by Christine Duhaime, B.A, J.D., Certified Financial Crime and Anti-Money Laundering Law Specialist
The news today that the Russian and Ukrainian governments have readied troops along their respective borders following the recent regime change in the Ukraine increases the risks of financial crime in the Ukraine, particularly in respect of: (a) removal of assets; (b) sanctions violations; and (c) money laundering involving politically exposed persons and high net worth persons.
Late last week, the Swiss announced investigations into funds allegedly held in their banks by former President Viktor Yanukovych (Ві́ктор Фе́дорович Януко́вич) and his son Oleksandr Yanukovych, and have frozen those assets while they determine if any of the assets are proceeds of crime derived from corruption, misappropriated state assets, or derived from other predicate offenses pursuant to anti-money laundering laws.
Viktor Yanukovych came from an impoverished family and held several low-level government administrative positions for decades, earning no more than $2,000 per month before entering politics in 2009. From 2009 to 2014 (a mere 5 years), by conservative estimates he reportedly amassed a personal fortune of $12 billion.
Reported $70 Billion Moved Offshore
On Thursday, interim government authorities in the Ukraine estimated that the Yanukovych government had exported approximately $70 billion to offshore bank accounts from 2011-2014.
Yanukovych’s son, Oleksandr, is a former dentist and is reported to have become one of the richest men in the Ukraine during the time his father was President, with a reported personal fortune of $500 million.
Regulators will be exceedingly interested (and motivated) in determining how $70 billion allegedly left the Ukraine in less than three years in the hands of politically exposed persons when anti-money laundering laws should have prevented that from happening at numerous points along the financial transactional transfer chain as a result of monitoring and reporting required in Europe and Asia by, inter alia, law firms, correspondent banks, private equity funds and asset managers, brokers, trust advisors, notaries and money services businesses in the Ukraine, intermediary countries and destination countries.
From a Salary of $2,000 per Month to $200 Million per Month
If the estimates in respect of the sums removed from the Ukraine are accurate, it is too large to be ignored.
If accurate, it demonstrates both that international anti-money laundering controls in place may be having little preventative effect, and that there were huge compliance failures on the Yanukovych file that may result in massive fines for numerous firms. For politically exposed persons, this is exactly the type of situation anti-money laundering and anti-corruption laws were designed to immediately detect and prevent.
Assuming the estimates are accurate, a compliance officer dealing with a high profile politically exposed person such as Yanukovych would have had to reconcile the change in his income from $2,000 per month to $200 million per month, document the source of funds and investigations undertaken in 2009 in respect thereof, and that the financial institution was satisfied as to the legitimacy of the funds and approved continuing to maintain an account.
Although Canada is a money laundering haven, it is doubtful that Yanukovych-controlled funds landed there. Canada is one of the only jurisdictions remaining in the world where the triple combination of lawyer-client professional secrecy rules, corporate beneficial ownership secrecy, and an exemption for lawyers from anti-money laundering reporting requirements, make it impossible to determine if proceeds of crime ended up in Canada or for law enforcement agencies to do much about it if they do. Russians tend to use the Canadian legal and financial system reportedly for that purpose but Ukrainians park funds in other countries.
Politically Exposes Persons
At the moment, the biggest risk regarding the Ukraine for financial institutions is that other politically exposed persons (“PEP“), or military and other government officials in the Ukraine will also export proceeds of crime and in the process, launder funds. There is also the risk that the receipt of funds or property will be prohibited by international economic sanctions.
PEP definitions vary from country to country but generally, a PEP is a head of state, a head of government, member of the Parliament, deputy minister, ambassador and attaché, high-ranking military officer, president of government agency, judge, leader of political party in Parliament and the spouses, children, parents, in-laws and siblings of any of those persons.
