11 Mar 2020
Economic sanctions regulations generally are written to be applicable to “property or interests in property.” These terms are very broad ones; for example, the Office of Foreign Assets Control’s (OFAC) Venezuela Sanctions Regulations defines them in the following way:
The terms property and property interest include, but are not limited to, money, checks, drafts, bullion, bank deposits, savings accounts, debts, indebtedness, obligations, notes, guarantees, debentures, stocks, bonds, coupons, any other financial instruments, bankers acceptances, mortgages, pledges, liens or other rights in the nature of security, warehouse receipts, bills of lading, trust receipts, bills of sale, any other evidences of title, ownership or indebtedness, letters of credit and any documents relating to any rights or obligations thereunder, powers of attorney, goods, wares, merchandise, chattels, stocks on hand, ships, goods on ships, real estate mortgages, deeds of trust, vendors’ sales agreements, land contracts, leaseholds, ground rents, real estate and any other interest therein, options, negotiable instruments, trade acceptances, royalties, book accounts, accounts payable, judgments, patents, trademarks or copyrights, insurance policies, safe deposit boxes and their contents, annuities, pooling agreements, services of any nature whatsoever, contracts of any nature whatsoever, and any other property, real, personal, or mixed, tangible or intangible, or interest or interests therein, present, future, or contingent.
The challenge for compliance professionals lies in appropriately identifying property in which sanctioned parties (including any entities considered to be sanctioned under OFAC’s “50 Percent Rule”, or similar ownership and control sanctions regulations or guidance) have an ownership interest. While there is no published guidance or advisory pronouncements from OFAC or other regulators on the expected standard of care, or suggested methods for identifying these ownership interests, it is clear that there is some expectation that firms will make an effort to do so in specific circumstances.
The Halliburton Lesson
In 2016, two units of Halliburton Energy Services agreed to pay $304,706 for alleged violations of the Cuban Assets Control Regulations (CACR). In particular, they provided goods and services to an oil and gas production consortium that was doing exploration and drilling in Angola. One of the owners of the consortium was the state-owned company Cuba Petroleo (also known as Cupet), which held a five-percent ownership interest. The settlement agreement described the violation as “dealing in property in which Cuba or a Cuban national had an interest.” One of the factors that increased the severity of the penalty was that Halliburton did not conduct “reasonable due diligence to determine who belonged to the Consortium and had a corresponding interest.”
OFAC’s Enforcement Guidelines lists 11 General Factors that are considered when determining the action it will take in response to apparent violations of its regulations and guidance, as well as when calculating the amount of any civil monetary penalty (CMP). General Factor C (“Harm to Sanctions Program Objectives”) states that one of the things considered when gauging the level of harm caused by an infraction is “the number, size, and impact of the transactions…and the nature of the economic or other benefit conferred.” While the transactions that Halliburton engaged in were not significant, a successful oil-and-gas exploration project could have been a significant source of revenue on an ongoing basis to Cuba, thus undermining U.S. policy goals. The figure which OFAC really cares about is the benefit to the sanctioned party, which is a combination of the sanctioned parties’ ownership stake and the total economic benefit to the firm or joint venture in which the sanctioned parties have that ownership interest.
In this case, OFAC did not explicitly state that the standards for understanding ownership interests are different when there is a direct business relationship. However, Cupet’s small-percentage of ownership, coupled with OFAC’s focus on Halliburton’s lack of due diligence actions and procedures, as well as its listing of a number of information sources available to the firm at the time it engaged with the Consortium, make the distinction plain.
This duty to understand the parties with whom one deals with has been borne out in a number of 2019 enforcement actions, such as the settlements with PACCAR Inc. and e.l.f. Cosmetics. It was further reinforced in the May 2019 publication of A Framework for OFAC Compliance Commitments, which specifically mentioned the need for due diligence in mergers and acquisitions, with regard to a firm’s supply chain, and with regard to its customers, intermediaries and other counter-parties with whom it deals.
While there are many types of real property, there are comparatively few types where the sanctions implications could be significant, and where the ownership can be identified through research. These fall under three broad categories: non-commercial enterprises managed by sanctioned governments, transportation vehicles that are more often used internationally, and buildings.
