The UK Office of Financial Sanctions Implementation (“OFSI”) has updated its guidance on enforcement and monetary penalties for breaches of financial sanctions (the “Monetary Penalties Guidance”, available here), to include a number of paragraphs setting out OFSI’s expectations around the nature and type of due diligence that companies should undertake when assessing whether an entity is owned or controlled by one or more designated persons, for sanctions purposes.
This update to the Monetary Penalties Guidance focuses on the extent to which OFSI will consider due diligence of ownership and control to be a mitigating (or aggravating) factor in its assessment of breaches of financial sanctions (in particular, in circumstances where “an incorrect assessment of ownership and control of an entity is relevant to the commission of the breach”). The updates do not change the legal test for ownership and control that is set out in relevant UK sanctions legislation (and which is further addressed in Chapter 4 of OFSI’s general guidance on the UK’s financial sanctions regime, available here).
The updates to the Monetary Penalties Guidance follow the significant expansion of OFSI’s civil enforcement powers that came into effect on 15 June 2022, which enable OFSI to impose civil monetary penalties on a strict liability basis. In summary, this means that OFSI will not have to prove that a person had knowledge or reasonable cause to suspect that they were in breach of financial sanctions. Please see our previous blog post on these important changes here.
In respect of how OFSI will take into account due diligence on ownership and control as part of its “Case Assessment” process, OFSI’s new guidance includes the following important points:
- OFSI’s guidance generally supports a risk-based approach to due diligence, and notes that due diligence will be a mitigating factor “where the ownership and control determination reached was made in good faith and was a reasonable conclusion to draw from such due diligence”. Conversely, failure to carry out appropriate due diligence, or carrying out due diligence in bad faith, can be seen as an aggravating factor by OFSI.
- OFSI will consider whether due diligence was “appropriate to the degree of sanctions risk and nature of the transaction”, and a factor in this assessment will be “[t]he nature of a person’s contractual or commercial relationship with the entity”. This may mean (for example) that a higher standard of due diligence is expected where an entity is a direct customer or counterparty of the party undertaking the due diligence, and there is a greater ability to review KYC materials and other customer documentation, and potentially ask due diligence questions to support the assessment.
- OFSI “would expect to see evidence of a decision making process that took account of the sanctions risk and considered what would be an appropriate level of due diligence in light of that risk”, and OFSI would usually expect such decisions to be made “by reference to an internal framework or policy, but recognises that there is no one-size fits all approach”.
- OFSI notes that, depending upon the circumstances, assessment of the following (non-exhaustive) areas may be helpful mitigation:
- Formal ownership and control mechanisms
- This can include assessment of factors such as percentage of shares and/or voting power of shareholders; how a company’s shares are owned and distributed; different classes of shares; and corporate constitutional documents (such as a company’s articles of association or constitution).
- The guidance also refers to recent changes to shareholdings and ownership as a factor that can merit further investigation, and possible indications of attempts to evade future sanctions: “Whether ownership / shareholding has recently been altered or divested, including in possible anticipation or response to the imposition of financial sanctions. If so, consideration of whether this warrants further investigation into the possibility of joint arrangements or indirect or de facto control”. This follows OFSI’s previous publication of a Red Alert with the National Crime Agency and other organisations in July 2022 (available here), which also includes a focus on red flags that may suggest that parties are taking steps to evade potential future imposition of sanctions.
- The guidance also notes that a relevant consideration will be “[w]hether changes to ownership and/or control were part of a pre-planned or wider business/financial strategy”, and whether there are “[a]ny commercial justifications for complex ownership and control structures”.
- A relevant factor in this assessment will also be “[a]greements between shareholders or between any shareholders and the entity (e.g., shareholders’, joint venture, operating, or guarantee agreements)” – which is also in line with OFSI’s position that shareholdings of separate Designated Persons can be aggregated where there is a “joint arrangement” between the parties.
- Assessment of influence / de facto control over an entity
- In line with the UK’s broadly-framed control test that is set out in legislation (which provides that control can be established where it is reasonable to expect that a Designated Person would, in most cases or in significant respects, and whether directly or indirectly, be able to ensure the affairs of the entity are conducted in accordance with the person’s wishes), the updated Monetary Penalties Guidance sets out OFSI’s expectations of assessment of “[i]ndications of continued influence (or the potential for it) by a designated person, including through personal connections and financial relationships”.
- Factors that will be relevant to this assessment can include:
- The “presence or involvement of proxies, including persons holding assets on behalf of a designated person”.
- Ownership or control via trusts associated with a Designated Person.
- Where shares have been divested, the “nature of any relationships and prior involvement of the person benefitting”, and how transfers of shares were funded and “whether this was done at an accurate and true valuation”.
- Operational steps taken to limit the Designated Person’s ability to exercise control or make use of corporate assets.
- Information relating to “the circumstances of board and/or management appointments, including the backgrounds, relevant experience, and relationships with designated persons”, and information on the running of board meetings and governance processes.
- Any ongoing financial liabilities directly related to the Designated Person, such as “personal loans, loan guarantees, property holdings, equipment etc.”.
- “Other shareholder agreements, voting agreements, put or call options or other coordination agreements in place between the entity and the designated person or controlled entities”.
- Any benefits conferred to the Designated Person by the entity or relevant transactions.
- Regular checks and ongoing monitoring
- Where a relationship or activity is ongoing, OFSI sets out its expectation that due diligence in relation to ownership and control should be “reviewed at appropriate times”, since ownership and control is “not static”. OFSI will take into account “the regularity of checks, and/or ongoing monitoring where appropriate”.
Businesses should consider assessing their approach to sanctions screening and due diligence to ensure that they take account of OFSI’s approach, and in particular give proper attention to the assessment of influence or de facto control, which includes factors that may not always be immediately obvious. The use of unusual structures, trusts and family connections are all commonly-observed sanctions evasion tactics, and these updates to OFSI’s guidance make clear that this is an area of particular focus for OFSI going forward.