Not So Elementary, My Dear Watson: Complying with International Sanctions

As seasoned investigators, we are routinely engaged by our clients to carry out due diligence investigations to minimize the risk of exposure to sanctioned parties. These parties include individuals/companies appearing on government blacklists such as the US Office of Foreign Assets Control (OFAC) list of Specially Designated Nationals (SDNs). For example, any companies that are 50%-owned, either directly or indirectly, by an SDN, are considered blocked by OFAC (and in the EU, the threshold is even lower, at 25%). As a result, merely checking international sanctions lists may not prove sufficient when deciding whether to proceed in conducting business with new customers. And even though it may be tempting not to carry out a due diligence investigation into shareholders with stakes below these thresholds, should it later come to light that a minority shareholder is a sanctioned, high-profile politician, the media and the court of public opinion will not be swayed by technicalities.

With this in mind, it is important to understand that circumvention goes hand in hand with sanctions regimes, and typically entails a combination of “tried and tested” techniques alongside evolving strategies. While the current round of multi-lateral sanctions being imposed against Russian targets is unprecedented in terms of speed and breadth, the sanctions circumvention “playbook” does not need to be rewritten. Russia has had a head-start, having had to respond to the more limited sanctions introduced following the 2014 annexation of Crimea. What is more, Russian companies can also look to their peers abroad — for example, Iranian energy companies — for historical examples of how to evade international sanctions.

Some typical methods to evade sanctions include:

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• Front companies. In what now seems like ancient history, prior to the first Gulf War, the Hussein regime used a series of front companies in both the US and the UK to acquire restricted, dual-use technology. In some cases, rather than forming a new company, Iraqi agents acquired controlling interests in established US/UK companies, providing greater cover for their activities. This type of sanctions evasion continues today. In March 2021, the US Attorney’s Office in the Central District of California charged ten “Iranian nationals with running a nearly 20-year-long scheme to evade US sanctions on the Government of Iran by disguising more than $300 million worth of transactions — including the purchase of two $25 million oil tankers — on Iran’s behalf through front companies in the San Fernando Valley, Canada, Hong Kong, and the United Arab Emirates.”
• Falsifying documents. The “time-honored” art of falsifying documents also remains ever popular, particularly in the world of logistics/transport. That being said, it has become harder to obfuscate the origin of sea and air cargo given the accessibility of plane and ship tracking databases, though these databases are not fool-proof and they cannot, for example, definitively provide evidence of cargo being switched in ports. Physical inspection of, for example, shipments of oil, is not practicable, but where there are strong suspicions of particular ships frequently being used to hide the jurisdiction of origin, spot checks — even a chemical analysis, as oil molecules can typically be traced to their country of origin — can be carried out.

A recent example of these practices appeared in 2019 when the US Treasury reported that Stanley Black & Decker had reached a USD 1.8 million civil settlement regarding alleged violations of Iranian sanctions regulations committed by the board directors and senior management figures of a Chinese-based subsidiary it had acquired. The Chinese subsidiary engaged in “non-routine business practices” in order to conceal and facilitate prohibited exports to Iran. The Chinese subsidiary used six trading companies (in the UAE and China) as conduits for these sales. Employees of the Chinese subsidiary created fictitious bills of lading, with inaccurate data regarding the ports used for transporting goods, and instructed their customers not to write “Iran” in the bills of lading. At the time, OFAC noted that “the enforcement action highlights the importance for US companies to conduct sanctions-related due diligence both prior and subsequent to mergers and acquisitions, and to take appropriate steps to audit, monitor, and verify newly acquired subsidiaries and affiliates for OFAC compliance.”

• Unusual payment terms. In tandem with some of the classical means to evade detection, “balancing the books” can be carried out through transfers of cryptocurrencies which are difficult to control, let alone prevent, and which allow for substantial degrees of anonymity. Cryptocurrencies have been particularly popular in Iran, where bitcoin mining — introducing new bitcoins into circulation — is frequently seen in the energy sector.
• Alternative jurisdictions and platforms. Russia can turn for assistance to a number of influential allies, China being primus inter pares. Chinese banks would certainly benefit from the billions of Russian-owned dollars in Western banks being redirected to Shanghai. Chinese nominees could then act on behalf of sanctioned individuals and companies in carrying out transactions in the West, with Western financial institutions being unable to determine the ultimate source of funds. India recently abstained in a UN vote to condemn Russia’s invasion of Ukraine and it too may provide a conduit for sanctioned Russian businesses to conduct their businesses from afar. Dubai may also prove useful as a platform for sanctioned entities; Dubai has long been a major hub for Iranian financial and other activities. Amongst other things, Iranian business use offices in Dubai to place orders in Western jurisdictions and then re-import the goods after their arrival in Dubai.

Against this backdrop, the first line of defense is to identify the immediate red flags. For example, are shell companies being used to obfuscate the true ownership of the company? Assuming the ownership can be identified, have the company and its key officers/shareholders ever been historically linked to any sanctioned country? Was the company in question only formed recently? If the company is established, has it recently changed ownership? If it has changed ownership, are the new owners family members/loyal associates who have served as nominees for individuals associated with sanctioned jurisdictions? Do payment terms appear unusual?

Of course, even identifying these red flags can be difficult without the proper experience and resources (including language capabilities and the ability to work in all relevant jurisdictions). Checking compliance databases is only a first step in a due diligence investigation involving sanctions parties.