When a country’s government is itself a target of sanctions, property in which it has an ownership stake may have sanctions implications. In addition to the real estate owned by state-run companies, these include diplomatic facilities and government-run schools.
Diplomatic facilities are relatively easy to identify, although one does need to consider what such offices may be called. While the ones that spring to mind are relatively straight-forward (e.g., consulates, embassies, missions and representative offices), others, such as the U.S. Interests Section in Cuba, require a knowledge of the history of diplomatic relations between individual pairs of governments. Additionally, to properly identify all such facilities, one should be aware of linguistic and/or cultural differences that may result in such offices being named differently.
State-run schools are harder to comprehensively identify. While universities may be well-known and easy to identify with standard Internet research tools and databases, other schools, such as technical or vocational schools, or schools for younger children, may elude easy identification. There is also a risk in misidentifying a school as state-run when it is, in fact, a private school, or vice versa.
For both sets of properties, there is undoubtedly a temptation to search for the facility address as well as the name of the facility. While this has the advantage of guarding against changes of name in order to evade detection, it makes an assumption that such state-run facilities are the only tenant at that address. While that is likely true for diplomatic facilities located in countries with which there are deeper ties or in larger countries, that assumption may prove false for facilities located in less strategic nations or in nations with smaller populations. A similar calculus also holds for educational facilities.
Modes of Transport
While automobiles can undoubtedly be driven or transported across international boundaries, it is far more likely that firms performing sanctions screening are to encounter marine vessels or aircraft.
The overwhelming majority of cargo vessels are easily identifiable because the ships of 173 nations, which weigh a certain amount or more (300 Gross Weight Tonnage, or GWT, for cargo vessels, and 100 GWT for passenger ships), are assigned an International Marine Organization (IMO) number by Lloyd’s Register. Other vessels, including fishing boats and pleasure yachts, do not require an IMO number. All vessels that operate in international waters are registered at a national level, nonetheless. While this still leaves some vessels unavailable from a research standpoint, vessels that operate purely domestically present a significantly lower sanctions risk.
In contrast to the global IMO number system, aircraft tail numbers are assigned on a country-by-country basis (although the tail prefixes are assigned by the Convention on International Civil Aviation). While the national aircraft registries include ownership information, there is no single repository for such data.
Nonetheless, a party that wishes to conduct due diligence on an aircraft or vessel with which it is dealing, should be able to identify the overwhelming majority of those conveyances, and the ownership information stored with the registration. It should be noted, however, that the ownership information may not include the ultimate beneficial owner, requiring one to do additional research to identify all the parties in the ownership structure. For example, U.S. Representative Steven Lynch, in 2017, introduced the Aircraft Ownership Transparency Act, which would have, had it passed, required aircraft owners to disclose and document their beneficial owners to the Federal Aviation Authority (FAA).
While many, if not most, countries require the identification of the ultimate beneficial owners in real estate purchases as part of anti-money laundering program requirements, that information is not necessarily included in the associated land records for the property. Even if they were, land records can be stored on even more local levels than marine vessels or aircraft. For example, in the U.S., land records may be stored on the county-level, as they are used, in part, for issuing property tax bills.
Nonetheless, if one is researching a specific property (or aircraft or marine vessel), due diligence procedures used for other purposes can likewise be used to identify all the entities and persons in the ownership structure. Should public sources, private databases, custom due diligence providers and/or direct outreach to parties fail to adequately identify all the beneficial owners of the property, that should be considered a red flag when deciding whether to continue processing the proposed business transaction.
E Pluribus Unum? (Out of many, one)
So, if these pieces of property are comparatively easy to identify for a firm conducting sanctions due diligence, why are there, apparently, no commercial databases of such information?