The Financial Action Task Force (the “FATF“) in its Recommendations 2012 now has three types of PEPs – a foreign PEP, a domestic PEP and a person who is a senior member of an international organization. The only distinction between foreign and domestic PEPs is that foreign PEPs are foreign to your country. With respect to international organizations, while the organization does not need to be prominent, the function held by the senior person must be a prominent function for the person to qualify as a PEP. The organization is not, by definition, a state-controlled or owned agency (since those are subsumed in the definitions of a PEP (domestic and foreign)). The chart below sets out the FATF Guidance on PEPs (click on it twice for a large version).
FATF Politically Exposed Persons PEPs by Christine Duhaime
There is an obvious artificiality with maintaining a distinction between a foreign and domestic PEP because a person can be a foreign PEP everywhere in the world except in their own country. For example, that is true of Xi Jinping, China’s President and General Secretary of the Community Party, who is a PEP everywhere except in China. Eventually, the distinction will be eliminated by the FATF. It was maintained for political reasons in the last round of amendments to the Recommendations. In order to address this, however, the FATF Guidance says that if a person is a foreign PEP, that de facto makes them a domestic PEP in their own country. Logically, this makes sense for crime prevention purposes because in order to export proceeds of crime, the PEP must first use their own domestic financial system and thus, more importance should be placed on domestic, and not foreign, PEPs.
There are many places that financial institutions trip over in PEP compliance.
Financial institutions and reporting entities often believe the PEP rules just flow from national proceeds of crime legislation but they are often included in several laws, including anti-corruption, sanctions, anti-terrorism and other relevant criminal laws and treaties implemented at the national level that must be read together to comprehend how to monitor and address PEPs.
The difficult part of the PEP regime is, of course, initial identification, particularly with beneficial ownership. Make sure you understand what beneficial ownership actually is and how to decipher things like corporate records from different jurisdictions, share pledge agreements, settlement instruments and registers of shareholders and directors. Clever lawyers use many layers of beneficial ownership deliberately to frustrate the task. Your compliance person needs to be aware of that and be smarter than the lawyer who structured transactions to obfuscate beneficial ownership.
The financially painful part of the PEP regime is that it may cost you a VIP client, or many, if your compliance people are not sophisticated, well-liked or can be trusted by your PEP. It is possible to fulfill the compliance function competently and ethically yet still be someone the PEP will want to share personal information with. If you are dealing with a PEP from China, they will determine whether they trust your compliance person in two minutes or less. In Vietnam, it will take several meetings to establish trust.
The awkward part of the PEP regime is asking the invasive questions of a PEP over source of funds, and close associates. The new FATF Guidance requires ascertaining from a PEP, the identity of his girlfriend or mistress. They too are PEPs under the FATF Guidance and often export funds for PEPs to other countries undetected. In Asian countries, this is not unusual.
Male PEPs often have credit or charge cards issued not only to their spouse but also to their girlfriends and they often buy financial products for them. Thus, financial institutions may already have this information in their records in any event. The reason charge cards are preferred is twofold: it allows for the transfer of wealth which is not easily detectable by tax authorities; and facilitates the export of wealth from one jurisdiction to another.
According the FATF, the risk factors for PEPs include a person who:
- Is involved in public procurement (as a government official or as company that obtains procurement contracts as part of their business, such as P3 (public-private partnerships).
- Is in energy (oil, gas, wind energy, hydro) construction, mining, defense, sports or gambling/gaming sectors.
- Has ties to a Minister of Finance to exert pressure on implementation or enforcement of anti-money laundering laws, ether personally or through economic councils or other bodies.
- Is involved in large infrastructure projects.
- Is involved in finance, particularly to government agencies or for government projects.
Many financial institutions have determined that it is too costly, as a matter of compliance, to monitor for PEPs simply because monitoring is both labour and resource intensive. Some banks are closing PEP accounts or refusing to open them. Although PEPs are higher risk, they are not necessarily criminal and the reality is that the benefit of having PEP clients far outweighs the marginal increase in compliance if the PEP program is well-structured and implemented. If your institution is large enough, you should have a person who is a full-time PEP global expert or who knows PEP law in a few jurisdictions, whose job is to: (a) make the call on whether a person is a PEP; (b) extract the necessary information from the PEP, including beneficial information; and (c) monitor their transactions for compliance.
