Asset Tracing and Corporate Intelligence Techniques: What Financial Institutions Can Do to Prevent Evasion of the Sanctions Against Russia

Recent Developments

The sanctions campaign and the unprecedented response to the Russian invasion of Ukraine has created a need for a task force type of tracking and response. K2 Integrity has organized the volume of information coming out about the sanctions into a six-point framework:

• Targeted financial and economic sanctions against specific individuals and entities related to the Putin regime, military actions in Ukraine, and key institutions in the Russian economy: These sanctions are intended to put pressure on Putin to change, weaken, or contain Russia’s ongoing aggression. Any actor subject to the jurisdiction of sanctioning authorities should track ongoing developments to ensure compliance and to meet blocking requirements. Those jurisdictions have expanded in recent days to encompass additional countries that are doing more with respect to targeting individuals and entities through blocking sanctions.
• Increased trade prohibitions: What was off the table regarding energy is now on the table including a full import ban on energy in the United States currently making its way through Congress. This effort has been echoed in other financial centers, where trade prohibitions have begun on specific entities and sectors and have expanded across broader sectors, increasingly moving toward a comprehensive trade ban.
• Self-sanctions: More companies are deciding to self-sanction and pull out of Russia to the extent possible. This has been especially prevalent in the energy industry, with Shell, Exxon Mobile, BP, and others shutting down operations in Russia even before any applicable trade ban is in play.
• Countermeasures from Russian authorities: The Russian countermeasures seem to be following the script of those used in 2014 after Russia’s annexation of Crimea, though with greater intensity and speed to include sanctioning of senior leadership in the U.S. and other financial centers. Additionally, there are repressive efforts inside of Russia, including detention of U.S. and other citizens on charges that do not appear to be legitimate, which actions are expected to intensify.
• Efforts to expand regulatory coverage to bring greater transparency to vulnerable sectors: A new Executive Order from the White House last week directs agencies in Washington to work together through an interagency process to tighten efforts to clarify obligations in ways that allow for greater transparency and accountability in the virtual currency sector. This effort is driven in part to combat Russian sanction evasion through the emerging virtual currency sector. Jurisdictional authorities may similarly accelerate or intensify efforts to enhance the transparency of other sectors vulnerable to Russian sanctions evasion – including real estate and capital markets.
• Multilateral cooperation for combatting Russian elites, proxies, and oligarchs: The G7 and Australia have united in a policy and tactical effort to share information around investigation targets. This cooperation is unprecedented in its speed of response as well as its effectiveness, with hundreds of millions of dollars of real property already seized as a result of such cooperation.

Investigating Illicit Assets

The amount of illicit Russian money is estimated at between $500 billion to $1 trillion. As the biggest tracing and searching challenge is not knowing exactly what assets to look for outside of normal luxury items, investigators should broaden the asset classes they are looking for to include escrow, receivables, and investments such as art and wine.

Another challenge is proving beneficial ownership since a certain asset can be known to belong to a particular person yet be owned through a series of offshore shell companies. One tool to combat this is the proposed public register of beneficial ownership of offshore property, though it only will list owners with more than 25% ownership stake.

In tracking sanctions evasion, many of the approaches are the same: being alert for shell entities, trusts, proxies, sudden shareholder structure changes, and zombie companies that have been dormant and then show some strange activity.

Illicit Assets Case Study

(This case study has been anonymized to protect our client’s confidentiality.)

In early March 2014, a large Russian public company in the financial services sector (Company A) had two sets of shareholders: A Russian company (Company B) that owned 51% of Company A, and another set of shareholders that together owned the remaining 49%. On 20 March 2014, following the Russian annexation of Crimea, Company B was sanctioned by the United States, making Company A also subject to sanctions. The shareholder structure of Company A suddenly changed, with 2.5% of the shares being sold to a subsidiary of Company A, effectively bringing Company B’s ownership under the 50% threshold.

Now, the company effectively owned part of itself. It wasn’t a share buyback as such, because of the indirect ownership of the subsidiary. However, what is interesting is that this transaction was made public on 31 March, which is when Russian public companies are obliged to file quarterly disclosures, but it was dated back to 14 March, i.e. before the sanctions took place. This was discovered when a Western financial institution had a payment blocked to Company A due to the sanctions. This is an example of how sanctions monitoring actually works to identify sanctions evasion.

Virtual Currency

Historically, virtual currencies may not have been used much for sanctions evasion (with an exception possibly for North Korea and maybe Iran). The reason is that to move large amounts of money through virtual currencies, the underlying blockchain will reveal those movements. To take advantage of this, the United States is setting up crypto surveillance programs to track assets on the associated blockchains.

Companies providing services to virtual asset service providers (VASPs) should realize they may be providing operational accounts for VASPS that may have established shell companies. Many shell corporations have been specifically created to obfuscate both the origin and the destination of assets. Shell corporations are one of the biggest tools sanctioned entities and individuals use to move funds in the international marketplace. In addition, zombie entities (entities that have been dormant for years that are suddenly activated) may also be used to move assets. Every financial institution has the ability to detect this type of activity through fairly typical customer due diligence and transaction monitoring systems and controls. Upon detecting such activity, financial institutions should reach out to their customers to understand the purpose, explore if the customer’s organizational structure has changed, and examine if there is a change in the customer’s asset flows or if the customer’s company has transactional activity that scaled up quickly. Finally, organizations should incorporate the Panama Papers, Paradise Papers, and Russian Laundromat databases into their due diligence research.

Key Implications and Risk Management Best Practices: Sanctions

• Jurisdictional authorities, financial institutions, and corporations should accelerate the development, implementation, and integration of sanctions regimes into broader counter-illicit financing frameworks.
• Civil society/NPOs, financial institutions, and jurisdictional authorities should collaborate to clarify, expand, and operationalize information-sharing capabilities to identify and pursue sanctioned parties and their support networks and assets.
• Financial institutions should collaborate with strategically important and higher risk clients and sectors to build shared sanctions risk management expertise and controls and to create an expanded sanctions compliance network.
• Jurisdictions and corporations should accelerate efforts to understand and minimize exposure to sanctioned countries and parties as countermeasures continue to grow against those issuing, supporting, or implementing such sanctions.

Key Implications and Risk Management Best practices: Asset Tracing

• Understand the ownership structure of assets and monitor it for changes, such as the appointment of new shareholders or issuance of new shares (dilution of share capital).
• Improve understanding of the use of nominees, proxies, and shell companies.
• Focus on relationships with third-party enablers: incorporation agents, fiduciary agents, legal and financial advisors.

Key Implications and Risk Management Best Practices: Cryptocurrency

• Review best practices for virtual asset services providers (VASPs).
• Review current KYC practices with a focus on Russia, Ukraine, and countries that typically have facilitated Russian transactions (Cyprus, Serbia, etc.).
• Identify other types of high-risk digital currency customers.

Technology as a Driver

Although technology has enabled more complicated transactions that occur much more quickly, it has also introduced opportunity for tracking and tracing to the blockchain. People can obfuscate the name on an account transaction, but the transaction doesn’t lie, and the behavioral patterns revealed by those transactions become very important to understand. The Executive Order from President Biden directing agencies to work together to provide a well-maintained regulatory framework for oversight of digital assets is a signal that as cryptocurrency adoption becomes more mainstream, we need to oversee it and make it more transparent.

Stay Tuned

As the Russia-Ukraine situation evolves, K2 Integrity will continue providing our clients with up-to-date information in the form of sanctions news alerts, weekly summaries of key sanctions developments, policy alerts, additional webinars, and other means, including through our website and our DOLFIN platform.