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Addressing Beneficial Ownership Requirements in Your Compliance Program (Part I of IV)

We repeatedly hear about the importance of beneficial ownership, and the requirement that companies confirm beneficial ownership of its third-parties, vendors and suppliers.  At the same time, there is increasing pressure from regulators and law enforcement to identify and unravel beneficial ownership when dealing with business partners.

There is no question that beneficial ownership is a critical issue.  I have frequently stated (i.e. repeated myself) on this issue — that third-party due diligence, to be effective, must include beneficial ownership analyses. 

The Beneficial Ownership Picture

Without belaboring the point, the United States is still behind other countries in tackling this difficult issue.  While FinCEN finally implemented customer due diligence regulations in 2018 applicable to “financial institutions,” the United States is definitely behind in imposing legal requirements on disclosure of beneficial owners.  The European Union’s 5th AML Directive imposes on member countries specific requirements that they create a beneficial ownership registry similar to the one already established and operating in the United Kingdom.  Mind you, the jury is still out on how effective and reliable these registries are but it is a fresh start to address the issue.

The United States Congress has several proposals to consider in this area and there is increased interest in strengthening U.S. regulation of beneficial ownership.  This would be a welcome development for regulators, law enforcement and prosecutors.  For too long, money launderers and other white collar criminals have taken advantage of the U.S. lax system surrounding shell companies, beneficial ownership and other issues needed to enable transparency and disclosure of real parties in interest.  As a result, the United States continues to be a significant player in the money laundering arena.

Corruption and Sanctions Risks

As a refresher, and from a compliance officer standpoint, let’s review the basic importance of beneficial ownership requirements.  The term “beneficial ownership” means the natural person owner(s) of an entity — e.g., corporation, partnership.  As you strip the layers away of a legal entity, eventually you uncover or reach the natural person (or persons) who owns and/or controls the entity.

From an anti-corruption perspective, compliance officers have to identify the natural person owner(s) of third parties, vendors and suppliers.  In other words, a third-party may contain a hidden foreign government official owner as a means to pay a bribe to the foreign official as part of payments made to the entity. 

A classic case involved Manual Vicente, the President of Sonangol, the Angolan state-owned oil and gas company, who owned a secret 10 percent ownership interest in a company that in turn was part owner of a drilling operator.  Vicente was provided this ownership interest in exchange for his assurance that the partnership would be awarded a valid tract for exploration.

A company that joins the drilling partnership has to be aware of the beneficial owners of its joint venture partners.  Vicente was able to disguise his ownership interest and escape detection for years.  Eventually the company uncovered his ownership interest and disclosed the matter to the DOJ and SEC.

To complicate matters for compliance officers, beneficial ownership has direct and significant implications for compliance with OFAC sanctions.  Companies are prohibited from transacting business with Specially Designated Nationals (“SDNs”) – either as third parties, vendors, suppliers and customers.  OFAC maintains a critical 50 percent rule, which prohibits companies from dealing with any entity that is owner 50 percent or more by one or more SDNs.

To translate this rule, if SDN A owns 30 percent of entity C and SDN B owns another 30 percent of entity C, entity C is prohibited entity even though it is not specifically listed on OFAC’s SDN List.

Understanding the Risks

Given this risk picture, companies have to tailor their controls differently depending on anti-corruption or sanctions risks.  For example, if an SDN owns only a 10 percent interest in Company A, OFAC sanctions would not prohibit your company from conducting business with Company A.  For reputational reasons, however, your Company may choose not to deal with Company A.  At a minimum, however, your company will have to monitor and refresh inquiries concerning the SDN’s ownership share and ensure that the SDN does not have links or agreements with other owners such that the SDN exercises control over the entity. 

From the anti-corruption perspective, the SDN’s 10 percent equity interest in the company may reflect a bribery payment to the SDN/government official as a corrupt exchange for increased business or omission of government action.  Again, the circumstances will dictate the corruption risks in this situation.  At a minimum, it is a large red flag that may ultimately prevent your company from dealing with Company A because of the SDN/government official ownership interest.

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