear exactly. Um, individual member states are currently responsible for viol, um, for prosecuting, investigating and prosecuting enforcements. And on a, um, a. On a practical level that isn't happening possibly to the level that it should.

Um, and is there, is there currently a, uh, a central register of all imposed sanctions like globally? There isn't any free central tool that's reliable or official in any way. Um, separate official databases really need to be checked by companies undertaking compliance checks for sanctions risks. There are paid for digital tools, which can help with these first level checks, but ultimately.

If you want to uncover, um, the real sanctions risk behind a new business partnership, you really can't rely on digital tools alone to check that sanctions risk. Um, for all sorts of reasons that we can discuss when we go into the process of sanctions due diligence. Um, there's also the 50% ownership rule in the concept of narrative sanctions, um, which means that a lot of companies that are officially under sanctions don't appear on any official list.

But they are sanctioned by association. So that means that they're 50% owned by one or more person that appears on a sanctions list. Um, actually I read up an interesting statistic that shows that. Individuals and entities that appear on official sanctions lists actually make up an estimated 5% of those that are actually fall under sanctions.

So this shows that there's a lot of, um, hidden sanctions risks that if you're only screening via official sanctions lists, you will miss. Okay. So it's not, it's not so simple as just putting a name into, into some search books and, and, and seeing whether. The person or the company has been sanctioning to do more.

Yeah, no, definitely not. Because I mean that can't account for your subjects or your business partners activities to date. You know, their other business interests, their political contacts and their network, which all contribute to the risk of being sanctioned. Yeah. Okay. And if I understood you correctly, you are saying that in order to be fully aware of all those underlying risks you need to conduct, uh, sanctions, uh, due diligence, can you maybe, uh, speak a little bit about this in, in more detail?

What, what does it entail exactly this process? Sanctions due diligence is, uh, a process that I guess is comparable to traditional integrity, due diligence or anti-money laundering, linked due diligence processes. So I mean, companies that might consider or would should consider sanctions due diligence and necessity.

Um. It really, for example, when they're considering cross-border transactions, particularly in ju jurisdictions that pose a heightened risk of sanctions, or for example, with partners that have a heightened risk profile because of where they operate or the sector they operate in. For example, strategic sectors, um, will have a heightened risk profile for sanctions.

Um. Or, uh, the type of activity they're engaged in. Um, and in cases especially, I think, and this is really important, in cases where a business partner might have a particularly complex corporate structure, that means there are some difficulties in identifying really underlying ownership because, um, as I just discussed before, there's this risk of.

Sanctions by associations. So it's really, really critical when you're looking at sanctions risk to, um, make sure that you know who the ultimate beneficial owner is. And besides establishing the ownership structure, uh, what are the other things that you absolutely need to check on a, uh, sanctions due diligence assignment?

Primarily if companies are undertaking sanctions, due diligence, they need to answer a series of fundamental questions about their business partners that can be compared to traditional, um, integrity due diligence or a ML due diligence processes. So that would be who is your customer? Um, what exactly do they do and, and where do they do it?

Um. This information then needs to be checked for existing and potential sanctions exposure and assessed on the basis of aggregated risks across the entire project. That's how, that's the kind of overall methodology and we would probably, we tend to break down sanctions, due diligence into three main steps and those that would be, we would first, I guess, investigate.

These questions. So who's your customer? What do they do? And where do they operate? And who their business partners are, for example. And then we would assess the sanc specific sanctions risks. And then the third step would be to monitor the, um, project or the business partner for ongoing risks or emerging risks.

So, for example, reputational risks that, um, develop into legal risks from a sanctions perspective. Um. Yeah. And so I, I guess the, the key step especially for, for us is the investigation part where we look into the factors that contribute to an overall increased sanctions Risk exposure for a company, I think is a really critical step, is looking into determining the beneficial, be beneficial ownership of, um, the target entity in the, of the investigation.

As I think we have seen in our, in our investigations, both of us, um, there's a lot of ways in which, uh, well, there's a lot of ways in which sanctioned individuals and entities can obscure ownership basically. And this is kind of the prime area where we see sanctions violations and circumvention, um, happening.

And that's what I, that's Aya, that's exactly what I wanted to say. Because we know from episode number one about UBO registries that the currently situation regarding beneficial ownership reporting is not exactly advantages for investigators. So I wonder how do you, when you check a, a company. Uh, you, you might expect that the UBO, the ultimate beneficial owner is a, perhaps a, a sanctioned Russian oligarch, but suddenly you see a completely different name there that maybe is no really no profile.

Like how do you deal with that? I mean, we know that sanctioned individuals frequently transfer stakes or shares in companies and assets to maybe trusted family members, friends, employees, to hold on their behalf. So I, I guess the first thing that we would do is check if these individuals are family members are related to the.

Sanctioned individual or if they're employees. Um, this is a very, very common, um, uh, tactic that we see time and time again. Mm-hmm. Um, we saw recently the release, for example, of the Rotenberg Files investigation by the organized Crime and Corruption reporting project together with some international newspapers.

That showed how the Rottenberg brothers who were really, really body, body with, um, Vladimir Putin, um, and are sanctioned, um, in the US and the eu, how they went about circumventing sanctions for years. And we saw in one case, for example, Boris Rotenberg's bodyguard Alexander. SLO was, um, made UBO of a British Virgin Island registered company that was formally owned by Boris Rotenberg and through which he held one of his yachts.