If all of the above data sources for aircraft, marine vessels and real estate contained the full set of entities and individuals in the ownership structure, with enough detail to weed out potential duplicates, generating a reasonably comprehensive set of sanctioned property would be commercially feasible, if very intensive from a data processing perspective. However, given that only details on the owner(s) at the time of the purchase of the property is contained in such records, the amount of research required to comprehensively identify such parties would require:
- Identifying all such property in all such registries and records
- Performing research to identify the entire ownership structure for each property
- Screening the entire database of such parties against sanctions lists and, for the regulators for which such requirements exist, any lists of entities implicated by ownership and/or control sanctions regulations or guidance
- Reviewing all matches that cannot be automatically cleared or confirmed. This may include verifying addresses or other personal information, as they may have changed since the purchase occurred.
Because of the significant cost to produce and maintain a reasonably comprehensive, accurate property database, absent market demand and/or regulatory initiatives (e.g. guidance or enforcement actions), commercial solutions are not currently available and are unlikely to be forthcoming.
For state-run facilities, the challenge is more in the actual need for such data than in the difficulty of identifying the facilities. As noted above, identifying diplomatic facilities is likely to be significantly simpler than comprehensively identifying state-run schools. However, for both types of facilities, there are simple alternatives to performing the research. State-run schools, overwhelmingly if not entirely, will be located in the sanctioned country, while the name of the diplomatic facility will undoubtedly identify the name of the country which the office represents. Thus, good databases of geographic place names in sanctioned countries provide a good alternative to curating databases of the specific facilities. Additionally, other than the well-publicized case of Amazon delivering a package to an Iranian embassy (for which no penalty has been announced, over two years after its public disclosure), there has been no regulatory guidance directing or advising the need for such data.
Where does this leave us?
Although there is a lack of guidance in this area, the difference between the handling of the Halliburton enforcement action and the “50 Percent Rule” guidance seems to provide a path forward on whether or not property interests need to be sought out aggressively. The 50 Percent Rule appears to be the standard for identifying ownership of corporate or other organizational entities when the relationship between the firm doing the sanctions compliance and the party being screened is at arm’s length. The trio of enforcement actions based on 50 Percent Rule violations (TD Bank, Barclays PLC and Cobham Holdings) have spurred demand for commercial solutions, which have been available from multiple data vendors for a number of years. When it comes to identifying sanctioned property interests, however, it is highly unlikely that OFAC or other regulators would expect firms (except, perhaps, with the most risky portfolios or the largest books of business) to build such screening databases themselves for use in transaction screening.
However, when there is a more direct relationship, such as an insurer looking to write a marine policy for a seafaring vessel, a higher standard is expected. Regardless of company size, sanctions regulators are likely to demand that more rigorous due diligence, similar to the level of rigor shown when onboarding customers or business partners, be performed for all identifiable property in which the firm deals directly. These cases might include the underlying conveyance in the aforementioned marine (and/or aviation) insurance underwriting example, any property mentioned in letters of credit that a bank is party to, or any identifiable real estate unit identifiable by name (e.g., an embassy) involved in a package pickup or delivery, for example.
Even here, there are cases where the value of due diligence would remain a matter of debate. For example, should one screen a street address at account opening on the chance that the putative account owner might be living in a residence owned by a sanctioned party? To go a bit further, should one look into any home loans on that address, on the chance that home loan payments would benefit a sanctions target? For all but the most expensive individual residences, the economic benefit derived from such payments would likely not pass regulators’ tests for significance, as it did in the Halliburton enforcement action. While the same might not be said for corporate buildings, as the size of a company increases, and the number of its office locations expands, identifying and researching such details (as part of onboarding due diligence) to ferret out any interests in corporate real estate may not be a realistic regulatory expectation.
Absent direction from regulators, the status quo is likely to prevail in terms of commercial solutions being available for identifying sanctioned property. Larger firms that have business segments with more exposure to sanctions risks may attempt to build out some of the datasets for higher-risk entities. Fortunately, for the overwhelming majority of firms, the likelihood of business dealings with such property, for which regulators might expect screening to identify them, is quite low.
Of course, a single enforcement action could change the calculus for sanctions compliance programs, and commercial compliance data providers…
Eric A. Sohn, CAMS, global market strategist and product director, Dow Jones Risk & Compliance, New York, NY, USA, firstname.lastname@example.org
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