The National Economic Crime Centre (NECC), a multi-agency unit in the National Crime Agency (NCA), and HM Treasury’s Office of Financial Sanctions Implementation (OFSI) have published a “red alert” on financial sanctions evasion typologies by Russian elites and enablers (Red Alert) that synthesizes information from a range of UK law enforcement agencies as well as industry to identify common techniques designated persons and their enablers are suspected to be using to evade financial sanctions.
The Red Alert provides a series of sanctions evasion indicators identified from real world case studies. It also sets out recommendations as to the level and type of due diligence that companies should perform on higher risk transactions and counterparties. The stated purpose of the Red Alert is to combat and disrupt financial sanctions evasion by complementing the private sector’s existing knowledge of these issues and facilitating preventative action in the form of enhanced business processes and procedures to identify and mitigate the significant exposure that many sectors of industry have to sanctions evasion following the unparalleled volume of sanctions designations introduced since the start of the Russian invasion of Ukraine.
In practical terms, the Red Alert offers a timely reminder of the challenges companies can face in effectively identifying and mitigating the sanctions risks posed by higher risk transactions and counterparties and underscores the importance of companies undertaking robust due diligence that is calibrated to address appropriately the sanctions risks, including sanctions evasion risks, posed by such transactions and business relationships. In particular, companies should carefully consider whether their existing sanctions compliance processes take into consideration the sanctions evasion warning flags and due diligence recommendations outlined in the Red Alert.
Divergence and the Rising Risk of Sanctions Evasion
Since the start of the Russian invasion of Ukraine, the United Kingdom, United States, European Union and other international allies have introduced an unprecedented suite of sanctions measures that target, among others, the elites who control Russia’s economic interests.
While there has been significant coordination with respect to sanctions designations and implementation across UK, US and EU agencies, differing timescales in designating particular individuals across jurisdictions has created opportunities for designated persons to facilitate the movement of funds and assets.
Based on case studies identified through financial intelligence and other sources, the Red Alert identifies a range of techniques that are being used by designated persons to evade the impact of sanctions on their personal and commercial holdings. While this behaviour often has occurred prior to the imposition of sanctions on particular designated persons, there also is evidence to suggest that this activity sometimes also occurs shortly after the imposition of sanctions.
Sanctions Evasion Offences
If a designated person seeks to move assets after their UK designation, they could commit a substantive breach of the pertinent UK sanctions regulations. The designated person as well as their associates and enablers also could commit a circumvention offence. These offences have broad jurisdictional reach, as they apply to UK nationals and companies with respect to their activities anywhere in the world and non-UK persons undertaking activities within the United Kingdom.
These offences have additional reach because the long-standing policy of the UK government is for the Crown Dependencies (e.g., Isle of Man) and British Overseas Territories (e.g., Cayman Islands and British Virgin Islands) to apply the same sanctions as the United Kingdom, with this policy objective being given effect either by Orders in Council or through each jurisdiction’s own legislation (e.g., Guernsey, Jersey, Gibraltar and Bermuda, which legislate for themselves).
As breaches or circumventions of UK financial sanctions constitute criminal offences, the onward handling of funds or assets representing a benefit from such conduct by financial institutions, professional services firms and others also may amount to a money laundering offence under the Proceeds of Crime Act 2002. It is therefore crucial that companies take appropriate steps to identify and mitigate their potential exposure to sanctions evasion risks.
Identifying Sanctions Evasion Warning Flags
The Red Alert identified a range of sanctions evasion methodologies that companies should remain alive to when designing and conducting due diligence on higher risk transactions and counterparties. Examples of the types of warning flags identified in the Red Alert are outlined, by theme, below.
Ownership and Control of Assets
Although a designated person may claim to have relinquished ownership or control of an asset, there is a risk that the designated person may have retained their influence through trusted proxies or enablers. Some warning flags to remain alert to include:
- Designated persons communicating changes to the beneficial ownership of their corporate structures to trusted proxies such as non-Russian or dual national family members, business associates or nominee directors/shareholders – or multiple beneficial ownership changes – prior to or shortly after sanctions take effect, potentially indicating that the designated person has maintained indirect control over such structures;
- Designated persons apparently divesting investments to ensure that their ownership stake falls below 50% – or relinquishing previous controlling stakes – shortly before or after sanctions designations on a non arms-length basis, which may facilitate the designated person continuing to exercise undue influence through associates, corporate governance structures or joint arrangements with others;
- Ownership transfers to previously unknown individuals whose economic footprint does not correspond with their newly reported wealth;
- New equity ownership secured by a long dated loan to the former equity owner; and
- Holding companies based in jurisdictions that are offshore and/or historically linked to former Soviet Union jurisdictions (excluding the Baltic States and Ukraine).
