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THE AGGREGATE 50% RULE: IS THE CUP

H A L F F U L L O R H A L F E M P T Y ?

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The “OFAC 50% Rule,” and its EU equivalent, are not new guidance documents. However, no firm had ever been ensnared by an enforcement action for not blocking assets on the basis of that requirement.

These regulatory strictures, which put meat on the “owned or controlled” wording prevalent in the sanctions regulations issued by active financial crime regulators across the globe, received renewed attention in the wake of the sanctions imposed on Russia for its actions in support of separatist movements in eastern Ukraine, and its annexation of the Crimea region. OFAC, in fact, reissued the 50% Rule guidance, later amending it to include cases where 50% or greater ownership by multiple sanctioned persons or entities would cause the sanctions to apply to the owned entity. This “aggregate 50% Rule” would then also be applied to the firms listed on the Sectoral Sanctions Identification (SSI) List.

The revised 50% Rule guidance applies to all OFAC sanctions programs, as noted by links to the guidance from the sanctions overview documents on OFAC’s website. That fact was recently reinforced by Barclays’ $2,485,890 settlement with OFAC. According to the details published on OFAC’s website, Barclays processed 159 violations involving multiple corporate customers who were, due to the ownership stake of Industrial Development Corporation of Zimbabwe, also subject to U.S. sanctions.

Fleshing out the ownership structure of corporate entities, however, is a task best left to the experts. Our experience in researching sanctions ownership in relation to the Ukraine-related sanctions involved many twists, turns and dead ends.

C A M E R A O B S C U R A

Russian corporate structures are intricate, perhaps intentionally so. Lukoil’s corporate “map” has over 300 separate legal entities, for example. Tucked inside this maze is LICARD EURASIA FILO HIZMETLERI SANAYI VE TICARET LIMITED SIRKET, which is 1% owned by Lukoil Inter-Card LLC and 99% owned by LICARD Euro Services GmbH. On its face, this would seem to be benign, as the overwhelming majority of the firm is owned by a German subsidiary. Digging further, however, one discovers that LICARD Euro Services GmbH is fully owned by Lukoil Inter-Card LLC. Therefore, the Turkish subsidiary is actually wholly owned by the Russian firm!

Company identity also shifts over time, further clouding the overall picture. Consider AK Sibur OJSC and Sibur Holdings, which were two separate companies. In 2006, however, Gazprom sold a 50% stake in AK Sibur to Sibur Holdings. Then, according to 2012 news stories, AK Sibur went out of business. Or did it? One news story the next year referred to the two companies as one and the same, while another reported AK Sibur’s assets being absorbed into Sibur Holdings.

Furthermore, transparency and accuracy of online records leave something to be desired. Defense Systems OJSC is owned by Oboronprom, but that relationship does not appear in Defense Systems’ corporate documents. Luckily, Oboronprom’s website, as well as news stories, do establish the relationship. Additionally, the two firms share the same managing director.

In a more generic sense, researching information in online records often leads to dead ends. In more than one instance, company locations listed online turned out to be out of date. In one case, the address was discovered to actually be the location of a school, while in another, it was the location of a completely different kind of company. Additionally, we discovered that private citizens can be listed anonymously in corporate documents, totally obscuring their beneficial ownership of a company.

Another consideration when performing such research is the ability to understand documents in the local language. In one notable case, while Sibur Holding’s English website noted the presence of a subsidiary dealing in fertilizer, the native language site contained a story about the subsidiary’s sale years earlier.

T O I N F I N I T Y… A N D B E Y O N D ?

One thing the Barclays enforcement action pointed out in exquisite detail: one cannot pick and choose which sanctions programs you will perform 50% Rule research for, and how extensive and in-depth that research needs to be. In geographic areas in which your firm does a significant amount of ongoing business, it makes sense to match that additional exposure to

One cannot pick and choose which

sanctions programs you will perform

50% Rule research for, and how extensive and in-depth that research

needs to be.

T H E A G G R E G AT E 5 0 % R U L E : I S T H E C U P H A L F F U L L O R H A L F E M P T Y ?

E R I C A . S O H N , D I R E C T O R O F B U S I N E S S P R O D U C T

sanctions risk with a corresponding enhanced level of scrutiny.

While, for many of the country-based programs (as well as the narcotics trafficking sanctions program), those areas are likely well-defined and confined to areas in close proximity to those formally identified by regulators, that is not always possible. The over 4,000 entities identified as having ties to EU and OFAC Ukraine-related financial and sectoral sanctions are located in over 80 countries, for example.

So, how hard does one look for ties to sanctions lists in order to manage regulatory risk – and does it make sense to look further in order to reduce potential reputational risk from relationships that are not formally prohibited? After all, OFAC does say to proceed with caution for aggregate ownership stakes less than 50% as such firms may be targets of future designations, and because a significant minority owner may still exercise control by non-ownership means.

It is a balancing act, to be sure, and one driven by practical concerns. For example, depending on the jurisdiction, smaller ownership stakes don’t have to be made public and are therefore unknowable. Additionally, the number of ownership stakes tends to increase geometrically as the size of the stake increases. That means that you might have 2 or 3 times as many 5% or greater owners as you have 10% or greater owners. And owners with smaller stakes have less control and influence, further reducing the impetus to cover them in research. So, one has to determine how much research effort to put into covering people whom are less likely to be of concern.

On the other end of the spectrum, based on beneficial ownership guidance (admittedly a different,

albeit related, field) issued or proposed by multiple regulators, it appears that one’s research needs to extend at least as low as 25% ownership.

To put these numbers in perspective, there are on the order of only about 350 unique persons and entities on the EU and OFAC Ukraine-related sanctions lists. By including all ownership stakes down to 10%, regardless of whether or not the 50% threshold has been met, we have managed to identify 4200 additional entities, which is roughly 80% the size of the entire SDN List. One can only imagine what that figure would be were the threshold to be dropped to the US reporting threshold of 5% ownership.

The other logical research extension, based on actual events, but not backed by regulatory guidance or inference, is researching the relatives and close associates of those on sanctions lists. The most prominent case is that of the Rotenberg family, which passed ownership of Hartwall Arena, an events venue in Finland, multiple times from members who were sanctioned to those who were not. As such cases proliferate, most likely with respect to the Ukraine-related sanctions, impetus for expanding guidance to cover people and firms associated with those already subject to sanctions could grow, especially for the largest firms involved in wealth management and international funds transfers.

The best harbinger of things to come can be found in OFAC’s enforcement actions. The Civil Monetary Penalty or Finding of Violation imposed on a prominent Tier 1 firm today will likely evolve into a general regulatory expectation 12-18 months down the line, if not sooner. These may the best way to plan for your compliance program’s future.

E R I C A . S O H N , D I R E C T O R O F B U S I N E S S P R O D U C T

Eric has over two decades of experience in regulatory compliance and risk management. He previously provided advisory services for a global array of clients’ compliance programs. Eric is ACAMS certified, serves on the ACAMS Editorial Task Force and contributes thought leadership regularly for industry conferences and publications.

For more information, visit www.dowjones.com/risk

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Dow Jones Risk and Compliance

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