Under a series of executive orders, the Department of Treasury’s Office of Foreign Asset Control is authorized to sanction companies or executives that do business in Russian-occupied Ukrainian territory, including Crimea. The geography is narrow; the potential naughty list is wide. It includes:
- Anyone who may have worked in Russian “financial services”
- Two of Russia’s largest banks, the VEB and the PSB
- The Swiss company building the Nord Stream gas pipeline from Russia to Germany, including its CEO, Matthias Warnig
- Anyone in the secondaries markets for Russian sovereign debt (under last year’s executive orders, Americans were already banned from playing directly in Russia’s debt market. The new sanctions expand the ban.)
Some private funds and their portfolio companies are already paying their reputational pounds of flesh. Mainstream media reports this week “exposed” companies with ties to LetterOne, a private equity adviser founded by Putin allies Mikhail Fridman and Petr Aven. Both men are on the sanctions list.
This is merely the beginning. In his first State of the Union speech as president, on March 1, Biden said more and harsher measures are in the offing. The Department of Justice is putting together a task force to prosecute Putin cronies. “We are joining with our European allies to find and seize your yachts, your luxury apartments, your private jets,” the president said. “We are coming for your ill-begotten gains.”
The American response so far has been muted compared with Europe’s. Even Switzerland – long noted for its stubborn exceptionalism – has closed its shops to the oligarchs.
The investment industry seems to have got the memo. Deutsche Bank – which has been fined multiple times for alleged illicit transactions related to Russian clients and money – says its actively managed mutual funds will no longer do new business in Russia. Firms such as Pictet Asset Management, Abrdn and Amundi SA are pulling up stakes, too.
Strict liability, stiff penalties
That’s probably the wisest course of action. Whatever other opportunities for regulatory arbitrage exist in the investment industry, sanctions aren’t it.
Under federal law, any American – or anyone “subject to U.S. jurisdiction” – can be fined or even imprisoned for doing business with anyone on the sanctions list. Regulators define “doing business” broadly: the rules forbid giving to or receiving gifts from a sanctioned party, for instance.
All transactions, even those executed by foreign institutions, cleared in US dollars also fall under US jurisdiction. In 2014, French bank BNP Paribas agreed to pay US regulators a record $8.9 billion for charges that it cleared dollar transactions for entities in sanctioned countries, including Iran, Cuba and Sudan. The bank also pleaded guilty and was banned from clearing dollar transactions for a year from 2015. Multiple other foreign financial institutions have since been fined for alleged US sanction violations.
The penalties for individual violators can also be stiff: up to $20 million in fines or 30 years in prison, depending on the facts of the case. Perhaps worse, unlike other areas of regulatory law, sanctions violations are subject to “strict liability.” You can be punished for violating the law whether you meant to break it or not.
That in and of itself ought to send fund advisers scampering to the OFAC’s sanctions list to make sure they’re in compliance right now, experts say. They also should prepare for even harsher sanctions to come.
“US and non-US companies with business in or exposure to Russia and Ukraine would be well advised to closely monitor the situation on the ground, as there is a potential for a rapid increase in sanctions,” lawyers at Paul Weiss said in a client bulletin.
In Paul Weiss’s brief, advisers should consider taking the following actions:
- “Review and update their sanctions screening and IP or geolocation blocking procedures” so that they are not inadvertently doing business in Russian-occupied Ukraine.
- Adding place names “(cities, regions, ports and common alternative spellings of the same) as well as postal codes” of the occupied regions to their firm’s sanctions filters.
- Brush up on the OFAC’s 2015 advisory letter issued when the Obama Administration sanctioned Putin and his friends to punish them for invading Crimea. That letter warned firms to look out for ways that companies or people could try to evade sanctions – by changing “Crimea” to “Russia” in address boxes, for instance. Expect a similar set of evasions under the new sanctions, Paul Weiss says.
Best practice: AML program
Ross Delston is an independent compliance consultant and expert witness based in St Louis. He says that firms should also consider adopting their own written OFAC policies. Compliance with sanctions is subject to strict liability, but a robust program can be a mitigating factor if the feds ever decide to come after you, he says.
Better still, Delston says, is an OFAC program that’s part of a robust anti-money laundering program. Fund advisers, notoriously, aren’t subject to most American anti-money laundering regulations. Sanctions or no, it’s still a best practice, Delston says.
“Even though there’s no AML penalty, having an effective AML program can be a great way to screen out bad actors,” he tells PFCFO. “You should recognize that when you’re dealing with high-net-worth individuals in a kleptocracy, and especially if they’re politically exposed – a friend of the prime minister, say – you’re at the highest level of risk.”
An anti-money laundering program might also help reduce friction between fund advisers and the broker-dealers who sell their securities, Delston says.
FINRA rule 3310 requires B-Ds to build, develop and maintain anti-money laundering systems. A 2020 no action letter from the SEC, however, allows B-Ds to rely on an investment adviser’s customer identification program so long as:
- The reliance is “reasonable under the circumstances”
- The IA is registered with the Commission
- The IA signs a contract promising to live up to FinCEN’s five AML “pillars”
The five pillars are:
- Written policies, procedures and controls based on a written risk assessment
- “Periodic” independent compliance tests
- Naming an AML officer at the firm
- Staff training
- Ongoing customer due diligence
Long time coming
In Delston’s experience, fund advisers that try AML programs often miss the second pillar, the periodic review. FINRA’s guidance for B-Ds, unlike the banking regulators, requires an annual review, but Delston says he recommends a yearly review for all firms, “because AML is always evolving.”
Most money laundering experts expect that, eventually, fund advisers are going to be brought under FinCEN’s Bank Secrecy Act rules. Delston is not one of those experts.
“FinCEN has tried at least twice in the last 15, 20 years,” he says. “We thought the regulations were imminent, then they were withdrawn and a new proposal was put out in 2015. Then those were withdrawn. I’ve predicted that this rule is inevitable for so long that I’ve come to the reluctant conclusion that it’s not inevitable.”
That doesn’t mean fund advisers can afford to wait, Delston adds. An AML program may well pay for itself.
“It’s something that should be considered in order to mitigate the reputation risk that exists when they take on the wrong client,” he says. As the latest sanctions illustrate, he adds, firms “should have a program just as a mitigant against doing sanctions screening wrong and getting caught.”
Bill Myers covers private fund policy from Washington, DC