And I, I think, you know, in, in that case, if we could link Alexander Kozlov to Boris Rotenberg through his employment history, then that would be a very clear red flag. Um. So it's about looking at the network and seeing how they fit in. But I wonder that's a, that's a very interesting point. And I, and I wonder because this is then, uh, this is obviously, I understand from your per, per perspective how it is a red flag.

But then when you report this information, I guess to your client, to a company that is, uh, concerned about sanctions, uh, and they see that, uh, uh, they are basically de dealing with a non sanctioned. Individuals. So like strictly from a strict legal perspective, they don't, they actually have n. I, I assume nothing to worry about.

Well, that's actually recently recent changes to we've seen, uh, we talked about the 11 sanction package and actually just before that, and in that package, there's been a redefinition of who is. Potentially in the category of being sanctioned, we've seen a widening of that to include family members of prominent Russian business people, or I think the wording in the 11th sanctioned package was the definition of, um.

Those that can be added to the EU sanctions list also covers. Now, people who quote otherwise significantly frustrate those provisions related to sanctions. So we see what we see as a widening of the definition of people who can fall under sanctions. So if it becomes clear to sanctions, um, bodies that, um, apply sanctions that.

Individual is holding though a share in a company or a sanctioned on behalf of a sanctioned individual. Then there's definitely a sanctions future sanctions risk there. And we see in the US that the US OFAC is, is prosecuting individuals that. Are, um, employees or friends of sanctioned individuals who are holding their or managing those assets?

I think there was a case in February this year, there was, um, the US indicted a US Register, uh, resident Russian individual who was an associate. Of, uh, the designated Oli Oligarch named Vekselberg. So he was charged, um, of conspiring to violate and evade US sanctions and money laundering laws, um, because he was basically making payments to maintain some luxury pro properties owned by Vekselberg.

And, uh, he even tried to sell them on for Veel Berg. And I think in that case, you know, the US F authorities. Felt it was clearly quite a clear case that this, he was, I mean, he had been going around talking about how he was best buddies with Wexberg. So, um, yeah. But I think in this case, if you were a company and you were thinking of, um, it getting involved in a business relationship with a company that you, that.

We suspected, um, was actually owned by a proxy on behalf of a sanctioned individual. Then what you are looking at as a company, you are looking at the risk that that future business relationship has to be broken off because that company will be sanctioned. So, and I, and I. And I suppose the fact that you as a investigator, as a, uh, sanctions due diligence investigator, that you come up with this conclusion that that probably means that, uh, any sanctions enforcement officers that are in the US or you will probably come up with, with the same.

Conclusion. Yeah. Obviously it depends where and at what point they start looking into these individuals, but what we see is this, you know, as I, as we discussed before, this really dynamic landscape where there's constantly more individuals and entities being added to these lists. That, that, you know, there's, there's, there's.

If you can pinpoint that there is a sanctions risk, then, you know, not only, I mean, there's the reputational aspect of, uh, in, in the current context of working with companies, um, Russian companies and so forth, and that's one aspect. And that depends on your organization's risk appetite, but then there's also the risk that these reputational risks turn into real legal risks associated with sanctions.

Yeah, and I mean, it's not just, not just in terms of determining beneficial ownership. It's, it's not just, you know, if, if it was as simple as just looking into proxies and, you know, there are ways of identifying proxy ownership, it's, it's. Usually with some investigations and discreet inquiries, it's, it's, it's possible to identify proxy ownership or non nominal ownership.

But, um, there's also, you know, there's other, there's other ways of obscuring ownership. So we see the use of obviously non-transparent jurisdictions or regulatory loopholes or the restructuring of assets for greater secrecy. Um, so, and often in those cases, even if you can't. Conclusively identify the ultimate beneficial ownership You can see, again, if you investigate closely enough, you can see activity that that presents represents really a, a major red flag.

We had, uh, one case recently where we were investigating some funds in Lichtenstein, for example, that were primarily used as a vehicle to own and, um, provide financial, um. Support for a company operating in Russia. Um, we started looking into this company in Russia and we made some inquiries on the ground, and it came back that almost certainly, or it seemed to be fairly widely acknowledged that this company was a vehicle for two very, very high profile sanctioned individuals close to Putin.

What we, when we then went back to look at the Liechtenstein context, what we found was that these funds that had, were basically used to own this company operating in Russia. They had recently all three changed their legal structure to a different type of legal structure, and the new type of legal structure allowed these.

Funds to bypass legislation that required them to declare their ownership according to Lichtenstein's, newly expanded, uh, beneficial owners register requirements. So this, so again, bene beneficial ownership problems. Exactly. And in this case it was, you know, combined with these inquiries on the ground, it, it provided quite a conclusive, I mean, quite, quite a good argument, um, against, I would say.

Investing in that particular project. Mm. Yeah. That, that is really interesting. Thank you for, uh, giving this example. It's always good to have some real life, uh, scenarios. Well, thank you so much, Verina, for joining me today. I, I really enjoyed this conversation actually. Uh, and I'll make sure to. Invite you again once there's some fascinating developments on the sanctions front.

But, uh, until then, I, uh, wish you all the best and, uh, yeah, take care. Yeah, you too. Bye.