The recent imposition by the United States and European Union of Ukraine- related economic sanctions on Russia illustrates the speed with which world powers can implement a sanctions program that achieves foreign policy objectives and, at the same time, alters the multi-national business environment. Russian sanctions are also notable because they conﬁrm the iterative and progressive approach that many countries have adopted when issuing sanctions. Accordingly, businesses seeking to comply with sanctions regimes would be well advised to develop a compliance program that is equally iterative and accommodating of rapid shifts in the political landscape.
The purpose of this article is two-fold: (1) to assist investment funds in complying with recent economic sanctions on Russia; and (2) to propose a procedure and methodology to develop a proactive approach to compliance that enables investment funds to anticipate and mitigate risk as sanctions evolve in each of the jurisdictions where they conduct business. The compliance procedures outlined below are directed towards investment funds but can be adapted to suit many types of business.
OVERVIEW OF RUSSIAN SANCTIONS
Beginning in March of 2014, President Obama issued a series of executive orders setting forth the groundwork for economic sanctions on Russia. First, on March 6, 2014, President Obama issued an executive order sanctioning certain persons and entities identiﬁed as responsible for undermining the democratic processes in Ukraine or misappropriating Ukrainian state assets.1 Second, on March 16, 2014, President Obama issued an executive order sanctioning certain Russian government ofﬁcials and individuals or entities involved in the Russian arms industry.2 On March 20, 2014, President Obama issued a third executive order providing authority to expand sanctions beyond persons involved in the immediate conﬂict in Ukraine to include persons or entities operating in certain sectors of the Russian economy, including the ﬁnancial services, energy, metals and mining, engineering and defense and related material sectors.3 Most recently, on April 28, 2014, the U.S. expanded the list of persons and entities sanctioned under the previously issued executive orders and announced new restrictions on the export of high-technology items that could contribute to Russia’s military capabilities. The sanctions apply to all U.S. persons regardless of where they are located; all persons and entities in the U.S.; and all U.S. incorporated foreign entities.
The immediate impact of U.S. sanctions is that approximately 65 Russian persons and entities have been added to the U.S. Treasury Department’s Specially Designated Nationals (SDN) List. The assets of persons or entities on the SDN List are “blocked” and U.S. persons cannot conduct business with them anywhere in the world. Although the number of persons and entities added to the SDN List so far is relatively small, President Obama’s executive orders lay the groundwork for a signiﬁcant expansion of sanctions with the potential to cover entire Russian business sectors, including the energy, military and ﬁnancial services sectors.
Other countries have joined the U.S. in imposing sanctions on Russia. Most prominently, the E.U. issued sanctions on March 6, 2014, freezing all funds and economic resources belonging to, owned, held or controlled by persons involved in misappropriating Ukrainian funds or causing human rights violations.4 Like the U.S., the E.U. adopted further sanctions shortly thereafter and, on March 17, 2014, announced a new round of sanctions freezing economic resources for those responsible for undermining democracy in Ukraine.5 While there is some overlap between U.S. sanctions on Russia and those issued by other countries, there are also signiﬁcant differences between countries’ sanctions programs. To be effective, therefore, a sanctions compliance program should track and analyze all such sanctions.
BEST PRACTICES FOR SANCTIONS COMPLIANCE
In the past, businesses often approached sanctions compliance on an ad hoc basis, conducting a screening procedure in their database when new sanctions were issued but rarely incorporating an ongoing analysis of those sanctions into their business model. As the Russian example illustrates, sanctions programs now evolve quickly and expand with little notice. In order to keep up with the new era of sanctions, investment funds should consider developing and implementing compliance programs that are equally ﬂexible and adaptable to change. The hallmark of such a program is a collaborative effort between compliance and investment personnel to understand economic sanctions and how they may affect the business now and in the future.
The remainder of this article discusses compliance best practices in the following contexts: (1) developing a compliance approach for an investment fund’s current business; (2) incorporating additional protections when making new investments; and (3) ongoing diligence, including documentation, testing and training.
- Develop a comprehensive approach to compliance by analyzing and understanding your business.
Investment funds will be best protected when they understand how economic sanctions interact with their current and future business plans. The most effective compliance programs are those that engage compliance and investment personnel in a collaborative effort to understand, and react to, economic sanctions on an ongoing basis.
Know who you are doing business with.