Liquidation or Concealment of Assets
Designated persons may seek to transfer assets and funds, directly and indirectly, to jurisdictions where sanctions are not in place, such as the UAE, Turkey, China, Brazil, India and certain former Soviet Union countries. These efforts may include the use of secrecy jurisdictions or invoking Russian legal protection from sharing information. Some relevant warning flags include:
- Movement of assets previously associated with a designated person through family members or otherwise on their behalf, with disbursement of funds occurring offshore through secrecy jurisdictions;
- Use of trust arrangements or complex corporate structures involving offshore companies, raising the possibility of the designated person retaining indirect control or a benefit from the transferred assets (g., circular ownership structures, shell companies and trust structures involving combinations of relatives or close business associates of the designated person acting as persons of significant control, trustees, beneficiaries, settlors, protectors, etc.);
- Sales or transfers of assets at a loss in order to realize their value before sanctions take effect;
- Clients connected with designated persons moving all of their assets to other financial institutions and closing their accounts in the United Kingdom; and
- Individuals on international sanctions lists, but not on the UK sanctions list, transferring assets to family members and close associates in anticipation of becoming a UK sanctions target.
Identification of Enablers
Enablers are individuals or businesses that facilitate sanctions evasion and associated money laundering by designated persons. Warning flags of relevance to the identification of potential enablers include:
- The use of pooled accounts, in which banks see only the name of the enabler and not the client, or funds transfers to entities associated in open source materials with a designated person;
- Use of banks and financial organisations owned by close associates of the designated person or extensive personal connections between a designated person and a known enabler;
- Numerous transfers of shares from sanctioned entities to non-sanctioned entities involving corporations incorporated by the same people and company (often with a registered office at the same physical address);
- A large number of off-the-shelf corporations with no trading record with nominee ownership used as throughputs;
- The use of complex trust structures for the ownership of assets, which are overseen by a trust company and its trustees for no apparent legitimate reason, particularly if open source materials corroborate that the trust company works for multiple designated persons; and
- Beneficial ownership changes notified to other firms in the regulated sector accompanied by an opinion from the client’s external counsel as to the new sanctions status of the entity, potentially accompanied by correspondence from a senior UK company representative to convey authority.
Detection of Suspicious Payments
To move funds that are subject to asset freeze sanctions, designated persons may explore the use of alternative payment methods, including the use of crypto-assets, to mitigate reduced access to the SWIFT payment system and move funds in circumvention of sanctions. Some warning flags with respect to suspicious payments include:
- The involvement of holding companies based in jurisdictions that are offshore and/or historically linked to assets in the former Soviet Union, or that are linked to designated persons;
- Use of payments from venture capital and private equity vehicles, many located in offshore jurisdictions, the Middle East, East Asia or other jurisdictions that continue to support the Russian government or express neutrality in international forums such as the UN;
- Payments received by UK businesses, often in innovative areas, such as fintech, including UK-registered payments service providers and electronic money institutes, owned in part by Russian nationals and/or others implicated in previous major trade-based money laundering schemes (often involving the Baltic and Nordic states);
- Payments via a fintech with a Russian investor nexus, including customer transactions that are initiated from, or sent to, IP addresses that have non-trusted sources, or are located in Russia, Belarus, jurisdictions with FATF-identified AML deficiencies or comprehensively sanctioned jurisdictions; and
- Increased use of third party open account payments, potentially indicating circumvention attempts through open account trade-based money laundering.
Due Diligence: Some Guiding Principles
The Red Alert outlines a series of principles that companies should bear in mind when assessing the robustness of their existing sanctions compliance controls and, in particular, when scoping and conducting due diligence on higher risk transactions and counterparties.
- Arms-length transactions need to be documented and should not be taken at face value. Guidance should be sought from the competent authority (e.g., OFSI in the UK) if companies have any doubt as to the compliance of a proposed transaction with sanctions and, in particular, whether a designated person could be considered to indirectly control an entity.
- Due diligence should be performed on a counterparty’s source of funds and/or wealth.
- Careful due diligence should be conducted on complex corporate structures and the commercial justification for such structures challenged.
- Careful consideration should be given to the issue of aggregation of ownership, particularly when more than one owner seeks to divest their shareholding. These issues can be made more complex by the divergent approaches to aggregation adopted by the UK, US and EU. Guidance should be sought from the competent authority if there is any doubt as to whether a designated person could be considered to own or control an entity.
- Evidence purporting to present a change in ownership of an entity should be closely scrutinized. Enhanced due diligence should be performed on the particular entity and consideration should be given to following up with the relevant competent authority to understand whether there is reason to believe that ownership has not been transferred appropriately.
- Legal assessments provided in support of the appropriateness of a transfer of ownership should be carefully scrutinized. In particular, companies should conduct their own legal assessment in determining whether a particular entity is owned or controlled by a designated person.
The Red Alert offers a timely reminder of the challenges companies can face in effectively identifying and mitigating the sanctions risks posed by higher risk transactions and counterparties. Given the recent introduction of strict civil liability in the UK for violations of financial sanctions and the swathe of sanctions introduced with respect to Russia over the past several months, the importance of undertaking robust sanctions due diligence on a risk sensitive basis cannot be overstated.
Companies should carefully review their sanctions compliance processes and procedures – and their due diligence processes with respect to Russia-related business in particular – to ensure that their approach to scrutinizing higher risk transactions and counterparties appropriately addresses the sanctions evasion warning flags and due diligence recommendations identified by the Red Alert.