As the Ukrainian crisis continues, financial institutions should take all reasonable steps to ensure that they do not knowingly or unwittingly assist in hiding or moving proceeds of crime for PEPs, their families and their close associates. And if for some reason, a high profile PEP slipped through the system and is a client, financial institutions should be conversing with the account managers now to document the compliance process undertaken at that time for the file.
Several counties, including Canada, have threatened but not yet implemented, economic sanctions in respect of the Ukraine. When implemented, in Canada it will be pursuant to the Special Economic Measures Act. Economic sanctions generally require every person and entity (firms, funds, corporations, charities, joint ventures, etc.) within the implementing country to freeze the assets that belong to designated Ukrainian officials; to refuse to deal with property held by a designated Ukraine person; enter into or facilitate a transaction of a designated Ukrainian person; provide financial services or other services to a designated Ukrainian person, or for their benefit; or provide goods to a designated Ukrainian person.
Like PEPs, the difficult aspect of economic sanctions compliance for financial institutions and others to whom it applies is determining beneficial ownership and identifying assets and property or transactions that may belong to, or benefit a designated person that are in the possession or control of a US person. Determining who a US person is under OFAC sanctions is not straightforward especially when dealing with partnerships and associations. For example, a Canadian private equity fund with a US partner formed pursuant to a JV, makes the Canadian private equity fund a US person and it must comply with OFAC sanctions which are much tougher and have greater exposure than Canadian sanctions. But they don’t which exposes the US fund to non-compliance issues.
Sanctions of the type contemplated for the Ukraine will apply to banks, credit unions, insurance companies, fund and asset managers, securities brokers and money services businesses (as defined by the Proceeds of Crime (Money Laundering) and Terrorist Financing Act), and although the fines for non-compliance are low in Canada, the prison terms for directors and officers failing to comply with sanctions are not short.
Enter Bitcoin, the most popular global digital currency. There is nothing to prohibit the transmitting of funds via Bitcoin to and from the Ukraine at the moment while sanctions are pending and while there is an absence of financial regulations in respect of Bitcoin but that depends also on the local Bitcoin legal regime. In Québec, the provincial securities legislation, derivatives legislation and money services business legislation purportedly apply to Bitcoin, and in the US, Bitcoin is subject to FinCEN’s Guidance on MSBs.
As soon as Ukrainian economic sanctions are implemented, irrespective of Bitcoin regulations or the absence thereof, every Bitcoin entity will have to comply with national sanctions laws for Ukrainian transactions. Bitcoin people unfailingly believe that since pure Bitcoin transactions are P2P (namely, when you artificially extract the cash-in and cash-out transactions to buy and sell Bitcoin (e.g., depart from the regulated financial system to buy and re-enter to sell)), Bitcoin is not subject to economic sanctions. Nothing could be further from the truth. Although I appear to be an unpopular minority of one to hold this position, there is nothing in sanctions law in Canada, US or the EU that suggests that Bitcoin is exempt.
When Ukrainian economic sanctions are implemented, every Canadian and Canadian company in Canada (for Canadian sanctions), or in the US when US economic sanctions are in place, every American entity and person (and their joint venturers, affiliates, entities with whom they have invested or provided venture funds or otherwise financed, etc.) will be prohibited from providing financial (e.g., Bitcoin) or other services to designated Ukrainians or to the Ukraine (depending upon how severe the sanctions will be), and if they receive any Bitcoin from or going to a designated Ukrainian (or from the Ukraine), will have to freeze it immediately and inform the relevant enforcement agency responsible for sanctions.
Think About Asset Recovery
In order to protect financial institutions, their compliance officials should monitor Ukrainian financial transactions (in or out) closely for proceeds of crime, PEPs and the removal of state assets. Unwittingly facilitating the illegal removal of state assets by deposed political leaders is bad for the reputation of every organization and it exposes organizations to costly and protracted litigation, enforcement or forfeiture claims over state asset recovery, not to mention regulatory action over anti-money laundering compliance failures.