As a starting point for sanctions compliance, investment funds should consider developing and maintaining a ﬁle including information concerning key parties to an investment (e.g., joint venture partners, ofﬁcers of investment target, persons who hold a substantial ownership stake, etc.), their role in connection with the investment and any diligence that has been conducted on those persons or entities in the past. If compliance red ﬂags have been researched previously, the result of that research can be maintained in the ﬁle. This type of documentation, which should be updated regularly by compliance and investment personnel as new developments occur, will enhance an investment fund’s ability to ensure that it is not doing business with a sanctioned entity, such as a person on the SDN List, and will make the process of incorporating new information into past research more efﬁcient.
Understand how your business may expand to touch sanctions.
As the Russian example shows, the imposition of sanctions on a country does not necessarily mean that it is shut off from foreign investment. However, even if a current investment does not raise a sanctions compliance concern, investment funds would be well advised to analyze and understand how their money will be used in the future and by whom. Without such an understanding, there is a greater risk that an investment will evolve in a way that presents a sanctions problem down the road.
Understand how sanctions may expand to reach your business.
Even when investment funds are conﬁdent in the scope and future development of their current investments, they are still susceptible to risk if there is an unexpected expansion of sanctions. The most effective compliance programs will include a process for investment and compliance staff to monitor likely developments in sanctions so that the business is equipped to respond if sanctions expand in a way that touches current investments.
- When making new investments, seek contractual protections and rights to access information from the investment target.
In addition to the best practices described above, enhanced contractual provisions provide another layer of protection from sanctioned-related risk.
Require sanctions-related contractual representations and warranties.
When engaging in new investments where there is the potential for sanctions-related risk, investment funds can decrease risk by requiring contractual representations and warranties in investment contracts, such as shareholder purchase agreements, stating that the target of the investment, and its employees and agents, is in compliance with all applicable sanctions regimes and will remain compliant in the future. Depending on the nature of the investment target, investment funds may also wish to require contractual rights to inspect the target’s ﬁles and have ongoing access to its information systems. Including such contractual protections does not alleviate all sanctions-related risk but is one of many steps that investment funds can take to mitigate risk.
Add sanction-based termination clauses to contracts. Investment funds can also protect themselves by inserting language in investment contracts that protect them from litigation risks if they terminate a contract early due to the designation of counterparty as a sanctioned entity. While the goal of a comprehensive and ﬂexible compliance program is to avoid a situation in which termination is necessary, termination clauses serve as a last resort when unanticipated compliance problems become insurmountable.
- On an ongoing basis, document and audit the compliance program and train employees.
To be effective, a compliance program should be well documented and tested by an internal or external audit on a regular basis. In addition, all employees should receive training on sanctions compliance principles.
Document the compliance process.
The processes and procedures described above are central components of a comprehensive and ﬂexible compliance program. Implementing such a program requires that it be well-documented and clearly deﬁned so that each member of the compliance and investment teams is aware of their responsibilities and understands the need to communicate with one other regarding compliance concerns. In the documentation, investment funds should consider including ﬁle notes that set forth each of the sanctions-related compliance steps taken in connection with an investment. The availability of such documentation will allow investment and compliance personnel to remain on the same page throughout the life of an investment.
Audit the compliance program.
A regular audit of a sanctions compliance program, whether done in-house or by an external auditor, will serve to identify any gaps in the compliance program and can provide a helpful third-party perspective on any potential compliance enhancements.
Establishing a regular schedule for training employees, agents and consultants on sanctions compliance will help to ensure that each member of staff understands the basic risks associated with economic sanctions and learns to recognize red ﬂags. Some members of staff will likely require less training than others but, as with anti-money laundering and anti-corruption compliance, ensuring that each employee has a basic understanding of key sanctions compliance issue enhances the effectiveness of a compliance program.
Given the political goals associated with the implementation of economic sanctions, it is a fact that regulators will scrutinize investment funds’ business dealings to ensure full and prompt compliance. Thus, compliance with economic sanctions is a cost of doing business in a globalized economy and ad hoc measures are unlikely to be effective. The challenge, therefore, is to integrate a compliance program that effectively decreases risk while at the same time furthering business objectives. Implementing well-crafted processes and procedures that are robustly implemented by investment and compliance staff and monitored on an ongoing basis can be an effective way to meet this challenge, thereby adding value to the business overall and enhancing the effectiveness of compliance procedures.